We believe that Martha Stewart Living Omimedia (MSO) is a compelling short at current levels. To start with, we believe that Martha Stewart is best viewed as a single entity. We believe that the value of the merchandise business is dependent on the media businesses. In essence, the media businesses promote the Martha brand and it is only the existence of a brand that speaks to consumers that allows the company to sign lucrative merchandising agreements. Likewise, the corporate expense is needed to manage the entire enterprise, though we admit that some of it might be redundant if the company is sold. Our short thesis is based on the following considerations:

1)      Meredith Deal: We think the profitability of the Meredith deal is being a bit exaggerated. People seem to be assuming that Martha will realize a $10-$15 million increase in operating income quickly. The full sentence reads, “On a normalized basis, MSLO’s Operating Income is expected to improve by as much as $10-$15 million annually.” How is a normalized basis defined and how long does it take to get there? Our understanding is that this $10-$15 million is only achieved if Meredith can achieve much better results in selling advertising in the magazines or on the website and that at the current revenue run-rate, there would be almost no change in publishing EBITDA. There is certainly no guarantee that Meredith will be able to better sell advertising either on the web or in magazines linked to something that we view as a dying brand.

2)      Declining franchise: We believe that the relevance of the Martha brand has been steadily declining. As evidence, we believe investors should focus on each the media types that Martha targets. Circulation revenue from magazines has fallen from $62.6 million in 2008 to $25.5 million in 2013. Part of this decline has come from certain titles like Everyday Food and Whole Living being discontinued while others like Martha Stewart Living have seen the number of issues decreased. The broadcasting division has seen its programming move from NBC to the Hallmark Channel to PBS. In fact, Hallmark replaced Martha’s programming with reruns of Little House on the Prairie. Finally, searches on Google Trends and Alexa show that there has been a steady erosion in page views and searches for terms such as Martha Stewart or Martha Stewart Weddings.

3)      Low underlying profitability: We estimate that 2014 EBITDA (adding back restructuring expenses but not adding back stock compensation) will be $8.5 million. The company now claims that they will see an improvement of $10-15 million from the new publishing agreement with Meredith. At the midpoint, this would bring EBITDA to $21 million. To stop here would be highly misleading because we believe that the company also has been recognizing approximately $15 million of annual EBITDA from JC Penney that is likely to go away at the end of 2017. Of this $15 million, $6 million is non-cash income related to the amortization of a gain from the cancellation of JCP’s prior ownership of MSO stock. The remaining $9 million is our estimate of the profitability being earned on the approximately $11.1 million of annual contractual fees JCP owes MSO each year through the end of 2017 related to minimum sales volumes and design fees. We believe MSO is realizing outsized profitability from these fees because JCP stocks only about 250 SKUs from MSO of which more than half are window treatments and the rest are holiday-focused tchotchkes. Thus, we estimate underlying EBITDA adjusting for non-cash income and unsustainable JCP fees is really closer to $6 million even after the benefit from the new Meredith deal. It is also important to note that the minimums at JCP are not being met. The fact that the minimums are not being met, JCP is not getting access to the categories they originally thought, and that the deal was signed by an Ex-CEO makes us think this deal will not be re-signed when it expires.

4)      Retailer relationships eroding: We believe that the core retailer relationships at MSO are eroding. The relationship with Macy’s was clearly strained due to the JCP debacle and Home Depot has also been cutting the number of SKUs it carries and de-emphasizing the Martha brand. Since Home Depot does not have to make any minimum payments, they are not incentivized to push items that are not selling well. We think the struggles at both JCP and HD show that Martha has little product appeal outside of cooking, bed, and bath.

5)      CEO with questionable history: The new CEO has a questionable history due to his association with Sims, where fraud occurred and where he subsequently resigned in connection with the fraud. Furthermore, as part of the Meredith deal, MSO has handed its website and the profitability of it over to Meredith. However, on the Q2 2014 conference call, the CEO seemed to embrace the idea of the website being worth hundreds of millions.

6)      Martha Stewart’s Age: Martha Stewart is 73 years old and becoming less relevant. We do not think it is appropriate to assume any perpetuity value to her. To justify this, think how valuable Julia Child was when she was on television versus how valuable she is today.

7)      Blackstone’s Disappointing Results: Blackstone was hired by Martha Stewart in May 2011 to explore strategic partnerships. It is fair to assume that Blackstone was given an open mandate and told to simply go out and create a shareholder value any way they could. This would include new television or magazine deals, new merchandising agreements either domestically or internationally, and even selling in the company. In the end, Blackstone could only come up with a deal that would land Martha in a courtroom where it was being sued by a valued partner. We think this shows the demand to be partnered with Martha is very limited.

8)      High valuation: Based on the current stock price, MSO has an EV of approximately $200 million. We do not give any value to the NOLs because the company produces minimal taxable income and the NOLs would be lost in a sale due to section 382 of the code. Accordingly, the company trades at 33x underlying EBITDA.

In summary, we believe that Martha Stewart is an expensive stock with a declining brand and eroding retailer relationships. We believe a fair value would be 6x EBITDA, which equates to $1.71 per share, even though the company produces almost no FCF other than the design fees it is getting from JCP.