Description

The stock trades at or near the liquidation value of the company’s brands. There is substantial positive change in management and their business which should provide a tail wind for financial improvement and stock appreciation. I believe there is more than a 4/1 risk/reward ratio at current prices.

It has been left for dead by the investment community after a number of years of mismanagement and restructuring. The new leadership is transformative culturally and financially.

The business is under new management as of June 2011. According to employees and suppliers, things are definitely better than they have been in nine years on a number of different levels. I’ve known the company for eight years and concur.

Company Background and History

Nautilus Inc. is a fitness products company that sells equipment through direct and retail channels. The company’s products include home gyms under the Bowflex brand as well as exercise bikes, ellipticals and Treadclimbers under the Schwinn and Nautilus brands. After huge success with the Bowflex brand in the early-mid 2000’s, the company attempted to grow revenue by any means possible and expressed little interest in growing the bottom line proportionately. In preparation for a surge in topline growth, the company moved to a much larger facility, purchased an apparel brand and agreed to purchase their contract manufacturer. As margins began to turn south, the stock came under intense pressure and the largest shareholder eventually won a proxy fight for control of the company in late 2007. The new management that was put in place made smart financial decisions, but took over right in the face of the Great Recession.

Opportunity

Until earlier this year, the controlling interest in the company (around 33%) was held in a single purpose activist fund. In the second quarter, the managers decided to close the fund and the shares were distributed to the partners, creating a surplus of stock for sale. The shares were immediately pressured from the low $3’s to below $2 after the distribution and the Year end may see some good tax loss selling as the basis is probably around $8 for most of the LP’s. This severely discounted price represents a real buying opportunity considering that the business has realistic growth catalysts highlighted below.

Valuation:

The current market cap is $50mm and the company has $11mm of cash with $6mm of debt, resulting in a $45mm enterprise value. Under conservative assumptions, their sales should get back to $200mm and 8% EBITDA margins by 2013. The company should add another $15mm in cash to the balance sheet during 2012 and 2013. Assuming an EV/EBITDA multiple of 6x at the end of 2013, I arrive at a $3.77 valuation which represents a 48% IRR over two years. The company also has a $70mm NOL which should shelter income for the next few years. Combined with a low interest expense, this performance translates to an owner’s free cash flow yield of 35% by 2013. Again, these assumptions are conservative and I have not modeled the new CoreBody Reformer product to be a hit with consumers. I consider that a free call option at these prices.

Reinvestment Opportunities:

Both the direct and retail product development model should not be capital intensive. They should be able to grow through new product innovation (to be seen with CoreBody, New Treadclimber). The current business model should be able to pay nice dividends while investing in innovation and regular maintenance R&D. Management is seeing numerous opportunities from innovators in the health space each year and they are hiring a VP of product development to better evaluate and develop those partnerships.

Governance and alignment:

Board and management compensation are reasonable. The new management’s options are struck above the $3 level. The CEO, CFO and newly appointed COO (who has been there five years) have been buyers of the stock above current levels. Although the purchases are not for a large dollar amount, they are significant to the current management team. The CEO moved from Indiana to take the job and his references are positive.

Catalyst