Description

ONEIDA LTD. (OCQ) – SHORT THESIS

I am recommending OCQ as a terminal short. Poor management, declining sales, numerous acquisitions and a decaying brand have resulted in a company that is overvalued, overleveraged and overextended. Given its history, it is a relatively little risk in shorting the stock as there are scant possible upside surprises. Ultimately, I believe the stock is a zero, but in the near term - I believe the stock gets cut in half to $3 -- or TTM ~3x EV/EBITDA and 15 P/E multiple.

Business Description
Incorporated in 1880, Oneida is the world's largest maker of stainless steel silverware. Since its inception, the Company has manufactured and marketed tableware - initially silverplated and, later, sterling and stainless steel products. By acquiring subsidiaries, entering into strategic distributorship arrangements and expanding its own tableware lines, the Company has diversified into the manufacture and distribution of commercial and retail china dinnerware and the distribution of other tableware, kitchenware and gift items, most notably crystal and glass stemware, barware and giftware.

The Company's principal industry segments are grouped around the manufacture and distribution of three major product categories: metalware (65% - '02 revs), dinnerware (27%) and glassware (7%). The Company also distributes a variety of other tabletop accessories, kitchen utensils and giftware (1%).

The principal source of the Company's flatware is the Company's Sherrill, New York manufacturing facility. In addition, the Company also utilizes the facilities of Oneida Mexicana, S.A., its wholly owned subsidiary located in Toluca, Mexico, to manufacture flatware patterns that are not produced in Sherrill, New York. The Company also imports flatware and cutlery from several international sources.

OCQ serves three primary markets - consumer (37% of sales), foodservice/institutional (45%) and international (18%). The consumer market is centered on individual consumer through retail and direct operations. OCQ's retail accounts include national and regional department store chains, mass merchandise and discount chains, specialty shops and local establishments.

OCQ's foodservice and institutional accounts include restaurants, hotels, resorts, convention centers, food distributors, airlines, cruise lines, hospitals and educational institutions.

In August 2000, OCQ acquired all outstanding shares of Delco International, Ltd., a leading marketer of foodservice tableware products for more than 60 years. Delco's mass-market customer base includes distributors, restaurant and hotel chains and institutional accounts, while Delco's ABCO division is the tableware source for over 50 airlines worldwide. OCQ was forced by the SEC to restate earnings for the 2000 and 2001 fiscal years and the first three quarters of fiscal 2002, with respect to accounting for costs and related tax effects associated with the Delco acquisition - a total total downward adjustment of ~$3.44 million in net income,

International activities span both the consumer and foodservice markets described above, and include the marketing and sale of the Company's domestically manufactured and internationally sourced products throughout the world.

In June 2000, the Company's English subsidiary, Oneida U.K. Limited, acquired all outstanding shares of London-based Viners of Sheffield Limited. Oneida U.K. Limited and Viners of Sheffield Limited, the leading marketer of consumer flatware and cookware in the U.K., currently serve the Company's European, African, Middle and Far Eastern and Asian and Pacific markets.

Retailing Paradigm Shift
Traditionally, Oneida customers would purchase products from traditional retailers - Kmart, JC Penney, May's, Federated and Kohl’s. However, the emergence of specialty retailers such as Bed, Bath and Beyond, Best Buy, Mervyns, etc have essentially passed Oneida by. While the brand remains strong, the availability of high-quality substitutes makes branding less important.

On the institutional side, purchases are driven by replacement, not growth. The economic landscape has cause airlines, hotels and other clients to delay the purchase of tableware and increase the average life of their existing inventories. The continued downturn in the hospitality industry does not bode well for the company.

Substitutes
Primary substitutes for Oneida products are private label tableware. Walmart, for instance, has essentially made many products commodities by By branding its own internal product lines, sourcing from Asia, and selling at lower prices, Walmart (and others like them) displaces the mid-level Oneida and forces consumers down-market. Institutions place no brand equity on flatware, with supplier choice being the driver of demand.

Competition
As you can see, competition is heated. In addition to the Walmarts and Targets of the world, OCQ faces competition from hundreds of importers specializing in foreign tableware. Typically, a set of flatware from China is ~20% cheaper - even after the costs of importing and distribution. As a result, OCQ has lost market share and shifted significant production capacity overseas. On the high end, Mikasa (ARC Int'l), Waterford Wedgewood, and Noritake have slowly displaced the Oneida brand. On the lower end Libby, the leader in glassware products, has recently made inroads into tableware.

To be fair, the economic downturn has affected everyone in the industy with very few earning returns above the cost of capital. Market share gains have come at a great cost and at the expense of Oneida.

Oneida Specific Issues
Liquidity Crunch
o Oneida acquired more than 6 companies during the last 4 years at a price tag ~$180mm, which have been financed mainly with debt. OCQ shopping spree has left the company with $243mm in debt, $3mm in cash and only $16mm revolver outstanding. OCQ is in violation of a number of debt covenant, but has secured a waiver on certain covenants through the end of the second quarter. OCQ believes it is "unlikely" it would meet more restrictive covenants by an Oct. 26 deadline and that it was trying to obtain further waivers.

o Last year, OCQ generated $41.9mm in operating Cash flow with $44.8mm coming from inventory reduction - liquidating inventory to pay down debt. Inventory is currently at $175mm and cannot be reduced much further.

Jul 03 Apr 03 Jan 03 Oct 02 Jul 02 Apr 02 Jan 02 Oct 01
Sales 106.0 104.2 130.0 124.5 111.6 115.0 126.0 128.5
Inv N/A 175.4 167.6 181.5 172.8 160.7 169.5 190.2
Debt N/A 242.5 225.4 255.0 244.1 256.3 271.6 290.9

I have a had time believing OCQ will generate operating cash flow this year or in the future, but management swears recent restructuring, layoffs and a "lean" manufacturing system will bring significant cost savings (>$20mm). For whatever reason, OCQ continues to pay a dividend (and have been for 257 straight quarters), amounting to $1.4mm annually.


Other concerns
1. Poor quality of earnings: FY02 - OCQ reported Net Income of $8.5mm. That same year, OCQ received and recorded as income, $8.6mm from stock received from Prudential -- 2002 should have shown a Net Loss.
2. Serial restructurer – the 'recurring' non-recurring charge and one-items. OCQ takes restructuring charges and inventory write-downs almost every year, utilizing reserves for a rainy day. OCQ already 'pre-announced' a $46mm charge related to plant closings! In '02, OCQ recorded $9.1mm less COGS from the reserve.

2002 BegBal Charge Deduct. EndBal
Receivables Reserves 3,072 2,797 2,394 3,475
Inventory Reserves 13,323 435 9,164 4,594
2001
Receivables Reserves 1,409 2,802 1,139 3,072
Inventory Reserves 1,172 26,021 13,870 13,323
2000
Receivables Reserves 1,520 823 934 1,409
Inventory Reserves 1,466 4,010 4,304 1,172

OCQ has recently announced another 100 job cuts at the Sherrill plant and the potential closing of certain other plants. In reality, there is only so many costs you can extract and overhead you can cut. OCQ is just about at its peak.

3. Restatements – In Nov. 2002, OCQ restated its accounting treatment for the DELCO acquisition, capitalizing $3-4mm of expenses.
4. Gross margin in FY02 reflect ~$3.7mm in LIFO liquidation gains.
5. Phantom Book Value – the $125mm in equity book value consists of $134mm of Goodwill! Who owns OCQ? Not the shareholders.
6. Under-funded Pension. OCQ's pension is underfunded by over $25mm, or ~50%. Most likely, a minimum payment trigger will cut into earnings in the future.
7. Decaying Brand with minimal investmetn - OCQ has spent very little (<$1mm)in R&D to shore up their brand and designs over the past few years. mentioned above.

Bull Case
OCQ is the largest, most recognized brand in tableware. The stock has been beaten down and is not followed by Wall Street. The downtrodden economy has affected everyone. In tableware, people are taking longer to upgrade. However, Bulls believe when the economy improves OCQ is facing a situation of pent-up demand. All the restructuring and cost-cutting might actually pay off. An alternative view is all the bad news is already in the stock...any upside surprise would be hailed as the inflection point.


Conclusion – Short OCQ to zero. A spendthrift economy combined with declining sales and increased debt burden will cause OCQ to trip even more covenants. With so little room to move, OCQ will be forced to either sell out (unlikely given it produces little cash and has so much leverage) or declare bankruptcy.

Catalyst

- Further erosion of sales and brand
- Liquidity crunch/tripping more covenants/Creditor patience runs out
- Institutional investors flee
- Further accounting issues
- Dividend gets suspended