Description

The Stephan Co. is traded on the American Stock Exchange under the symbol TSC. TSC is engaged in the manufacture, sale and distribution of hair care and personal care products at both the wholesale and retail level. The company is comprised of The Stephan Co. ("Stephan") and its eight wholly owned subsidiaries, Foxy Products, Inc., Old 97 Company, Williamsport Barber and Beauty Corp., Stephan & Co., Scientific Research Products, Inc. of Delaware, Trevor Sorbie of America, Inc., Stephan Distributing, Inc. and Morris Flamingo-Stephan, Inc. The following list of websites contains information regarding some TSC subsidiaries:

· www.thestephanco.com
· www.trevorsorbie.com
· www.francesdenney.com
· www.thewilliamsportbarber.com

I believe TSC is potentially worth $7 to $9. I say potentially because egregious employment agreements and lack of independence on the board have significantly suppressed the value of this company. Currently a preliminary proxy has been filed pertaining to a management lead acquisition of the company for $3.25 per share in cash plus a subordinate note for an additional $1.25 per share payable over 42 months together with interest at 4.5 percent. If this deal closes within six months the expected return would be between 6 and 7 percent. I suspect management will have difficulty pulling it off as proposed. Even if they close the transaction I believe shareholders have potential to recoup significant additional money through litigation. Alternatively, if they cannot close the deal I believe value will be unlocked in other ways.

For example, on December 4, 2003 Richard L. Scott Investments LLC (“RLS”) filed an amended 13D that included an excellent letter to members of the board. RLS owns approximately 9 percent of TSC and has been an aggressive purchaser of stock paying as high as $4.31 per share. RLS’s letter tells pretty much the entire story so it is a must read for anyone interested in this idea.

Valuation:

Without considering outstanding stock options there are currently 4,410,577 shares outstanding (for simplicity I will ignore options in this write-up because I view their impact to be relatively insignificant compared to other issues). Hence the total price of management’s offer is approximately $20 million at $4.50 per share.

As of their September 30, 2003 10-Q filing TSC had approximately $13.5 million of excess cash on their balance sheet. Additionally, TSC owns a 33,000 square foot building in Fort Lauderdale, Florida and three buildings in Tampa, Florida – one of which is 12,500 square foot another is 30,000 square foot and the third is of an undisclosed size. I estimate the real estate to be worth $3 million or about $40 per square foot. My “rough” estimate is that management is paying $3.5 million for the actual operating business, or 1.3 times adjusted EBITDA of approximately $2.7 million prior to the effect of the employment agreements. RLS notes in their letter that they believe EBITDA to be approximately $3 million. I am adjusting that downward by charging a lease payment of 300,000 per year, 10 percent of the real estate value estimate. At the same time I am adjusting downward the $20 million total price by the $3 million RE value and the $13.5 million in excess cash.

I should also note that I come up with an extra $2.4 million of excess cash vs. RLS. RLS nets out the current and long-term debt. I only net out the long-term portion. I justify this because the adjusted current ratio would be 2.8 including the current portion of LTD. My adjustments to the current assets are to net out the cash and add the $2.8 million of other assets, which is inventory that the company claims will not be used within the year. The result is current assets of $13.8 million vs. $4.96 million of current liabilities including $2.35 million in current portion of long-term debt.

Consider that if you adjust the most recent balance sheet by changing to current assets the $5.92 million of CD’s and the $2.87 million of other assets (inventory), current assets would total $31.95 million. Total liabilities are $10.74 million. Hence the buyout price is less than TSC’s net current assets value. Then think about the real estate value and the pre-tax adjusted cash flow of approximately $2.6 million per year. Capital expenditures have averaged less than $100K per year for the past three years. In 1999 they were $304K. I estimate pre-tax adjusted cash flow by subtracting from my adjusted EBITDA of $2.7 million $.1 million of annual cap-x.

By applying a 7 to 9 multiple to pre-tax adjusted cash flow and adding the excess cash and RE value, per share values would be $7.87 to $9.05 respectively.

The big unknown with this idea is how long it will take to realize value. I am optimistic that RLS and impending transaction will prove to be the necessary catalyst. In the meantime, TSC pays a quarterly dividend of 2 cents per share for an annual yield of almost 2 percent.

Catalyst

Activist shareholder, proposed management buyout, litigation, valuation