Monday, January 16, 2006

the Bear Case on Tweeter (TWTR)

I have previously mentioned Circuit City (CC) as a short opportunity around $25 but I think Tweeter (TWTR), in the $6's is a more compelling idea with a medium term (6m-2yr.) time frame in mind. Tweeter is a consumer electronics retailer that caters to the mid-high end shopper. Market cap of ~$150mm, FY05 sales of $795mm.

Before we get to the bear case, what do longs hang their hats on?

Gross Margins have increased nicely over the past 3 FY's (34.3% in '03, 38.9% in '04, 39.5% in '05). GM improvement is due in part to a greater focus on installation services and parts & accessory sales.

Q4 of FY05 saw SSS up 10%

Recent positive analyst comments -- JPM sees SSS gains up mid-upper single digits in 2006 and expenses coming under control. The analyst also notes that TWTR is cheap compared to Best Buy or CC on a price/sales basis. Finally, JPM sees the HDTV upgrade cycle as a big benefit to TWTR.

Before I start with the bear case, note that my belief is that the market in general (and specifically certain retailers) will come under pressure in 2006. I think TWTR will suffer from a gradual slowdown in the U.S. consumer.

Bear case:

GM% has been increasing nicely, but so are selling expenses and G&A. Selling expenses have moved up from 30.1% in 2003 to 34.1% in 2004 to 36.5% in 2005 and G&A has moved up from 6.0% in 2003 to 6.7% in 2004 to 6.8% in 2005. I think part of the selling expense ratio deterioration stems from the increased focus on home services/installation. Sure this provides a GM lift, but TWTR pays for it in selling expenses. On the G&A side, the deterioration here might be due to having these corportate expenses spread over fewer stores--which brings us to the next point....

Stores are closing. 176 were open at FY end 2004 and 159 were open at FY end 2005 (net 17 closed). Because of this, I don't put that much weight on the JPM comment that SSS growth should be ok next year. It sure as hell better be! You just removed 17 dumpy stores from the store base.

Weak balance sheet--TWTR had $1.3mm in cash and $39.2mm in working capital at the end of FY05. Of the co's credit facility ($90mm in revolving credit loans and $13mm in term loans), all but $15.3mm has been drawn down. Int. expense has hurt and will continue to hurt the inc. st.

Even if you don't include the restructuring charge from 2005 ($16.5mm), operating loss still widened to $30.6mm from $20.9mm the year before. OCF flow for the year was minus $26.7mm.

Couple of Red Flags:

Accounts Rec. were $17.8mm in 2004 vs. $28.2mm in 2005 (up 58%) while sales were up 4%.

Sale-Leaseback transaction -- This type of transaction involves a co. selling an asset to another party and then leasing that asset from that party. So it enables the seller to get an asset off the b/s and generate some cash up front. For TWTR to make such a move makes sense; they're hardly flush with cash. So TWTR decided to enter into a sales-leaseback transaction with its Rhode Island store with (drumroll) the Chairman of the Board of TWTR! The co. mentions in the footnotes that they had independent valuations of the property. But I still have an uneasy feeling here. Did TWTR do all they could to maximize the value they rec'd for this property?

Store closing arrangement--I think this stinks too. As mentioned earlier, TWTR closed several stores in FY05. So the co. had to get out of leases, restructure leases, etc. And who did TWTR turn to for these RE services? Gordon Brothers. And who runs Gordon Brothers? The Chairman of the Board's brother. Super. Longs can't like that.

It's difficult to come up with a price target for TWTR because all of the earning's based metrics don't apply. My guess, based on strong competition from BBY/CC/WMT and even SHLD, a weakened U.S. consumer, a faltering b/s and a bloated expense structure is the $3 range. I would not be surprised to see shares in that vicinity by the end of 2007.

{Note that I have no current position in TWTR or Best Buy or CC}


Anonymous Anonymous said...

Is the use of Gordon Brother's a conflict of interest?

9:52 PM  
Blogger BTS said...

I guess that's for each long/short to decide for themselves. It is disclosed in the 10k for all to see, though.

9:33 PM  

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