WeeValue (51.33)

Rummaging Around the Trash Bin – Part 2

May 20, 2008 – Comments (0) | RELATED TICKERS: NLS

A little closer to the top

 

OK, so our first exercise in taking out the trash didn’t reveal the most fruitful results.  That’s not unusual, in fact, it is the norm.  In order to get anything that I am comfortable plopping my hard earned money down on, I have to wade through a lot of trash bins!  For your blogging pleasure this time, I have Nautilus.  A little history:

 

In its current incarnation, Nautilus started life as a company called Direct Focus, Inc.  Direct Focuses’ primary product was the Bowflex home gym.  In 1999, Direct purchased Nautilus.  At one time, Nautilus was THE standard in multi-station gyms.  They practically invented the concept.  Direct Focus also changed its name to Nautilus at that time.

 

Over the years, they have acquired Schwinn Fitness, Universal and StairMaster.  They also acquired Perl Izumi – an apparel brand.  Now, I’m not sure I’d call this di-worsification – they picked up some nice fitness brand names – but I can’t see a lot of synergies with apparel group and the equipment group

 

As they acquired more businesses, they (apparently) lost focus.  Rapid growth ensued from 1999 through 2002 and profitability increased.  Since 2002, profitability eroded.  Nautilus has never been a stellar company from an operating perspective, with the exception of several boom, boom years from 99-2001.  Remember, they started life as a direct marketing company (think infomercials).

 

More recently, they have become unprofitable.  In the recent past, the ROE has decreased from 15% in 2003, to the 9-10% range in 2004-2006, culminating in losses in 2007…

 

The stock price has followed right along, dropping from $27 in 2005, to around $6 today.

 

So what’s to like, really?  Well just recently, things have gotten really interesting at the Nautilus headquarters.  An activist hedge fund called Sherborne Investors has recently accumulated about 25% of the shares outstanding.  After very little dickering, they outsted the CEO and installed Edward Bramson, the head of Sherborne, as the top dog.  To the credit of Nautilus, the Perl Izumi division was already up for sale, but it was finalized under Bramson. 

 

A couple of other good points:

 

Bramson cancelled a deal to buy Land America, their key Chinese manufacturing vendor.  They locked into a production contract until 2010.They have very little debt.The sale or the apparel division should generate significant cash for them to gain time to right the ship.The structure was simplified in order to give each division the proper focus going forwardAlthough I wouldn’t call it a moat, they do have some of the more recognized brand names in the fitness industryThey have positive cash from operations both last quarter and last year. 

One concern:

 

Bramson will be a key player in the future.  I have not found out a lot of information on him, but it does not appear that he has a huge amount of retail experience.  On the other hand, he seems to have a habit of only running each company he gets involved in for a short time until operations are stabilized, then installs new management. 

Valuation:

 

Like JBSS, Nautilus is a little difficult to value, since it is not current profitable.  However, based on competitors in the industry, operating margins probably run from 3% to 6%.  Assuming revenues of $500m for the remaining equipment business, that gives us income of $15m to $30m or $.50 to $1 per share.  Using a conservative 15X multiple, we can see a price of $7.50 to $15 per share.  Alternatively, NLS has been cash flow positive both last quarter and last year.  They could conceivably earn $1 per share in FCF once operations stabilize.  This would give them a $10-$15/share price with a conservative DCF growth of 5%.

 

So what’s the verdict:  For me, this is a buy (in fact I bought some already).  No, its not the greatest, wide moat (or medium moat) company in the world, but I think the odds are in Nautilus’ favor.  Consider:

  Its very unlikely they will go bankrupt.  With little dept, the cash from the Izumi sale and positive cash from operations, business would have to significantly deteriorate for them to go under.Profitability may be just around the corner.  Considering they generate positive cash from operations, the negative earnings are largely one time items related to the sale of apparel, firing the CEO and canceling the Land America deal. 

Similar to JBSS, I think the potential upside from the $6/share price is 100-150%.  Unlike JBSS, I give much different odds. I think that the odds of catastrophe are more like 10%; maybe 30% odds that they don’t get substantially better and 60% odds for a double.  I like this situation much better.

 

Also, when considering a company like this, I like to keep in mind that a specific valuation target is important.  Given that they are average businesses, they are not likely to be long term winner, but getting back to fair value should provide good returns.  Unless something dramatically changes in the business, this is not a buy and hold investment.  It’s a buy, wait, hit or miss target and get out.

 

Another nice thing is that the outcome of this investment is going to have very little correlation to the over all market.  Nautilus will succeed or fail based on management’s ability to successfully right the ship – its not going to be related to interest rates, their ability to borrow or develop packaged securities.

 

Feel free to let me know if you agree, disagree or don’t care!