Why I'm Buying Circuit City Calls
Circuit City (CC) is a company wrought with cancer. To one side lay death and bankruptcy and the other a prosperous and heroic return to life and profitability.
The issue shareholders are currently facing is that the man who will probably determine which way CC falls is the same man who brought them to this point: current Chairman and CEO Philip Schoonover. I quote from the most recent 10Q: "We underestimated the financial impact from the disruption of our transformation work." Mr. Schoonover is describing the negative financial impact caused by his decision to remodel stores during the holiday season. How intelligent would one need to be to understand that holiday shoppers want things clean, fresh, and decorated? They don't want construction going on while they shop – it ruins the mood and is an especially dangerous business maneuver when everyone knows Best Buy (BBY) is always a pleasant place for holiday gift-finding. Why would one who holds such a responsibility to the shareholders of the company he operates make this type of decision?
I don't know either, but I'll give the fellow the benefit of the doubt and say it was a one-time (albeit huge) mistake.
On to the important part. Here is why I'm planning on picking up some Call Options on Circuit City within the next week. As of Circuit City's most recent quarterly filing, some positive statistics are as follows:
· 170 million common shares outstanding with a float of 165 million
· $483 million in cash & cash equivalents
o That's $2.84 cash per common share
· $4.30 common stock price
o Circuit City has cash equivalent to 66% of its current common stock price
· Price/Book = 0.48
· Total Debt/Common Equity = 5.62 %
· Price/Sales = 0.06
· Total Long Term Debt = $60.8 million
The Bank of America (BAC) and Circuit City are expected to close on a $1.3 billion asset-backed credit facility deal at the end of January. In addition, management has begun reaping cost savings awards on their implementation of structural changes. For the nine months ending November, 2007 Circuit City saw an SG&A expense savings of ~$181 million. This number is expected to rise to ~$200 million per annum in FY 2009.
One thing to keep in mind is that bankruptcy is not out of the question for Circuit City. However due to the aforementioned statistics and more importantly the level of cash it currently has, I expect Circuit City will be acquired or brought private before bankruptcy takes hold. An argument could be made that possible suitors will wait until they go bankrupt and try to pick up pieces on the cheap. The issues with that argument is that it assumes there's only one suitor waiting and willing. When (and if) this credit facility goes through, expect an entity to rush in and capitalize on the value Circuit City currently presents.
Disclosure: David Schrader expects to purchase CC Call options sometime in January, 2008.
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This article has 16 comments:
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David Schrader
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27 Comments
Jan 09 09:32 AM-
Long-Short Guy
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249 Comments
Jan 09 09:38 AMThe problem with CC is that it's been a crummy business for so long, it's hard to turn around, and it could burn a lot of cash if it loses money. That makes me wonder whether it's a value trap. People have been writing about it for a while:
www.seekingalpha.com/a...
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Lisa
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291 Comments
Jan 09 09:40 AMWhy calls and not the stock itself? I'd be interested to see your analysis of the options versus the stock.
Also, give the time it takes for these value plays to work out, I'm not sure you want to be paying for time with an option.
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billb
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65 Comments
My Website
Jan 09 09:44 AM-
David Schrader
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27 Comments
Jan 09 09:49 AMI couldn't agree with you more. For my money, that's where the risk/reward comes in. I've found that by investing in Calls for this type of speculative play one is able to make a solid return if they're right and lose a minor amount (relative to an equity stake) if they're wrong.
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David Schrader
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27 Comments
Jan 09 10:21 AM1- I have zero faith in the company's current management. The company is poorly run, their stores are dirty, their customer service is miserable, and their employees tell you to spend your money at Best Buy (BBY) (haha true story). Even with all of this their sales have not plummeted (though they are falling). In my opinion the company would become profitable in the hands of different management. If you look at the current holders (as of the last filing date on Bloomberg) you'll see some smart money in the top ten with significant positions. I'm of the belief that something is going to change soon (CC gets taken private or acquired).
2-Calls provide me with an outlet to leverage my idea. If I were to hold the equity I would need to invest over 10x the capital to control the same amount of shares. YES, I understand that options expire worthless and equities retain some value. However, in my estimation this company is headed to one of two places: bankruptcy or corporate action. I don't foresee a middle ground. If CC does go bankrupt the equity loss will be so large (and immediate) that the value derived from holding the equity versus the option will be minor. If CC sees some corporate action, the option may produce a ROI of >2x+ that of the equity holding.
In terms of time frame BillB, you have a solid point. 5 1/2 months is not much time. Perhaps I'll extend the Calls to JAN 09. Within the next 12 months I expect something significant will occur.
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Amit Chokshi
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88 Comments
My Website
Jan 09 10:42 AMA lot of CC "smart money" has been there since the teens, I wouldn't place much faith in that. Check out ROHI if you want an example of smart money that is getting fried as well.
Also, why would this be a buyout candidate. LBO firms are choking on a bunch of crappy retail LBOs like Linen's N Things, Claires, etc. Why go down that road again with a struggling retailer?
Secondly, they can't do a buyout, CC has no cash flow to lend against. The $480MM or so cash will be burned through which is why CC has set up the ABL facility.
The book value is worthless too, for CC you need to do a liquidation analysis. !00% assessment for cash, but A/R would be taken down to 70%, inventory probably 50%, PPE would be down to 50% and other assets around 50%. The rest would basically be zeros as far as tangible value so CC really just has $2.7B in tangible assets $2.9B in liabilities. Not to mention the lease breakage costs too.
Still, it's probably oversold and some calls might work out well but management is clueless and htere's little evidence that anyone wants to put in effort to bring anyone in to replace them. It's prob a tough job to take on too, competing with BBY, WMT, SHLD, COST, and TGT basically.
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SmartGuyStocks.com
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66 Comments
Jan 09 10:52 AMI think it's cool of you to go out on a limb and write the article, but I think you need to be clearer that this is Vegas-style investing. This company has horrible management, the commission style employee pay doesn't work, BBY is CRUSHING this company, we are entering the worst time of year for retailers (no matter the strength of an economy), and the credit markets are horrible for a buyout.
The title of this article should be: Taking a Complete Gamble and Praying for a Buyout.
I only mention this for those who may be less aware how speculative this is ...
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David Schrader
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27 Comments
Jan 09 10:57 AMI appreciate the comment. You're 100% right. Thank you for clarifying for folks who may not have gathered the risk level (mainly since I failed to mention it). Sometimes I forget people trade based off of other's info and not their own research. In terms of praying, I doubt God participates in the financial markets. From what I gather, our money is no good up there haha. Patriots all the way baby!
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User 137777
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1 Comment
Jan 09 11:30 AM-
Long-Short Guy
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249 Comments
Jan 09 11:41 AM-
Long-Short Guy
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249 Comments
Jan 09 11:42 AM-
billb
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65 Comments
My Website
Jan 09 11:49 AM-
David Schrader
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27 Comments
Jan 09 12:39 PMI've noticed something interesting on this site. If someone has something negative to say but doesn't have any evidence to support it, they remain anonymous. Yet all the others who have pointed out actual flaws and not attempted a shameless and baseless personal attack attached their site ID. Intriguing, no?
I haven't even picked up the Calls yet, and didn't plan to until after publication. You may be correct on the operating leases, and if so, point well taken. However next time you should leave personal attacks on a stranger out of your argument as it detracts from your credibility.
It would seem as if the consensus is that the risk outweighs the potential reward. I thank everyone who has published comments up to this point and any after. I've noted your points and will ensure to provide a more thorough evaluation in my next article. I do hope you all will read and critique the next one as well.
Dave
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jonreagan
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68 Comments
Jan 10 11:17 AMHaving said that, I feel that this is a bad stock in a bad neighborhood. I won't even touch the good stocks (e.g., JWN, AEO...) in this bad neighborhood! Specifically, I take issue with your comment that the re-model screw up was a one-time mistake. An even bigger one was the decision to lay off 3400 sales associates at the beginning of the year, replacing them with lower wage newbies. That tells me that these guys don't have a clue on how to win in the retail business. Nordstrom taught all of us that a customer-driven culture is the only way to win this sector, particularly when it comes to something specialized like electronics.
So two mistakes of this magnitude--which amount to self-inflicted wounds--tell me to stay away from CC. They just don't have a clue. Best, JR.
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meta99
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4 Comments
Sep 17 10:07 PM