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Monday, August 10, 2009

Bidding on BIDZ (Part One) - Core Thesis and Overview

This post is about yet another Internet/tech-related company. We will likely share some non-Internet/tech ideas in the future. If you've been reading along, we previously disclosed certain other holdings (from different sectors) at the bottom of past posts.

Bidz.com (BIDZ, $4.28)
Market Capitalization: $99.5 million (assuming diluted shares of 23.2 million)
Net Cash as of 3/31/09: $3.2 million (no debt)
Enterprise Value: $96.3 million
Net Tangible Assets as of 3/31/09: $35.1 million ($1.51 per share)
2008 Operating Income: $24.1 million (25% of EV or four times)
2008 Net Income: $14.4 million (14% of MC or seven times)
2009E Net Income: $8.1 million (8% of MC or 12 times)

In recent months, we established a position in Bidz.com (BIDZ, $4.28), which is an online retailer of jewelry that utilizes both an auction format (bidz.com) and a fixed-price format (buyz.com). Bidz is another niche franchise Internet company, a description we used in March/April for Youbet.com (UBET, $3.15), Blue Nile (NILE, $49.83), Stamps.com (STMP, $8.61), and The Knot.com (KNOT, $9.92).

Bidz happens to report 2Q09 results today 8/10/09 after market close. On Friday, the company actually moved up the reporting date from Wednesday 8/12/09, which is somewhat unusual and could be perceived as a positive sign coming on the heels of Blue Nile's report last Thursday.

Although revenue is down materially amidst the recession, management is focused intently on profitability and leveraging Bidz's variable cost model to support margins. In 1Q09, Bidz delivered an operating margin of 8.1% with earnings of $0.07 per diluted share and guided to a pretax margin of 5.3% (midpoint) with earnings of $0.03-0.05 per share for 2Q09. Consensus 2009 revenue is $129 million (down 38% Y/Y) with earnings per share of $0.29 (versus $0.57 in 2008).

Our long thesis is NOT a call on the quarter, which could look like this: revenue trends still down 40-50% Y/Y on economic weakness and meaningfully lower marketing dollars, yet margins and earnings could be better than expected, providing support to the stock. We'll see - forecasting is especially difficult at present. Instead, we're focused on the durability and strength of the business model, which we believe warrants a higher valuation.

While shares rallied from recent lows along with the market, the stock remains at the low-end of BIDZ's two-year trading range and currently trade at 12 times 2009E earnings:

We believe shares are out of favor for one obvious reason -- consumer discretionary with a customer demographic skewed toward low- to middle-income households -- plus, a handful of other reasons: (1) questions surrounding management/director relationships, (2) an SEC investigation into inventory practices, (3) an FTC probe into marketing practices, (4) a flurry of me-too, bandwagon lawsuits related to management, business model questions, and the share price decline, (5) concerns surrounding competition, and (6) a modest amount of insider selling.

In our view, all of "the hair" on top of macroeconomic concerns offers an excellent entry point into a high return on capital business with a growing global franchise. We own the company (via the stock) because of the following:
  • Jewelry retailing is a good business over time
  • Difficult-to-replicate franchise with history of profitability and extremely high returns on invested capital
  • Favorable long-term secular trends
  • Shareholder-friendly management team
  • Attractive absolute and relative valuation on current and future earnings potential
In addition, while near-term fundamentals will likely remain challenged, we see several potential positive catalysts to remove key overhangs:
  1. SEC investigation resolved
  2. FTC probe resolved
  3. Law suits fall by wayside
Although hard to gauge probability or timing for these catalysts, we think some could prove near-term events based on the company's aggressive share buyback program. We make the assumption that shareholder-oriented management isn't so foolish to be buying back the stock if there were material risk in any of the above. For what it's worth, the company assured us in June that it is working through the SEC/FTC inquiries and confident that Bidz is in the right (not surprisingly, as also relayed on quarterly conference calls).

We will discuss risk factors and our thesis in future posts, but let's briefly consider valuation now since numbers will shift around after our post today:
  • As noted above, shares of Bidz are trading at seven times 2008 earnings and 12 times our 2009E earnings of $8.0 million ($0.35 versus consensus of $0.29).
  • Although difficult to foresee improved top-line performance and/or multiple expansion in the current market environment, we believe BIDZ could fairly trade at 15 to 20 times earnings (5% to 7% yield) given the company’s established, difficult-to-replicate, high-ROIC online franchise. Importantly, we believe an informed private market buyer would award a similar valuation.
  • Such a valuation would imply a $5.25 - $7.00 ($6.13 midpoint) fair value today on depressed 2009E earnings. Giving credit for a return to growth at some point and normalized earnings of $12.0 million ($0.50 per share, still below 2007-08 levels) would imply $7.50 - $10.00 per share ($8.75 midpoint).
  • On a relative basis, BIDZ is extremely inexpensive compared to Blue Nile (NILE), which trades at 69 times TTM earnings (*pre 2Q09 results for all NILE TTM figures herein) and 50 times consensus 2010E earnings. NILE trades at 39.5 times TTM EBITDA and 2.4 times sales, compared to 4.9 times and 0.55 times for BIDZ, respectively. Further, Blue Nile’s TTM reported operating income of $16 million and 5.5% margin, lower than Bidz’s $19 million and 10.7% margin.
  • BIDZ also trades at a significant discount relative to Amazon (AMZN, $85.32), which trades at 56 times TTM earnings and 40 times consensus 2010E earnings, but has a reported TTM operating margin of only 3.8%.
  • We see Blue Nile’s business as less discretionary (please see our May post) than that of Bidz, warranting at least some premium. However, we see no reason why the wide gap should persist over time, particularly if certain Bidz overhangs are removed. We expect NILE’s valuation multiple to compress while BIDZ’s multiple expands.
  • Finally, we have a recent comparable M&A transaction in the online retail space: Amazon’s purchase of Zappos. Amazon management relayed on the company’s earnings call that Zappos had approximately $635 million in 2008A sales with “a small profit”. Amazon’s cash/stock purchase price of $847 million implies a price to sales purchase multiple of 1.33 times. If we awarded the same multiple to Bidz, the implied share price would be $10.46, or 2.67x current levels.
Company Description and 2008 Financial Results

Bidz.com, Inc. operates as an online retailer of jewelry in the United States and internationally. It operates a Web Site, bidz.com, for the purpose of selling merchandise, utilizing an online sales auction platform; and a fixed price online store at www.buyz.com. The company’s product inventory includes gold, platinum, and silver jewelry sets with diamonds, rubies, emeralds, sapphires, and other precious and semi-precious stones; and a selection of jewelry, including rings, necklaces, earrings, bracelets, jewelry sets, and watches and accessories. It also acts as an agent in the sale of certified merchant merchandise owned by third parties. The company was founded in 1998 and is headquartered in Culver City, California.

Below is an overview from a September 2008 management presentation (note that revenue growth no longer holds given recession and 1Q09 average items sold per day were 6,110 versus 12,186 in 1Q08):

Snapshot of Web site with mouse scrolled over some earrings:

Unlike eBay (EBAY, $22.55), which doesn't source or own the merchandise up for auction, Bidz sources and owns all merchandise, and holds short-term auctions where most bids start at $1. Bidz guarantees that items are "as described" and offers a"100% money-back guarantee if the item is not as described" less a 15% restocking fee.

Bidz generated $207.4 million in 2008 sales (+11% Y/Y, 76% US / 24% International), operating income of $24.1 million (+15% Y/Y, 11.6% margin), and net income of $14.4 million (down 20% Y/Y on higher taxes, 6.9% margin, $0.57 per diluted share).

Management, Corporate Governance, and Insider Ownership

David Zinberg, Chairman and CEO. David Zinberg founded Bidz.com and has served as the Bidz's Chief Executive Officer, President, and Chairman of the Board of Directors since inception in November 1998. Mr. Zinberg also served as the company's Corporate Secretary from its inception until March 31, 2001. From 1988 to 1997 Mr. Zinberg was the Chief Executive Officer of Asset Lenders of America (Bidz's predecessor), a collateral lending company.

Claudia Liu, Chief Operating Officer (wife of CFO). Claudia Liu joined Bidz in 2001 and was promoted to the company's Vice President of Operations. Prior to joining Bidz, Ms. Liu was Director and General Manager of Cybertowers Pte Ltd., a publicly listed company on the Kuala Lumpur Stock Exchange in Malaysia. Ms. Liu has over 15 years of experience in accounting, operations and general management. Ms. Liu received a Bachelor Degree in Social Science from Sheng Cheng University in Taipei in 1985.

Lawrence Kong, Chief Financial Officer (husband of COO) and Director. Lawrence Kong has served as the company's Chief Financial Officer since January 2, 2001 and as a member of its Board of Director since July 2003. Mr. Kong has served as Treasurer and Secretary since March 2006. Mr. Kong has over 20 years of experience in accounting, financial management and consultancy, Mr. Kong earned a Bachelor of Science in Accounting (summa cum laude) from the University of South Alabama in June 1982 and a Masters of Business Administration in Finance from the University of Chicago in June 1984. Mr. Kong is a member of the American Institute of CPA.

Leon Kuperman, President/Chief Technology Officer. Leon Kuperman has served as the Company's Chief Technology Officer since January 22, 2007. Mr. Kuperman has over 14 years experience in engineering, product development, product demonstrations, and business development initiatives for a variety of technical products and services. Most recently Mr. Kuperman was Chief Technology Officer at Truition, a Canadian technology company which he co-founded in 1998. Mr. Kuperman began his career at IBM Canada, where he was instrumental in building the technical structure for Net.Commerce, the flagship product of IBM's Internet division. Mr. Kuperman holds a degree in computer science from York University.

Bidz has three independent directors (60% of board): Peter G. Hanelt, Garry Y. Itkin, and Man Jit Singh, each serving a staggered three-year term. Biographies are available here. We would prefer to see annual elections and a higher percentage of independent directors on the board. In addition, global best practices call for the separation of Chairman and CEO positions.

Per proxy, as of 4/13/09, including shares and options, management and the BOD owned 67.3% of the company. CEO Zinberg owned 31.7%, Marina Zinberg (his sister and a company Vice President) owned 30.7%, and COO Liu and CFO Kong both owned 3.5%. Saied Aframian, a manager at a principal supplier, owned 5.1% of the company (more on Mr. Aframian later).

Please stay tuned - more to come in the coming week(s) on Bidz.

Happy investing,

Jeffrey Walkenhorst

Disclosure: Long BIDZ, EBAY, UBET.

© 2009 Jeffrey Walkenhorst
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