Where can those interested pick up the perfumes? By purchasing shares of Parlux Fragrances (PARL, $2.72), which has traded and continues to trade below net tangible book value (i.e. liquidation value) of approximately $5 per share since the market decline of September 2008.
Let's back up a bit. Through the 2H08 and 1H09 market swoon, we were as active as possible initiating new positions in beaten up names, including several REITs, Harry Winston Diamond Corporation (HWD - please click name for recent post), and Central European Distribution Corporation (CEDC - recently added to our CEDC position). Then, in summer 2009 -- following the monster rally off of the March bottom -- we began to seek areas and companies that remained largely left behind, but where we saw significant, unappreciated value.
Although we missed opportunities by passing on several names such as Sotheby's (BID) and Starbucks (SBUX) (click names for prior posts) in favor of American Oriental Bioengineering (AOB) and Bidz.com (BIDZ) -- which haven't worked out to-date and hold some important lessons -- our search also led us to areas such as the container shipping sector and solid waste companies such as Casella Waste Systems (CWST). In addition, we began to look more closely at Parlux Fragrances, where we already had some familiarity thanks to a friend and fellow investor.
Here's a link to the company's Web site and summary description:
- Parlux Fragrances, Inc. is a manufacturer and international distributor of prestige fragrances and beauty related products. It holds licenses to manufacture and distribute the designer fragrance brands of Paris Hilton, Jessica Simpson, Nicole Miller, Josie Natori, Queen Latifah, Marc Ecko, Rihanna, Kanye West, babyGund, Vince Camuto and Fred Hayman Beverly Hills, as well as Paris Hilton cosmetics, sunglasses, handbags and other small leather accessories.
To gain familiarity with the company's history, we recommend reading through the company's annual reports and also watching this management presentation from the 2009 Noble Financial Equity Conference (captured with Sonic Foundry's Mediasite/SOFO):
- Title: Parlux Fragrances - Webcast Link
- Date: Monday, June 08, 2009
- Time: , Duration: 00:29:56
Here's what was most interesting: shares of Parlux Fragrances had traded below net tangible book value (i.e. liquidation value) of approximately $5 per share since the market decline of September 2008. Parlux was a classic Benjamin Graham "net net" value play: shares could be purchased below net working capital and for only 40% of net tangible assets (the sum of total assets less goodwill and intangible assets less total liabilities = balance sheet liquidation value). The majority of total assets on the balance sheet were inventory and receivables, plus some cash. A key question was: could inventory be successfully converted into cash?
While shares of many discretionary retailers had already tripled or quadrupled from the bottom -- see large caps William Sonoma (WSM), Nordstrom (JWN), and Limited Brands (LTD) -- despite still challenging fundamentals at the time, micro/small-cap Parlux essentially hadn't moved. Admittedly, this was a different business than these higher margin retailers, not fitting with our preference for consistent, high margin businesses. Examples include our positions in eBay and j2 Global Communications (JCOM).
Parlux was a "cigar butt" net-net value play. Although certain value investors, including Warren Buffett, shy away from cigar butt investments, we are sometimes willing to tread in these waters when we see certainty of value. Further, we recall , page 169 re: buying companies offered below net working capital (NWC): in The Intelligent Investor
- .... "What is more remarkable is that none of these issues showed significant losses... and 78 [out of 85] showed appreciable gains" [in a two year period].
- "Never adopt permanently any type of asset or any selection method. Try to stay flexible, open-minded and skeptical. Long-term top results are achieved only by changing from popular to unpopular the types of securities you favor and your methods of selection." (Source: The Book of Investing Wisdom)
With Parlux, we were getting assets for less than free. Our research provided comfort that the company's balance sheet was sound and capable of converting assets into cash. Hence, we initiated and built a position around $2 per share in summer 2009.
Not everyone was/is on the same page. Skepticism was expressed in a 2/7/10 SeekingAlpha.com post, Parlux Fragrances Smells Better at a Distance. We commented on the post, including the following:
- Per Parlux's conference call last Thursday, the current cash position is approximately $15 million (as of this Feb, not 12/31), AR sounds current, and inventory is largely under control (and is clearly converting to cash). All of this implies tangible book remains largely intact despite "extraordinary returns" amidst weak department store sales for the company. Thus, PARL may well be a legitimate 50c dollar no matter how ugly recent results appear.
For FY2010 (end March), revenue was $148.1 million (down only 2% Y/Y in an extremely difficult retailing environment) with a slight operating loss following increased marketing and selling expense that didn't bring higher sales as well as a write-off related to the end of a license agreement with Guess. Importantly, tangible book value remains near $5.00 per share and, also, we believe Mr. Purches' commentary from his shareholder letter in the fiscal 2010 annual report is noteworthy -
- In light of the challenges and difficulties faced by the Company in fiscal 2010, the Board determined that a change in strategy was required. Our strategic focus is to return to profitability, and to establish a basis for growth.
- This focus has been four fold: (1) evaluate the potential of our existing licensed product lines and position these products in channels of distribution to provide profitability, (2) reduce discretionary spending and introduce profit improvement programs to provide an effective and efficient operating structure, (3) seek new licenses that will provide revenue growth, and (4) secure a credit line to assist us in reaching our sales and profit objectives.
- I am pleased to report progress on all four fronts: (1) we have written down those licensed product lines that did not receive the expected customer support, and are expanding our efforts internationally and to other channels of distribution for those that have viability, (2) major reductions in spending have been made and a profit improvement committee was established to provide on-going improvements, (3) we recently signed a worldwide fragrance license with Vince Camuto, the well established creative force behind numerous successful brands, which we believe will strengthen our position in department stores and other important channels of distribution; and (4) we signed an agreement with GE Capital Corporation for a $20 million credit line.
- Confidence in our future growth was tangibly expressed in the form of the purchase by parties related to Mr. Rene Garcia of a significant number of shares representing approximately 15% of our common stock. Mr. Garcia is one of the principals of Artistic Brands, a company owned by him and Mr. Shawn “Jay-Z” Carter. We currently have an agreement with Artistic Brands for a number of celebrity fragrances, the first of which will be spotlighted by the major introduction of a Rihanna fragrance during the latter part of our current fiscal year.
- Another growth driver could be acquisitions, the CEO said, but added that Parlux would only be interested if a competitor is divesting a fragrance brand. Parlux, which sells its perfumes at department stores like Macy’s Inc and at specialty retail shops like Perfumania Holdings Inc, has had some acquisitions discussions, Purches said, but nothing that has panned out as yet.
- The company has also no plans to get into cosmetics as have some of it competitors, Purches said. He intends to fund any takeover with cash or borrowings, and not with company stock.
- “We can’t buy anything with our stock, because our stock is terribly devalued,” Purches said. Shares of the company have fallen 20 percent in the past 6 months and have lost 87 percent of their value from a high of $17.15 in . “It is my objective to get the stock back up where it belongs, which is at least in the $8-$10 area, that means we have to make a profit, we haven’t made a (full-year) profit in two years and I think the stock price is reflective of that,” Purches said.
What happened? Parlux announced like-for-like six month FY2011 sales through September up 19% Y/Y and provided forward revenue guidance as well as expectations for profitability. From the release:
- During the course of the meeting, Mr. Purches, Chairman and CEO, noted that: “For the current fiscal year of 2011, we are forecasting lower net sales than the previous comparable year. If we eliminate our expired license, GUESS, from the prior year we anticipate an increase of approximately 15% to approximately $125 million in net sales in the current year. Keeping our focus on profitability, we have cut back new product launches, and advertising/promotional spending, which was reduced by 35% this current year. We expect to return to profitability this year.”
- Mr. Purches added: “It is worth noting that our first six months’ net sales ending September 30, 2010 are expected to be approximately $62 million, compared to approximately $80 million in the comparative prior year. This is significant when one considers that the prior year figures include $28 million of GUESS sales. Paris Hilton and Jessica Simpson products accounted for approximately 80% of our gross revenues for the first six months of the current year. We anticipate this ratio will decrease as we introduce new products later this year and into next year, most notably Rihanna in Spring 2011 and Vince Camuto in Fall 2011. With these new introductions we expect to grow the Company’s revenues, profitability, anticipating net sales of approximately $150 million in fiscal 2012.”
Importantly, our investment case for Parlux is based on net tangible book value. For this, let's quickly review the company's balance sheet as of 6/30/10:
Net tangible book value = total assets LESS trademarks and licenses, net LESS total liabilities
= $114.5 minus $4.5 minus $14.2 = $95.8 million
Divided by 20.6 million fully diluted shares = $4.65 net tangible book value per share
Even with the recent run in the stock, the company can literally be purchased for $0.58 on the dollar ($2.72 / $4.65 = 0.58 or 58%). Put another way, a dollar of tangible value can be had for $0.58, which to us -- makes no sense -- and is akin to finding money on the street. Normally, companies trade at this sort of discount if bankruptcy is a significant risk. In this case, a discount to inventory value and receivables would be warranted as a true liquidation might bring values below reported, balance sheet figures.
BUT, recent results and cash generation tell a different story, which implies that shares should trade at or above net tangible book value of just under $4.65 per share (rounded up to $5 for sake of discussion). Moreover, we can envision at least another $1-2 dollars of upside beyond the $5 for Parlux's going-concern value (celebrity relationships, licenses, etc.). Finally, if management executes and delivers margin expansion toward the company's former 10% target operating margin, we could see a fair value range meaningfully higher than current levels. But, this would be gravy. For now, we're focused on $5 as a starting point. This simply makes common stock sense.
Disclosure: long PARL, HWD, CEDC, CWST, EBAY, JCOM, AOB, BIDZ, YHOO, SOFO.
© 2010 Jeffrey Walkenhorst
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