I came across MWRK while reading this post at Fat Pitch Financials. I was intrigued by the thesis that MWRK could be falling below intrinsic value simply because Bear Stearns has a cash crunch and is being forced to liquidate stocks. Mothers Work is a niche retailer selling maternity clothes, and certainly seem to have many valuable brands.
Analysis of the company’s 2006 annual report shows that revenues have been growing briskly, and a workup of both the cash flow and the income statements suggests owner’s earnings of $10-12M. The company has a rather high level of debt, some $117M or about 10 times earnings. The latest quarterly report showed that for the 9 months ended June 2007, revenue was $445M, below the $460M of 2006, and comparable store sales has dropped 4.1% this year. I estimate that EBIDTA for 2007 will be $30M, minus $7M for interest on debt and $8M for taxes, earnings should come in around $15M, or an EPS of around $2.50. For a company whose growth has begun to flatten out, a PE of 10-12 is appropriate, yielding an estimated intrinsic value of $25-30 per share.
However, a quick look at the proxy revealed that the founders of the company, Mr and Mrs Matthias, received $1M each in compensation, with another 40K of stock options. Total management compensation is around $5M, an astonishing 33% of earnings. While I expect that CEOs of even small cap companies should earn at least $0.5M, the company seems to be employing two CEOs simultaneously and paying out the equivalent of three to four CEO salaries for a company of this size. In addition, the Mathiases are granted up to a maximum of 60K incentive stock options annually. And finally, amid widely recognized problems in its business, the company announced in the latest 10Q that it has set up a pension fund for the Mathiases, paying out 60% of the last drawn base salary, with the base salary increasing 3% for every additional year served. This cost the company another $2.6M. Lastly, insiders seemed to have cashed out large amounts of shares when the stock last peaked, and the share base seems to have been consistently diluted due to the exercise of stock options. Together with the iron-clad anti-takeover provisions (the company has both a poison pill and a staggered board), this is essentially a company that is run by insiders for insiders.
In addition to a rather shareholder-unfriendly management, the company itself seems to be encountering major strategic issues. Recent press releases suggest that the decline in comparable store sales has accelerated to 9.1% annually. The company is now laden with so much debt that opening new stores is too capital-intensive, and it has switched to marketing to departmental stores such as Macy’s. It remains to be seen whether this strategy will be successful, and it is likely that departmental stores will demand large cuts in profit margins in exchange for stocking Mothers Work’s product. Finally, while the maternity market is stable and somewhat recession-proof, it is not a growth market, and there does not seem to be any barriers against entry into the market by other well-known apparel brands. In fact, Mothers Work is in its current predicament because maternity wear became a fashion trend among the nonpregnant, and other apparel companies caught and started to make similar maternity clothes for both the pregnant and nonpregnant, resulting in plummeting sales for Mothers Work. While this fashion fad among the nonpregnant will pass, it is likely that some of the smaller apparel companies will find it profitable to retain a small line of clothes to cater to the expectant. Certainly, many women have already been conditioned to look beyond Mothers Work brands for maternity clothes.
In the final analysis, the company has far too many risks associated with it to be a long-term holding. The most fatal risk, in my view, is that the management seems to completely disregard the interests of the public shareholders. With such a large amount of risk, I will demand a massive discount to intrinsic value before the risk-reward ratio becomes attractive to me. I will consider this stock only it falls way below $14, which is the average exercise price of the existing options, and the debt situation comes under control.
P.S. After looking through some of the other stocks that Bear Stearns sold recently, it seems to me that Bear Stearns is selectively selling only the weaker, more dubious stocks in their holdings, while presumably holding onto the better stocks. This is exactly what a good portfolio manager should be doing when forced to raise cash; selling good companies at under-valued prices should be avoided whenever possible.