Monday, April 25, 2011

Bassett Furniture: Asset Catalysts

Bassett Furniture (BSET) is a vertically integrated furniture company, as it imports, manufactures, wholesales and distributes a range of furniture. The company was profitable during the housing bubble, lost money for a while following the housing crash, and is now operating pretty close to break-even. But for value investors, it's not the earnings that are interesting, but the catalyst events surrounding some of the company's assets.

Bassett trades for $95 million, but has a deal in place (that is expected to close by the end of this month) to sell a company in which it has a minority interest for $74 million! This sale will produce a gain, which is subject to tax, but the company notes that it has "net operating loss carryforwards of [$18 million] that can be utilized to offset the taxes on the gain." In addition, the buyer will place $7 million in an escrow account that Bassett could receive over the next three years if no unexpected contingencies arise out of the company being sold.

In addition, Bassett has current assets of $83 million, long-term investments (money market and bonds) of $15 million, another minority investment carried at $5 million (equity method), and many tens of millions of dollars of retail real estate (including its own locations and locations it leases to licensees who are wholesale customers of Bassett), versus total liabilities of $83 million.

Of course, there are some risks with this type of investment. The most obvious is that the proposed deal may not close. But even if it doesn't, investors have a pretty good idea of what that minority investment is worth, which should act as a margin of safety.

But perhaps the biggest risk is what the company will do with all that money. Management didn't exactly narrow it down for shareholders when it stated it may use the money for "the retirement of debt and certain other long-term obligations, the settlement of various obligations related to closed stores and idle facilities, restructuring licensee debt, paying a dividend, judiciously funding expansion of our Company-owned store network, and/or funding stock buybacks and/or funding any potential future working capital needs."

While such a wide range of possibilities may be a bit scary for value investors, the company does have a history of paying out special dividends and buying back shares when it has extra cash. Unfortunately, management may only have done this because it had a gun to its head, thanks to activist shareholders who challenged the company's capital allocation. Management would probably rather grow the company than serve shareholders, as the company's CEO owns less than a million dollars worth of Bassett shares, but got paid almost half a million dollars last year.

On the other hand, management has not been taking wanton risks as of late to grow the company at the risk of profitability; the company has been closing the least profitable stores, and capex has been consistently below depreciation as the company has limited spending to store upgrades/refreshes rather than unjustified expansion. But management does appear to be pleased with the results of some new-concept stores it has been testing, so the possibility is there that management will use the bulk of this cash inflow to fund a growth program with uncertain results.

As Bassett shrinks down to its most profitable stores, it may be on the verge of returning to profitability. At the same time, it is likely to receive a major cash injection that the company may use to benefit shareholders. Value investors who believe this management team to be prudent may find this a stock worthy of investment, but those who don't will want to stay away.

Disclosure: None


Ankit Gupta said...

This doesn't change anything here, but I just wanted to point out tax implications.

"Management would probably rather grow the company than serve shareholders, as the company's CEO owns less than a million dollars worth of Bassett shares, but got paid almost half a million dollars last year. "

His $500,000 gets reduced very quickly - he will average 29% on federal taxes alone, social security gets put on top of that, state taxes, etc. He might only end up with $300,000.

If he has a million dollars of stock, then a 15% tax rate on that is a much more efficient after-tax way of getting paid. $1M after tax is $850k, or 2-3 years of his after tax income. The problem is that if he believes he can make more money with his salary than with stock, he may act in that interest. On the whole, I have no doubt he will act in the interest of shareholder's, but when there is a question of something on the margin, he will be incentivized to act in his own self interest, because the incentives aren't aligned.

In addition to the monetary compensation, he will be getting some power and prestige (from Whitman) with his position as well. I don't know if he's a part of any CEO-exclusive group that meets to discuss issues in private, or in other groups, but there are benefits like that too. Plus his secretary, etc.

Something else I've looked at often is the board composition - if major shareholders are on the board, that's good, but still not always a perfect method of conducting business, because depending on how much of the board they compose, it can still be a large challenge to get people on the same page and very time consuming. It's much easier to start with a company run by someone with aligned incentives.

Adam Gaglio said...

Hey Saj,

What do you think about this situation now? Now that the deal is completed, backing out the non-operating assets (post-tax cash from sale + $15 mil in investments) leaves a market valuation of $15 million for the operations.


Saj Karsan said...

Hi Adam,

I'm glad it went through, and I am long a little bit, but now I just hope that management allocates the bulk of the capital in a shareholder-friendly way.

Sorin said...

Hi Saj,

Ever looked at Chromacraft Revington (CRC). They are in the furniture industry as well.

Saj Karsan said...

Hi Sorin,

I have yes, here's an old article. They look cheap based on assets but don't seem to be cutting costs enough, with no management ownership. What do you think?

Sorin said...

Hi Saj,

On paper the numbers look right but I get a strange feeling that something's missing from the picture ... so I'm circumspect ... I don't feel at ease. A like-minded friend of mine did initiate a position though ...