RadioShack as a net-net?…well sort of

Tandy Computers, CB radios, satellite dishes, transistors, capacitors, and stereo systems; what do they all have in common?  They were standard inventory at RadioShack just a few years ago, well maybe decades ago.  RadioShack has been hitting the news recently as they've become the most recognized "net-net" struggling with a turnaround.

RadioShack is an American retail chain that started as an electronics outlet and morphed into a cell phone store.  The company has a storied history with a whole website devoted to old RadioShack catalogs, and plenty of retro commercials on YouTube.  I spent some time browsing the old catalogs, it's amazing how much better and cheaper things are now.  To RadioShack's credit they were early on the cell phone trend.  Here's a little comparison:

Then (1987)

Associated YouTube commercial for the phone

Now

Interesting to note that the monthly price only dropped $10 over the last 25 years.

Is it a net-net?

The purpose of this post isn't to walk down memory lane, but to evaluate how attractive RadioShack is now that they're purported to be a net-net.  I use purported and net-net in quotes above because as you'll see below they don't quite qualify as a net-net as Benjamin Graham would define it.  Graham defined a net-net as net current assets minus all liabilities.  If an investor just focuses on the balance sheet RadioShack qualifies with current assets of $1741m and total liabilities of $1383m for a NCAV of $358m against a current market cap of $257m.  Seems great right?  RadioShack is trading at 71% of NCAV and cash flow positive, so what's the problem?

There was a very good reason Graham took liabilities at face value and discounted assets.  Liabilities have a way of torpedoing investments whereas companies are rarely evaluated on their assets alone.  The goal of determining NCAV is to calculate a price at which buying below gives a margin of safety.  If assets are included that can't be sold, or select liabilities ignored the investor is just fooling themselves into thinking an investment is safer than it actually might be.  To me this is the most serious error an investor can make, an underestimating risk.

I have my own spreadsheet that I use to calculate NCAV, I only use cash, receivables, and inventory against all liabilities.  Here is what it looked like for RadioShack using just the balance sheet from the latest 10-Q:

My numbers are slightly lower than the back of the envelope calculation above.  With a current price of $2.59 against my calculated NCAV of $1.63 RadioShack doesn't qualify as a net-net. If an investor moved on at this point it would be understandable, but I want to drill a bit deeper to highlight an second issue.

Many investors don't take liabilities seriously enough.  A net-net investor could be forgiven because after discounting assets and subtracting liabilities the value they have is very conservative.  The problem is some companies like RadioShack have liabilities that are off balance sheet, mainly leases and purchase commitments.

RadioShack's operating leases are non-cancellable, which means the lessor is going to get their money before a shareholder gets a dime.  Purchase commitments in RadioShack's case are contracts to purchase a certain amount of inventory over the next year.  They also have some marketing expenses grouped in with purchase commitments.  Purchase commitments are sometimes necessary for a company to lock in discounts on bulk inventory purchases.  It could also be necessary if the retailer is buying a specialty item where a custom production run is necessary.  The marketing expenses could be things like TV or radio advertising where blocks of time need to be purchased in advance.

If I re-do the net-net worksheet to include both the operating leases (discounted at 6%) and purchase commitments RadioShack fails to be categorized as a net-net.  Unless the company increases their inventory (which would be bad), their receivables (bad as well), or their cash it doesn't look like an investment in them on a net-net basis would have any margin of safety.

Can it turnaround?

I'm not an expert in turnarounds, but I did notice something while browsing through the old catalogs, RadioShack is no stranger to reinventing themselves.  In the 1940s the company billed itself as the largest distributor of amateur radio equipment.  In the 1950s and 1960s the stores started to carry more stereos and TV equipment.  In the 1960s RadioShack started to ride the CB radio trend feeding right back into the stereo craze of the 1970s.  In the 1980s RadioShack the store introduced computers, and VCRs.  The 1990s brought cordless phones, answering machines and pagers.  The company seems to have lost their way a bit in the early 2000s before stumbling back into the cell phone business.

I don't know if the transformations are in the company's DNA or if they were a forced necessity.  I would have more confidence investing in a company that's reinvented themselves multiple times over a company that's attempting it for the first time.  The big question to ask though is what's next for RadioShack?  What's the next big trend they can grab onto and ride to profitability?

Talk to Nate about RadioShack

Disclosure: No position