Stephan is a barber and hair styling supply company; I couldn't think of a less exciting business if I tried. The company's products are mainstays of barber shops and hairstyling salons everywhere, and their products seemingly haven't changed in 60 or 70 years, clippers, barber chairs, bibs. Up until recently the company's website was basking in the vintage Information Superhighway look of the early 1990s, which I felt reflected the pace of the company.
When I researched and initially invested in the company the thesis was simple, it could be boiled down to this:
- A discounted NCAV of $2.26
- NCAV of $3.48 and tangible BV of $3.78
- The Board of Directors contained an activist investor who emphasized book value as fair value, and had pushed for a sale in the past.
- The company was consistently profitable.
- They had $7m in cash, and a $10m market cap.
The bullet points provide a nice overview from an investment perspective, but miss a rich backstory.
Stephan was a family controlled company, Frank Ferola, the CEO and largest shareholder ran the company for 30 years, until he passed away suddenly last summer. An interim-CEO, Michael Smith, was elected by the Board and began his tenure.
In 2004 Stephan attempted to go private at $4.60 per share. Ancora Advisors submitted a 13-D stating that they believed that the $4.60 offer was a low-ball bid that undervalued the company, and that the company was worth at least book value. The 13-D also called out the CEO for an egregious employment contract, and excessive compensation. The going private bid failed, and a contested proxy battle ensued and resulted in Ancora winning a spot on the Board.
When I researched Stephan the investment thesis hinged on the question "was this company really worth NCAV or more?" My hope was they were worth at least NCAV, if not book value, the target that Ancora had painted on them during the proxy fight.
Fast Forward
The past year has been a whirlwind for Stephan, they hired a new CEO, re-wrote their website, took a big bath inventory write-down, have been party to two lawsuits, and are now dealing with two lagging brands. The stock has subsequently fallen 50%, and I've held the whole way down.
I generally like family controlled companies because shareholder interests are aligned with the controlling family. A controlling family wants the company to last a long time and continually provide income, two goals shareholders strive for as well. I mis-read Stephan, Ferola wasn't running the company with shareholders in mind, he was picking their pockets and lining his. I knew this was the case based on the proxy fight, but I foolishly believed that his death would be a catalyst for a sale, and shareholders would finally be rewarded. I thought the CEO malfeasance started and stopped with his compensation package, and once he was gone this negative bullet point would be as well.
What I missed is that when a CEO runs a company with himself in mind and then passes away suddenly there are a lot of loose ends that need to be tied before the company is salable. Ferola was running Stephan on a wing and a prayer. When he passed the company's new management unearthed all of the skeletons in the closet.
At this point most sane readers are thinking I'm insane, I increased my position in a clearly melting ice cube. In hindsight shareholders should have taken the going private deal from 2004, heck if someone offered me $4.60 for my shares today I'd hand them all over as quick as possible.
The company today is not the same company I initially invested in a over a year ago. A year ago they hadn't cleaned out the closets yet, and there were still cobwebs coating their inventory. The new management team has been aggressive at sizing up the situation and taking write-downs where necessary. The company is worth much less now than it was a year ago, although if I'm honest with myself they were worth the current amount a year ago, it's just that I overestimated their value.
Here is what that company looks like now:
When I researched Stephan the investment thesis hinged on the question "was this company really worth NCAV or more?" My hope was they were worth at least NCAV, if not book value, the target that Ancora had painted on them during the proxy fight.
Fast Forward
The past year has been a whirlwind for Stephan, they hired a new CEO, re-wrote their website, took a big bath inventory write-down, have been party to two lawsuits, and are now dealing with two lagging brands. The stock has subsequently fallen 50%, and I've held the whole way down.
I generally like family controlled companies because shareholder interests are aligned with the controlling family. A controlling family wants the company to last a long time and continually provide income, two goals shareholders strive for as well. I mis-read Stephan, Ferola wasn't running the company with shareholders in mind, he was picking their pockets and lining his. I knew this was the case based on the proxy fight, but I foolishly believed that his death would be a catalyst for a sale, and shareholders would finally be rewarded. I thought the CEO malfeasance started and stopped with his compensation package, and once he was gone this negative bullet point would be as well.
What I missed is that when a CEO runs a company with himself in mind and then passes away suddenly there are a lot of loose ends that need to be tied before the company is salable. Ferola was running Stephan on a wing and a prayer. When he passed the company's new management unearthed all of the skeletons in the closet.
At this point most sane readers are thinking I'm insane, I increased my position in a clearly melting ice cube. In hindsight shareholders should have taken the going private deal from 2004, heck if someone offered me $4.60 for my shares today I'd hand them all over as quick as possible.
The company today is not the same company I initially invested in a over a year ago. A year ago they hadn't cleaned out the closets yet, and there were still cobwebs coating their inventory. The new management team has been aggressive at sizing up the situation and taking write-downs where necessary. The company is worth much less now than it was a year ago, although if I'm honest with myself they were worth the current amount a year ago, it's just that I overestimated their value.
Here is what that company looks like now:
- Book value: $2.45, NCAV: $1.42
- $3m in cash on the balance sheet, plus $3m in inventory that was recently re-valued
- $3.50 a share in NOLs
- Of the two lawsuits the company is facing, they won one (in appeal) while the other is pending. They have repaid all but $85k of their long term debt, if they lose the second lawsuit they could take on debt to pay a settlement if necessary.
- The company re-located from Illinois to Florida to consolidate operations and save expenses.
- Legacy brands that have turned a profit until this past year when one time expenses and a corporate upheaval resulted in a loss.
Conclusion
I realize that Stephan isn't the best investment out there, this is a company with a foot in the grave and the other on a banana peel. Even with the market's imminent death sentence I believe this is an attractive investment. The stock is trading as if they will lose the lawsuit and they will continue to have problems. The company is in the midst of a turnaround, and management has been quick to realize losses in inventory and goodwill. I believe at this point we've seen all the bad news we're going to see, now the hard work begins of reviving sales and turning a profit. When that happens I believe that management is going to work to sell the company.
I hate to see investment positions work out like this, I'd rather have everything I own travel on a smooth straight line up and to the right, but that doesn't happen often. It's also worth keeping in mind that I don't practice concentrated investing, Stephan is a 1% position in my portfolio. I'd be happy to own 100 companies where the risk of permanent capital loss is low, but the opportunity for a 50-100% gain is high. As a note, I don't actually have 100 positions, I have slightly over 50 positions.
I'm going to be patient and see what happens for Stephan in the next year..
Disclosure: Long Stephan
Nate,
ReplyDeleteIs Ancora or other activists still involved?
Yes, Richard Barone is still on the board. I think he is part of the problem. He oversaw the pilfering of the company by Ferola and the massive inventory write-off. He also hired a very highly paid -- too highly paid for this company -- CEO who has yet to articulate a coherent strategy for the company.
ReplyDeleteThe rest of the board of directors is a complete joke. Essentially a bunch of old guys who couldn't care less about what happens to the company. The Chairman of the Board is a Miami attorney who owns zero stock in the company and doesn't bother to answer emails, calls, or otherwise engage with shareholders.
The company has been extraordinarily mismanaged, with essentially zero quality control in its cosmetic manufacturing activities, and production taking place in outdated, dilapidated facilities.
If you look at the revenue line, it's easy to see that this company has been "bleeding market share" for many years.
Instead of realizing this, after many years, and liquidating the company now that Ferola is gone, Barone has embarked on a risky turnaround attempt. Time will tell if this was wise but so far the results are not encouraging.
I just had to compliment you on telling a rare and fascinating tale of properly researched investment into an apparently transparent company with solid assets and a long history. All the fuzzy feel-good factors were there. Good lesson! Thanks again.
ReplyDeleteI fail to see how time is your friend here. And I fail to see how buying 50 stocks is making anyone except your broker rich while making a small contribution to reducing our deficit.
ReplyDeleteIt is odd that you would bother blogging extensively about 1% of your net worth with your aspirations of it becoming 2% of your net worth. Why don't you just find 5 or 6 of your absolute best ideas and buy 15-20% positions?
This Walter Schloss approach of investing worked for Walter but I'm not sure he ever pretended to be an analyst for individual issues along the way.
Maybe a lot of value blogs disappear so quickly because the writers all hold five positions. They write five posts then exhaust their material and never post again. Thankfully for the readers who enjoy this blog I have plenty of material to write about.
DeleteSounds like my style of investing isn't your style, no harm there, I couldn't imagine a world where everyone had to do something the exact same. The great thing about life is there is no one single path to success.
Haters gonna hate!
DeleteThanks, good writeup. It will be interesting to see if they can turn this around.
ReplyDeleteIf I'm doing my math right, 3.08 of the loss last year resulted either from non-recurring or non cash charges. Also, excluding Morris, the company was growing revenues in their other segments comparing 2012 to 2011. And morris revenues were flat latest q comparison.
For expenses, by my count, operating expenses have come down if you exclude all the non-recurring stuff, but COGS have gone up, even if you subtract out the inventory writedown (i'm guessing that went on COGS). So COGS is going up while sales are going down. Is that how you are looking at it?
One thing I don't like is the CEO doesn't own much stock. Have you looked into his track record much?
Nate, Great write-up. A follow up question: Are you not concerned about revenue going down every year?
ReplyDeleteDeclining revenues and continued losses will continue to push B/V and cash on hand lower and lower. Be careful here.
ReplyDeleteWhat are the Stephan Company's lagging brands?
ReplyDeleteStephan Company will continue to bleed to death. The new CEO came from a failed personal security company and had no prior knowledge of cosmetics, like Frank Ferola did when he came from Avon. Also, Ferola owned at least 26% of the company stock before his sudden death. Morris was the only subsidiary generating revenue, but after the massive inventory write-off created the biggest loss ever. Cash is good, but only if dividends are being declared. Otherwise it all goes into salary for company officers.
ReplyDelete