Special Situation Ideas for the week of 17 July 2017

Those looking into some catalyst might want to ponder over these names for the week. I have done research on few of them, the other I have read online on Barron’s and other publications. If you have questions, feel free to write to me on kedar@kedarcap.com

SHORT: Best Buy (BBY):  Best Buy  is a provider of technology products, services and solutions. It has operations in the United States, Canada and Mexico.
The company reports in 5 distinct segment: Consumer Electronics - home theater, home automation, digital imaging, health and fitness and portable audio (approx. 33% of rev); Computing and Mobile Phones - computing and peripherals, networking, tablets, mobile phones (including related mobile network carrier commissions), wearables (including smart watches) and e-readers (approx.46% of rev); Entertainment - gaming hardware and software, movies, music, technology toys and other software (approx. 5% of rev); Appliances - major appliances, for example, refrigeration, dishwashers, ovens, laundry, etc.) and small appliances for example, coffee makers, blenders, etc. (approx. 11% of rev); and Services - consultation, design, delivery, installation, set-up, protection plans, repair, technical support and educational classes (approx. 5% of rev). The stock has had quite a run-up in its share price in the last year, a run-up which was helped by the rise in the stock markets. The top line has remain largely flat to down, despite this rise. Most of the growth trends impacting BBY are directly correlated to population growth, housing recovery, and health living trends. Aside the top line, even the gross profit and operating profit margins have remained largely flat. So the question is – why a meteoric rise in the stock price? The answer lies in the rise in EPS mostly, from cost cutting and buyback in stock. Since FY15, the company has bought back stock and cut costs, both operating and fixed – a step that has directly impacted its bottom-line. That coupled with steady rise in housing and a positive trend in job markets has positively impacted BBY. The positive cash flow generation has been mostly deployed to keep the dividends and buy back the stock – not the best way to grow the business. The company has historically traded at 10x earnings multiple. Putting 13x earnings multiple and assuming the company earns between $4 - $4.50, the stock can trade as high as $54 a share, which it currently is. This also assumes an EBITDA north of $2.2bn. The recent announcement in another $3bn in share buybacks might keep the momentum going for a bit more. However, the risk to the downside are much higher, given the rise in stock markets, highs in employment rate, tightening of federal reserve policy and a growth in housing which is little long in its tooth. This coupled with the day when the magic of cost cutting and share buyback comes to an end, the stock can tumble more than 25% in the mid 40ies.

SHORT: Verint Systems (VRNT): The Company with a $2.5bn market cap specializes in customer engagement, cybersecurity, fraud, and risk and compliance software and services for some 10,000 customers in 180 countries around the world. The shares have risen nearly 30% over the past 12 months, yet its weakening track record over the past four years suggests that investor enthusiasm is misplaced. Revenue growth has dropped steadily, from 24% in Fy15, which ended Jan. 31, to an 8% decline in FY17. The sales drop happened despite the company having spent $765mn in that period on three major acquisitions designed to increase sales. Over the same period, costs for R&D, among other expenditures, have risen about twice as fast as revenue.  Based on GAAP, the company reported a loss of 47c in FY17 from an income of 99c in FY14. Although non-GAAP EPS is only 15x estimates EPS of $2.71 for FY18, GAAP EPS estimate is just 16c for a P/E of 250x. For a company that has been growing through acquisitions, stock-based compensation; acquisition expenses; restructuring expenses; amortization of acquired technology; and impairment charges are real costs and not extraordinary expenses. The current valuation is priced to perfection. Its customer-engagement business, which is about two thirds of sales, and its cyber intelligence business, which is the other third, compete with the likes of Oracle, Microsoft, and Salesforce.com (CRM). If the company does not get bought by a firm expect the price to drop.

LONG: Hain Celestial Group (HAIN) : The Company deals with organic and natural foods and other products. Most recently, Engaged Capital has submitted seven candidates for election to Hain’s eight-seat board. The fund bought into the company at an average cost of $34.63 per share. The company has a market value of $4bn. Engaged was an investor in Hain 2 yrs ago, and had successful activist engagements at natural/organic companies Boulder Brands and SunOpta. Hain has a great portfolio of organic brands, but suffered some setbacks, including a lengthy accounting issue it rectified on its own and slowing of top-line growth as its retailer mix evolved from natural specialty stores to major grocers. While Hain has done a great job of acquiring brands, its poor integration of them has led to profit margins much lower than peers. So the first opportunity here is operational: A more-efficient supply chain and rationalization of SKUs could double margins. The second opportunity is strategic. Hain is the last pure-play organic food company large enough to move the needle for companies like Pepsi and Kraft. Engaged has had a constructive engagement with management. The investor nominated seven directors not as a power grab, but to address the severe lack of relevant experience on the Hain board. There are also some positive trends that might help HAIN grow. For example, approximate annual growth in consumption of natural/organic foods over the past ten years in the U.S. is approx. 10%. In the US, less than 10% of all foods sold is organic/natural. While Hain has 3,000 SKUs, or stock-keeping units, only about 500 drive 90% of its revenue. If the fund plays its card right, there is a huge opportunity to drive.