Crown Crafts (CRWS.OB): Betting on Babies
Posted on November 9, 2006
Betting on Babies
Introduction
At first glance, Crown Crafts, Inc. (CRWS.ob, Current Price: $3.30), an infant products company that just recently finished a major recapitalization, seems like a ludicrous stock to feature on our value-oriented site. The company’s shares are up more than 500% already this year, with most of the rise starting just a mere four months ago. However, when you dig a bit deeper, we think you may reach the conclusion, much as we have, that despite the already extraordinary rise, the stock still has significant upside left, with minimal downside.
Of course we wish we had discovered CRWS in early July, but as Bernard Baruch famously noted, “I never made money by buying at the bottom, nor by selling at the top.” Moreover, in the case of CRWS, it would have been next to impossible for any intelligent “outside” investor to have considered buying the stock near its low, given the fact that the company teetered on the edge of bankruptcy and massive shareholder dilution prior to recent unforeseen events.
For all intents and purposes, therefore, we think it is best to view CRWS as a post-bankruptcy company or IPO, notwithstanding the fact that the company’s shares were publicly-traded prior to its recapitalization this past July. When seen in this regard it is easier to eliminate that “fear of heights” which normally, and quite correctly, accompanies the purchase of stocks that have already risen substantially.
The Business
Crown Crafts, Inc. designs, markets and distributes infant and juvenile consumer products, including bedding, blankets, bibs, bath items and accessories, and luxury hand-woven home décor under licensed and branded collections. Major licenses include Disney, Baby Einstein, Scooby-Doo, and many other well-known entertainment and retail properties. A full listing of licensed categories can be found at one of the company’s websites at: http://www.ccipinc.com/
Sales of the Company’s products are generally made directly to retailers, which are primarily mass merchants, large chain stores and gift stores. The Company’s products are manufactured primarily in China. Major customers include: WalMart (35% of sales), Toys R Us (30% of sales), and Target (14% of sales).
Crown Crafts currently has about 10 million shares outstanding, and about $13 million in debt. Sales in the last fiscal year were approximately $73 million, with income from operations (EBIT or Earnings Before Interest) of about $7 million or nearly $0.70 per share (the company has substantial tax loss carryforwards).
The Problems: China and Major Leverage
Crown Crafts, Inc., was founded in 1957. The company operated for a long time as a domestic textile manufacturer, an industry, which due to the China phenomenon, has been in a major decline for decades.
However, instead of rationalizing the business as outsourcing to China gained momentum, management at Crown Crafts leveraged up the company in 1998 and acquired three other US-based textile manufacturers.
The attempt at consolidation though did not work and as business conditions in the textile industry continued to deteriorate Crown Crafts proceeded to lose over $100 million in a three-year period. In 2001, the company was forced to begin a major restructuring in order to avert bankruptcy. Since that time, the company has been engaged in significant asset sales and operational realignments, which included the outsourcing of virtually all of its manufacturing to foreign contract manufacturers.
Recent Changes and Their Significance:
Debt Refinancing and Warrant Extinguishment Lead To A New Lease On Life
After over five years of corporate restructuring, by year-end 2006, Crown Crafts had succeeded in reducing debt from over $100 million to nearly $48 million, and the profitability of the company was restored. However, the company was still hampered financially by significant lender warrants, high leverage, and hefty interest rates.
Then in July 2006, after convincing bankers that CRWS was on sound footing, the company announced a new financing package, which substantially reduced total debt, cost of funds and, most importantly, extinguished all of the warrants that were exercisable by its lenders. Specifically, prior to the refinancing the Company had approximately 36 million shares issued and $48 million in debt. Following the refinancing, the company now has only 10 million shares and merely $12.6 million in debt. Notably, of that $12.6 million in debt, only $9.7 million is interest-bearing, down from $16 million in 12% debt prior to the refinancing.
Following the announcement of the above refinancing, CRWS’s stock understandably zoomed upwards by over 300%, primarily because equity which was previously essentially worthless, suddenly had the possibility of retaining some value. However, despite the rise in the company’s stock, the shares still do reflect the potential growth that Crown Crafts can achieve now that the company is finally operating under a normalized capital and financial structure.
More specifically, now that the company’s management can cease worrying about day-to-day corporate survival, they can concentrate on growing the company via the leveraging of extensive overseas sourcing relationships, the development of new license opportunities, and the consideration of strategic acquisitions. The company’s recent announcement of the licensing of the “Baby Mink” brand for sale into the fast growing Hispanic market, is but one example of the numerous growth opportunities that have opened up for the company now that financing is no longer an issue for management.
As you’ll see from the figures below, even not assuming any growth above and beyond what the company already has, CRWS’s stock, at current price levels, remains extremely cheap by almost any standard of measurement.
The Price, Downside Risk, Upside Reward
Before getting to some basic valuation considerations, it is important to note that there is little financial risk for Crown Crafts at this juncture. As noted above, the company now has minimal debt and interest expense is more than manageable based on conservative EBITDA estimates. The company does not have a substantial cash balance, but that is quite normal in this type of business and of no cause for concern.
The primary risk that the company faces now that it is no longer a manufacturer, is that major retail clients, such as Walmart, can go around CRWS and source products directly from manufacturers in China and thereby bypass CRWS, which is for all intents and purposes a middleman between China and Walmart. This is of course a risk that cannot be minimized, but it is something that almost every single retail product company currently faces in the US with ascension of China manufacturing and the dominance of big retailers, such as Walmart.
The major way to mitigate this risk is by gaining rights to valuable license properties, which lend a brand “aura” to your products, and/or by designing your own branded products. CRWS is pursuing both of these strategies, and recent financial results seem to indicate that the company is succeeding in these endeavors. At the same time, we think that now that the company can concentrate on strategic business goals, as opposed to financial restructuring initiatives, this drive to secure valuable license properties will accelerate. With time, and with some good negotiation, CRWS should be able to solidify its competitive position, to the extent that retail product companies can do this in China/WalMart world.
In valuing Crown Crafts, we would note that there is only one publicly-traded comparable. That company is Russ Berrie, which trades under the symbol RUS. The stock currently goes for a little over 1.2X Enterprise Value (EV) to Sales. However, a significant chunk of RUS’s sales are unrelated to the business line shared with CRWS. As such we think that the best way to get a valuation for CRWS is took look at RUS’s subsidiary, Kids Line, which was acquired by RUS in December 2004. Kids Line was a direct competitor of CRWS. RUS purchased Kids Line for $130 million, plus additional earnout considerations of over $10 million based on an EBITDA multiple of Kids Line EBITDA. The EBITDA multiple ranged from a low of 5 to as high as 8. We estimate Kids Line sales at the time of the acquisition at $74 million, implying a valuation of 1.75X EV/Sales.
Based on the above valuations for Kids Line, we estimate that CRWS is worth in the worst case scenario, 5X Average EBITDA over the last several years or $2.50 per share.
On the upside, assuming no top-line or EBITDA growth, which is very conservative, given the company’s recent earnings results, we think CRWS is worth at least 1.5X EV/sales or about $12. This would still be at a discount to Kids Line valuation, but the discount is warranted until CRWS proves several quarters of growth.
With at most 30% downside, and the potential of over 200% upside, we think CRWS is an excellent investment “gamble” at current prices.
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