Retail Stock Analysis: RVI

Until Mish gives me the retail board I've requested, I guess this thread will have to go on this board. Retail, Homebuilding, and Lending are my three main sectors for shorting in anticipation of a slowing economy.

Retail Ventures is the most screwed up of the shortable retail stocks that I've been able to find. RVI started losing big money in 2001 and by March of 2003 the stock was down to $1.50. The company has contiued losing money each year since then, but now the stock is up 14-fold to about $21. It's amazing how the actions of hedge funds can trump reason when it comes to pricing stocks.

RVI's EPS for fiscal years ending around January 31st:
2000 +1.03
2001 -3.03
2002 -0.90
2003 -0.13
RVI closed at $1.50 on 3/9/03.
Since then EPS have been:
2004 -0.15
2005 -0.57
2006 -2.94
2007 -2.22 (estimate)
In spite of those losses, RVI has been in a long uptrend and is now trading around $21.

RVI has three retail chains. Two are money losers and one is profitable:
Operating Earnings:
Value City
2005 -$24.862 million
2006 -$126.444 million
2007 Same store sales -1.3% (-5.6% Q4)

Filene's Basement
2005 -$26.728 million
2006 -$10.727 million
2007 Same store sales +3.1% (-1.3% Q4)

DSW
2005 +$58.275 million
2006 +$70.112 million
2007 Same store sales 2.5% (1.0% Q4)

In July of 2005 RVI raised money by doing an IPO for the profitable DSW. They still hold 63% of DSW so they include DSW's results in RVI's consoldated results, which I believe is intentionally misleading. RVI doesn't really benefit from the full profitabilty or balance sheet of DSW, but that's how it appears in the earnings statements. Meanwhile, DSW looks to me like it may become a liferaft for the controlling family once the mother ship finally goes down.

You can thank hedge funds for the long, steady rise of RVI stock. The largest listed institutional holders are hedge funds like Entrust Capital, but Cerberus Partners and Millennium Partners are huge beneficial owneres through warrants priced at $4.50 per share (19.3% for Cerberus).

During calendar Q4 '06 the stock went from $15.41 to $19.04 as institutional holders added 2.3 million shares. Some of them are probably jumping in just playing the momentum - 7 new holders combined to purchase over 3 million shares. Others were probably boosting their own NAVs with - the 5 largest holders added about 1.5 million more shares. The stock added another $2 during Q1 '07 in a very slow, controlled rise along the trendline. We won't see institutional activity for Q1 until the middle of May.

RVI is controlled by the Schottenstein family through a slight majortiy ownership held by Schottenstein Stores Corporation (SSC). Shareholders are essentially along for the ride as the company pays no dividends. Jay Schottenstein is Chairman of RVI and CEO of DSW. There are a multitude of potential conflicts related to these interlocking arrangements which are hinted at in the 10-K

SSC, Cerberus and Millennium are all sitting on a substantial number of warrants that can be exchanged for over 16 million shares of RVI at $4.50, over 3.8 million shares of DSW at $19.00 or a combination of the two. For the hedge funds, that represents a huge paper profit at current share prices with a very minimal cash investment. The warrants are tied to loans made to RVI that continue earning interest until redeemed or their expiration on June 11, 2012. The larger paper gains are probably highest when associated with RVI's current price, although my expectation is that the warrants will be redeemed for DSW shares several years from now as RVI's shareholder equity continues to deteriorate.

Those interests would like the stock to stay propped up, but all the other institutional holders could lose faith and take profits if earnings continue to suffer. Q4 and Fiscal 2007 earnings will be announced Wednesday, April 4th after the close. They missed on Q3 and the stock dropped a buck, but two days later they announced they were exploring options for selling Value and the stock got pushed right back up again (Like somebody would really want to buy Value City with $126 million in '06 operating losses.)

RVI raised $143 million in September by creating some derivative debt that is exchangeable for shares RVI holds in DSW. On paper, these "PIES" work out best for the creditors if DSW continues to rise, as the number of shares they can be converted must be within a range of $27.41 to $34.95. In Q3, RVI had to take a charge of $28 million related to the fair value of those derivatives as the price of DSW rose to $34.92. With DSW at $41.02 at the close of Q4 there may be large additional charges for the quarter. You can be sure the purchasers of the PIES are counting their gains based on this "fair value" when it comes to billing their clients based on NAVs.

Same store sales were down 2.8% in Q4, so earnings should stink again. Of course the spin machine could be used to manipulate the price up regardless of the reality of the results. I think the real question is one of how long the other institutional investors want to play chicken. For myself I'm content to just maintain a good sized short position and hope that there is an institutional race for the exit.

Edited 1 time(s). Last edit at 04/02/2007 12:26AM by RodgerRafter.

Nice post.  It shows that you have a good deal of knowledge about the subject.

1. THe stock has low volumes - so it doesn't take much to push up the price. Do you see any way for the hedge funds to be able to profit on their warrants without creaming the stock price?  i.e. they could buy puts to exercise post-warrant exercise.

2. What is the short interest? Is it low enought that there wouldn't be a floor?

3. Will the institutions dump stock if the results reported are poor? Or will they hold on putting additional pressure on the shorts.

 

I'm not sure if I would want to bet against Cerebus et al. It might be best to let them rip at the corpse - play their financial games - and focus on easier targets such as LEND, SPF, WCI and BKUNA.

Thoughts?

 

thanks rodger.

great analysis.

this stock is acting for big parts of the stock market.

spin, hege funds, weak fundamentals, high valuations , rumors..........rising stock prices .

 

 

Responses:

1. THe stock has low volumes - so it doesn't take much to push up the price. Do you see any way for the hedge funds to be able to profit on their warrants without creaming the stock price? i.e. they could buy puts to exercise post-warrant exercise.

There isn't much of a market for RVI options, although, any hedge fund can get just about any major investment bank to create and take the other side of a custom derivative for a price. Shorting to lock in profits on convertable bond and warrant positions is very common. Cerberus could have already done that on part of the position or may do that in the future.

2. What is the short interest? Is it low enought that there wouldn't be a floor?

12.6% of float. As this is a going-to-zero play I don't think that the short interest would provide much of a floor.

3. Will the institutions dump stock if the results reported are poor? Or will they hold on putting additional pressure on the shorts.

I never know when the big drops will occur. As with builder, lenders and other sectors before, I just short and wait. Usually that ends up working, but not always. In the case of the builders the drops came before the news. In the case of the lenders the initial drops came as a result of the news. I tend o think that retail will decline in advance of news because of inside information/research. The lenders were more secretive about mounting losses until they suddenly impacted earnings.

I'm not sure if I would want to bet against Cerebus et al. It might be best to let them rip at the corpse - play their financial games - and focus on easier targets such as LEND, SPF, WCI and BKUNA.

Thoughts?

I'm not a momentum player. I go by fundamentals and wait for reality to catch up with the market. As evidenced today, the ones that have already dropped a lot are prone to large bounces. My new positions generally go into stocks near their highs when I think the economic situation is right.

Edited 1 time(s). Last edit at 04/03/2007 01:06PM by RodgerRafter.

THanks for all the help and thoughtful replies. I appreciate the insight.

I keep coming back to how those putting money in expect to get it out - especially in the case of a hedge fund like Cerebus or Farallon. I am short LEND and I can't understand why anyone would lend them money - even at high rates - and if they did, how this would make a difference in the operating results sufficient to push the stock price up. I know it's reality versus the market - but reality doesn't always last long enough to make some money.

Thanks again. I hope RVI drops like a stone for you, and soon.

What if they prepaid their loss on stock?  Traders use the mantra, don't trade the news, trade the reaction to the news.  If people, like yourself and others, see them loaning money, even at high rates, they might follow the herd.  Trading is like pschology 101 in that you are playing against a hoarde of people that are doing different things. Playing those people against each other is the goal and a large hedge fund is losing cash on this.  So they push capital into the company, hoping for short term pops and they try and trade accordingly.  I for one, would be doing everything in my power to get anything out of these companies while I can.  In that vein, it's a rope a dope, and they make cash on the short term momentum for as long as possible in hopes of limiting the loss.  They can't win, but the can stem losses, to a degree.  Just a thought. 

RVI's earnings came out yesterday, claiming EPS before charges of 62 cents and a loss of 76 cents after a derivatives write-down. Of course the earnings before charges were hyped and the stock opened up 8.75%, but during the day it moved down to close at a +2.43% on the highest volume of the year.

Revenues were up year-over-year, but it was a 14-week quarter instead of the usual 13 weeks and they were operating about 8.3% more stores. They cut way back on advertising expenses and boosted prices to increase profitability. The result was lower same store sales per week by about 8% in their biggest chain and uninspiring results in the other two chains.

For the quarter, Value City had an operating loss of $17.975 million,
Filene's Basement had an operating loss of $1.226 million,
DSW had an operating profit of $100,714 million,
and Corporate had an operating loss of $175.955 million (which is where the derivatives loss occurred).

Indeed, it looks like the entire corporate structure is set up to transfer profits to DSW from other divisions. DSW rents space within Filene's Basement stores and the other divisions pay DSW for various essential services. DSW has net interest income of about $6.9 million, while Value City has net interest expense of about $15.5 million and Filene's basement has net interest expense of about $6.8 million.

Again I'm back to the premise that RVI sold off part of DSW to try and hide the truth about it's steadily deteriorating balance sheet. RVI reports consolidated revenues and profits including all of DSW, then takes out a portion of DSW's profits in the line for "Minority Interests" to allow for part of DSW that they don't own. They probably should take out more to make up for the warrants and PIES that will likely be converted into RVI's portion of DSW stock, but for now they don't appear to be doing that. RVI's stock has tracked DSW's as if the only value RVI holds is its remaining stake in DSW. At the close today, RVI had a market cap of $1.03 Billion compared to DSW's $1.88 Billion.

Here's an article questioning DSW's current valuation. An additional thing I believe it is failing to consider is that after DSW is done feeding on the rotting corpse of the rest of RVI the profits will probably decline substantially.

The stock got a big boost last year when RVI announced it was exploring options for selling off Value City. They were supposed to announce the results of their explorations around now, but during the conference call they repeatedly stated that they couldn't release any information on that effort. As DSW has already absorbed all of the profitable assets, it's hard to imagine creating a deal around Value City that would be profitable at this point.

Edited 2 time(s). Last edit at 04/05/2007 08:02PM by RodgerRafter.

Value City Department stores are down 8.7% (Sears also had a bad quarter, blaming housing for weakness in appliances)
DSW shoe stores down 3.6% (but they've opened up a bunch of new stores, just in time for the consumer to crap out)
Filene's Basement apparel stores up 1.6%

http://biz.yahoo.com/prnews/070510/clth026.html?.v=89 The stock has been breaking down of late. Hopefully this will give it an extra push. See the first post in this thread for much more about RVI.

And yet the stock price hangs tough. My initial thoughts would be that the relatively low volume level permits manipulation to some extent.

RVI's Non-GAAP loss was 21 cents per share for the quarter, on declining same store sales, or about $9.8 million lost vs. $139 thousand lost a year ago. Meanwhile, DSW reported a 54 cent gain.

It's all pretty confusing because RVI spun off DSW as a life raft for the owning family and have been using their remaining stake in it to keep the parent company afloat with cash now and then. DSW stock was down this quarter, which resulted in a paper gain related to DSW warrants RVI issued, so the GAAP earnings were a positive 6 cents.

DSW's shareholder equity is almost $400 million.
RVI's shareholder equity is almost $95 million, but
that includes all of DSW's equity minus $147 million for the part they don't own (minority interest), thus excluding the DSW stake,
the rest of RVI has negative book value of $158 million.

As I was saying...
RVI management took a slowly failing company in RVI and created one strong company in DSW and a rapidly dying one in RVI.

Current Ratings: 0 negative/0 positive

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RVI tanked about 10% on Tuesday, and my guess is the reason had more to do with an 8K filing that the media missed than it had to do with the company's earnings report. Cerberus Partners chose to exercise convertible warrants that weren't due to expire until 2012, suggesting they wanted to close out their position in the company now, rather than sit on the warrants interest free for another 5 years. We'll see later this month if there was a significant change in short interest (perhaps Cerberus had been shorting against the warrants and then just exercised them to be done with the position). We won't see until mid-August if Cerberus actually held onto the shares until the end of June (they showed no shares held as of 3/31/07, but then the warrants would not have shown up then).

8-K:
ITEM 3.02 UNREGISTERED SALES OF EQUITY SECURITIES.
On June 6, 2007, Retail Ventures, Inc. (the “Company”) issued 1,333,333 of its common shares, without par value, to Cerberus Partners, L.P. (“Cerberus”) in connection with Cerberus’ exercise of its remaining outstanding convertible warrants that were originally issued by the Company on July 5, 2005. The common shares were issued at an exercise price of $4.50 per share, for an aggregate cash purchase price of $5,999,998.50. In connection with this issuance, no underwriters were utilized and no commissions were paid.
The issuance and sale of the Company’s common shares discussed above were exempt from the registration requirements of the Securities Act of 1933, as amended (the “Securities Act”), under Section 4(2) of the Securities Act and the safe harbor private offering exemption provided by Rule 506 promulgated under the Securities Act as transactions which did not involve a public offering.
ITEM 8.01 OTHER EVENTS.
In connection with Cerberus’ exercise of its remaining outstanding convertible warrants, as discussed under Item 3.02 above, the Third Amended and Restated Senior Loan Agreement, dated as of August 16, 2006, between Cerberus and Value City Department Stores LLC, an Ohio limited liability company and a wholly-owned subsidiary of the Company (“Value City”), immediately matured in accordance with its terms. On June 11, 2007, Value City repaid the $250,000 principal amount of the loan, together with all accrued and unpaid interest thereon.

From the last 10-K:
...Cerberus and Back Bay the right, from time to time, in whole or in part, to (i) acquire Retail Ventures Common Shares at the conversion price of $4.50 (subject to existing anti-dilution provisions), (ii) acquire from Retail Ventures Class A Common Shares of DSW at an exercise price equal to $19.00 (subject to anti-dilution provisions similar to those in the existing Term Loan warrants) or (iii) acquire a combination thereof (the “Term Loan Warrants”).

Interesting that they chose to go with RVI shares instead of DSW on the exercise. There would have been a bigger premium on the DSW shares, but the cash outlay would have been much higher. Again this may have been a result of wanting to offset an existing short position.