[Member] HLYS is a Net-Net, But Is It a Value Trap

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Heelys (HLYS) is a one product company that became a sensation with its heeled footwear. The stock at one time traded as high as $38 and change in 2007. With fad of its signature product subsiding, the business and the stock price has been in a downward spiral ever since. As so often happens, the market often tends to punish a stock more than it deserves. Currently Heelys stock is trading at around $2/share. With the company sitting on $2.24/share in cash and no debt, the stock appears to be a classic net-net stock. The company has been running losses for the past 4 years and it is a quite natural to wonder if the company is a good investment at the current valuation or whether the cash burn will destroy any value in the stock before the ship turns around.

Heelys’ Stock Performance

I generally do not post stock charts with my analysis as I firmly believe that the past performance of a stock means zilch when looking at a company for investment. All we need to concern ourselves with is the current state of business and whether there may be any catalysts on the horizon that will turn the ship around and unlock the value for us, especially when we are reviewing a distressed stock for investment such as this one.

However, in this case I will go ahead and include Heelys’ stock chart to illustrate how far and how much a once wall street darling has fallen. If nothing else, it serves as a warning that investors should not get carried away and stay grounded to the realities of the business.

On the other hand, if you ever see a chart like this, it may be an invitation to stop and take a further look in the stock. There just might be some value that other investors are glossing over.

HLYS Balance Sheet

The balance sheet is asset heavy with most of the value concentrated in cash. Long term assets are present but are only significant on the margins (large part of LT assets are intangibles).

Balance Sheet Jun-30-2011
Cash/Cash Equiv 61.68
Current Assets 77.46
Intangibles 2.63
Long Term Assets 3.52
Current Liabilities 3.72
Long Term Liabilities 0.93
Total Assets 80.98
Total Debt 4.65
Total Equity 76.34
Shares Outstanding 27.57
Share Price 2.01
Market Value $ 55.42
P/B Ratio 0.73
Tangible Book Value 73.71
P/TBV 0.75
NCAV 72.81
P/NCAV 0.76

 

 

 

The cash and cash equivalents of 61.68 million is broken up as $29.24 m in cash and $32.44 million in liquid short term investments. In fact, since the market value is only about $55 million, Heelys management can decide to go private and still have enough working capital left over to continue operating. We will come back to this thought a little later. It is important enough to realize that at this point, HLYS is worth more dead than alive. An enterprising investor can just buy out the entire company, sell off every thing and pocket the cash with excellent profit. We will come back to this thought later as well.

Liquidation Value of Heelys

If Heelys were to be liquidated today we are conservatively looking at xxx in proceeds.

  • Cash = $61.68
  • Inventory (assume scrapped at 30% of value) = 9.31*.3 = $2.79
  • Receivables (assume 75% collection) = 5.49 * .75 = $4.11
  • Long Term Assets (assume book value of plant/equipment net of depreciation is close to market since Heelys is a relatively young company) = 0.73

We are being conservative here since the inventory is probably worth much more than 30% that we are assuming. Footwear is a mature market and the raw inventory is nothing special to Heelys and could be purchased by other footwear manufacturers.

Adding them all up, the assets are worth 61.68 + 2.79 + 4.11 + .73 = $69.31 million

Removing total debt at 4.65 million gives us a net Asset value of 69.31 – 4.65 = $64.66 million

Since the stock has a current market value of $55 million, we are looking at approximately 15% profit in the short time it takes to buy up the company and liquidate.

P&L Trends

The value of Heelys lies in its assets. At the current rate, its operations are destroying value. This is clearly visible from its P&L that I am summarizing below:

HLYS P&L

Quarterly Income Statement

Annual Income Statement

  Jun-30-2011 Mar-31-2011 Dec-31-2010 Sep-30-2010 Dec-31-2010 Dec-31-2009 Dec-31-2008 Dec-31-2007
Revenues 8.34 6.1 6.73 8.25 30.44 43.78 70.74 183.47
Gross Profit 4.23 3.39 2.78 3.6 13.91 16.5 21.96 58.68
Gross Margin 50.72% 55.57% 41.31% 43.64% 45.70% 37.69% 31.04% 31.98%
SG&A 4.98 4.11 5.93 3.46 17.4 22.83 27.84 26.06
SG&A/Sales 59.71% 67.38% 88.11% 41.94% 57.16% 52.15% 39.36% 14.20%
Net Income -0.97 -1.18 -3.21 -0.07 -3.99 -5.13 -5.92 22.32
EPS -0.04 -0.04 -0.11 0 -0.14 -0.19 -0.19 0.79
Shares Outstanding 27.57 27.57 27.57 27.57 27.57 27.57 27.32 28.21

 

The company has lost money since the FY 2008 as its annual revenues have declined 85% in the last 4 years. This is definitely not a healthy company. The problem is quite glaring. Heely’s has not been able to right size its SG&A expense to match the revenue decline. At one time the SG&A (payroll, selling, advertising) was about 15% of its sales. Now it is 60%. To its credit, the company has been growing its gross margin over the years but it has not been enough to make up for the SG&A increase (as a percentage of sales).

The SG&A value absolutely needs to be below the Gross Margin if the company wants to be profitable. How is the company doing towards correcting this gap? Lets see

As a % of Sales Jun-30-2011 Mar-31-2011 Dec-31-2010 Sep-30-2010 Dec-31-2010 Dec-31-2009 Dec-31-2008 Dec-31-2007
Gross Margin – SG&A -8.99% -11.80% -46.81% 1.70% -11.47% -14.46% -8.31% 17.78%

 

Appears that in the recent quarters this gap has narrowed quite a bit but it is difficult to be confident since seasonality plays a large role in this business. Sales in the June quarter and in the current quarter are typically higher as the retailers start stocking up for the back to school season.

The company still has quite a bit to do to get back in black. Fortunately, if the sales start picking up, they should be able to support  this level of SG&A but in absence of sales increase the costs need to come down fast. The company seems to believe that they have enough cash cushion to support new initiatives and sales push for months if not years and they can wait to see their top line pick up. Meanwhile shareholders lose patience, which is fine by me if the company is able to show that they have some cards up their sleeves.

Catalysts

Heelys have been making some changes in their distribution network this year. They removed the middleman at their Japanese operation and had to buy some of the inventory from them in the process. This inventory will be pushed out in the current quarter and with the middle man gone there should be some reduction in the SG&A line. It is important to realize that currently 67% of Heely’s sales are international (Japan, Germany, Italy and France) and are susceptible to economic climate in those areas as well. The company in its latest 10-Q reports that the Japanese Tsunamis had a big impact on its sales in Japan, which is perhaps true, so we might be looking for a certain pick up in international sales in this quarter and next.

While this will be mildly positive, what remains to be seen is how the company grows its top line and bring its SG&A in line with its revenues so it can start turning a profit.

Insider Buying

The management is sending some positive signals to the market by buying up stock in the open market in the $2/share range. 42,300 shares were purchased by insiders in the last 12 months. At this point the management holds 42% of the outstanding shares and 36% is being held by institutional holders.  Manatuck Capital Partners and Renaissance Technologies have upped their stake in Heelys recently and now own about 9% of the shares outstanding. Manatuck also has representation on Heelys’ board.

Exit Strategy?

With all the insider activity going on, it appears that the management and the close institutional holders believe that there is significant value that will come unlocked in the near future either via the market (business performance will improve) or they are setting the stage to take the company private or put it up for sale.

Recommendation

All things considered, Heelys stock presents a compelling value at these prices. I would hesitate to recommend a buy though since the management has been destroying value. But with the insider and institutional activity it appears that there is a concerted effort being mounted to correct the valuation of the company.

I recommend buying Heelys shares at $2/share or below with a small portion of your portfolio. If the current quarter shows improvement, there will be an opportunity to buy more but for the time being it is wise to ease into a position keeping the risks in mind.

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