Description
This is either the best near-term investment opportunity of my life, or I'm a complete idiot. Bonus: there's a smoking gun!
Opportunity
HOME's share price fell (57%) when it reported 1Q20F results, and has fallen another (30%) since then. It's now down (72%) ytd, and (87%) from its July 2018 high. Although fundamentals have certainly deteriorated since then, the long-term prospects for this growth retailer have not meaningfully changed. Meanwhile, the company is still in an active sales process, with at least two named suitors. The remaining private equity sponsor is rumored to be interested in rolling over their stake, and with the current price so far below the IPO price, there are many incentives to get a deal done, with room for a substantial premium.
Earnings Miss
The company's actual quarterly results were not terrible:
| |
Actual |
Estimates |
Guidance |
| Sales |
306.3m |
304.1m |
300-305m |
| SSS |
(0.8%) |
+0.4% |
Flat to slight + |
| GM |
28.8% |
29.4% |
|
| EPS |
3c |
4c |
3-4c |
The company blamed particularly bad weather for the salees shortfall, which is a bigger problem for HOME than other retailers given their lack of an ecommerce offering. Management commentary is corroborated by the credit card data, which shows a few bad weeks (during bad weather) interspersed among other solid weeks (during normal weather).
Although this quarterly result was below expectations, and would lead to some weakness in the stock, the nail in the coffin was the company's updated guidance:
| Quarterly |
Guidance |
Estimates |
| Sales |
340-345m |
352m |
| SSS |
(1)-1% |
|
| EPS |
14-17c |
27c |
| Annual |
New |
Prior |
| Sales |
1370-1390m |
1390-1410m |
| SSS |
(1)-1% |
+LSD |
| EPS |
67-74c |
102-108c |
This spooked investors for a number of reasons:
1) It was a 33% cut to FY EPS, after one quarter where the shortfall was just a penny.
2) Investors wondered how the business could unravel so quickly after prior guidance was given two months prior.
3) Investors wondered how management could have such a terrible handle on the business prospects.
And subsequently the stock has been puking. It appears that management kitchen sinked the guidance, citing:
- A soft start to the year due to poor weather
- Despite "we've been pleased with the rebound in our business as weather has improved"
- Markdowns taken on seasonal product, and expected markdowns in Q2 and Q3, to refresh inventory
- Despite new product lines coming later in the year
- The increase of tariffs from 10% to 25% with zero mitigation assumed
- Despite "mitigating the initial 10% tariff through a combination of value engineering, negotiated price reductions, and strategic retial price increases, without a material impact on our business"
- and "while we are prepared to intensify our approach to tariffs at 25%" they are not including any mitigation at this time
- Higher freight costs
- Despite spot freight rates actually dropping from the time they initially gave guidance.
M&A Reporting
Smoking Gun
Normally with this fact pattern, you could argue, "Ok, maybe they were in discussions, but clearly these weak results could have scared the suitors off, and we haven't heard any new rumors since then, so the conversations are probably over." However, we have one interesting unique situation:
- In 2018, there were 73 different days of insider transactions. If you dig deaper, from Jan 1 to Oct 10, they were exclusively sales, while the three transactions since then were just RSU grants. Since then, there have been zero insider transactions.
- This is for a growth company that had basically weekly insider sales prior.
- Then, on June 11, there was a very interesting Form 4 filed on behalf of Ashley Sheetz, their Chief Marketing Officer:
- https://www.sec.gov/Archives/edgar/data/1646228/000156761919013228/xslF345X03/doc1.xml
- This is the same day purchase and sale of 1000 shares of stock, with the footnote:
- "The purchase was executed in error. The sale was executed on the same date to reverse the purchase."
- Our best guess is that Ms. Sheetz executed her purchase, called the GC to report the purchase, and (s)he said, "Are you crazy?! You can't do that while we're in process!" and had her reverse the transaction.
Additional Facts
There were two key PE sponsors who IPOed the company (at $15 in August 2016): AEA Investors and Starr Investments. They did not sell in the IPO at $15, but instead sold at:
- $24.50 on 12/6/17
- $30.00 on 3/26/18
- $37.90 on 6/11/18
- $33.20 on 9/7/18
Our understanding is that Starr may have distributed the remainder of their shares (6.2m) to LPs as that fund neared the end of its lifecycle, which could explain the recent price insentive selling. Meanwhile, we understand (but could be wrong) that AEA's fund is indefinite life, and that they would be interested in rolling their stake into any buyout.
It seems reasonable that AEA, who had a great sucess with HOME privately and is playing with "house money" given its sales, would work with their close banker relationship to repeat their success at these low levels. Further, it's also possible that when the stock was around $20, it was difficult for the suitors to offer a substantial enough premium given the 52-week highs closer to $40. (Conspiracy theory: management kitchen sinked guidance to tank the stock and allow them to participate in a buyout at a low price.) That should no longer be a problem at $5.25.
Timeline
We believe the sale process began some time between October and February, so the process has taken six to nine months so far. We think it's unlikely this would drag on much longer, given the need to lift the blackout period at some point, if only for senior management to buy stock if they truly believe this is an opportunity. Although there have been no rumors since May, we think this could be constructive (albeit with confirmation bias), as the incentives for a banker to leak could be reduced as a transaction gets closer to fruition.
Even without a deal, this quarter should be in-line with guidance and expectations, so we'd expect the stock to grind higher once the shareholder base has turned over.
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.
Catalyst
Hopefully a buyout at $15 in the next few weeks; otherwise just a grind higher.