Description

Gaiam: “Gaiam, Inc. (NASDAQ: GAIA) is a leading producer and marketer of lifestyle media and fitness accessories. With a wide distribution network that consists of over 60,000 retail doors, 15,000 store within stores, and 5,600 media category management locations, and a digital distribution platform, Gaiam is dedicated to providing solutions for healthy and eco-conscious living. The Company dominates the health and wellness category and releases non-theatrical programming focused on family entertainment and conscious media. In addition, Gaiam has exclusive licensing agreements with Discovery Communications and other licensing partners.”

What doesn’t the average GAIA investor know?  Where is the edge? 

1)      The company has never been on sumzero or vic.  Minimal news flow.  Bloomberg shows only 1 analyst with a recommendation on the stock, and only offers one research report that is over a year old.  The company is under the radar. 

2)      People may not know the background of executive chairman Jirka Rysavy.  Here are a few facts…

-          Jirka was the founder and former ceo of Corporate Express, which eventually got sold to staples for around $5b (and was a Fortune 500 company while he was in charge).  Jirka started Corp Express with 11 employees and a profitless company (he purchased for $100 and $15k of payables).

-          In 2008, while running a fortune 500 company, he lived in a log cabin with no running water and also used an outhouse.  No smartphone.  Gaia is a hobby for him, not a company that will have its treasury raided or a multiplying share count.  If you follow his paper trail it truly seems he is much more concerned with business success than any specific amount of money. 

-          Brilliant investor, I will give lengthy anecdotal evidence later on. 

-          Performed dutch auction at corp express for 25% of outstanding shares.  Shareholder friendly. 

-          He currently holds about 6m shares in GAIA, making him the largest shareholder. 

-          He stepped down from ceo several years ago and continues as Exec Chairman.  His coo stepped into the ceo slot.  Seemingly, nothing has changed, except that it is probably easier to be chairman than ceo without a smartphone.  He still takes most questions on conference calls, and comments in every press release.  It is quite clear once you dive in that he is still running the show.  This fortune 500 ceo lends his services to GAIA for the director fee of $60k/yr. 

-          They recently spun out an internally developed solar division (Real Goods Solar (Nasdaq: RSOL)) where he was chairman.  Jirka resigned recently as RSOL chairman as GAIA sold down shares to focus on its core businesses.  He said he was stepping down at RSOL to focus on GaiamTV; a currently money losing operation that is what he is most excited about moving forward. 

3)      Lynn Powers, current ceo (still coo imo), is also capable.  She joined in 1996 and must see what Jirka sees. 

-          She is a capable coo.  “…and then served as senior vice president for strategic planning, marketing and merchandise at Millers Outpost, a casual clothing store chain. In that position she worked in merchandising marketing but also sourced product, gaining international experience traveling around the world a couple of times a year.  During her time at Millers, she helped grow the company from a 24-store operation into a 335-store chain. Its revenues rose from $35 million to $575 million in that period.”

4)      Hidden assets

-          At the end of q1, the company had $100m mc and $106m ev.  During 2012 they fully wrote off their investment in spin-off RSOL; notice the year-end share price…

-          What happened subsequent to the year -end write down?  The shares which had traded from $6 at the spinoff down to just $.57, rallied.  At the end of q1; they still held 10m of “worthless” shares. 

-          Since then, they have sold 6m shares for $16.4m.  This leaves them with 4.1m shares valued at $11.1m.  And like magic, they’ve created about $30m of value that doesn’t appear currently on the financial statements (pre-Q2 ’13). 

-          That is not all.  In 2008 they purchased a 150k sq ft Denver property in cash for $19m (hq), that is being depreciated on their balance sheet.  Instead of the $5m of depreciation on their balance sheet, it is more likely this property has increased in value.  It is paid off in full.  There is a $7m difference between the market price of the re versus where it’s carried on the bs according to the ceo.  On recent conference calls they say value realization of their real estate is an ongoing talk in bod meetings. 

-          They are also a media company and amortize many assets that still have plenty of value.  Does target still sell the same Rodney yee yoga dvd as they did 10 years ago?  I rest my case.  Jirka is also on a mission to monetize their media, much of it bought for pennies on the dollar. 

5)      Valuation.  Downside

-          $116m ev.  $127m bv.  $112m net tangible assets (nta).  If you want to include the remaining 4.1m shares (they just sold 6m at $2.75), nta increases to $124m.  In q2 ’13 cc, jirka said the real estate probably is worth $7m more than what the bs says (on books $19m, current value approx. $25-$27m).  This gets nta to $131m, with market cap at $123m.  This provides ample downside protection for a profitable company with a clean balance sheet.

6)      Valuation.  Upside. 

-          Messy financials.  The cash flow and income statement make it look unprofitable. 

-          In 2009 they generated massive cf, mostly as a w/c release.  They repurchased 1m shares (20% of company to date).  Record operating income.  Paid a dividend funded from excess dep/amm over capex (yes, I really love the chairman). 

-          In 2010 revs were flat and margins increased as they moved away from their outdated catalog model.  Net income had major improvements but cf was negative due to w/c buildup.  Increased non-theatrical market share to 7% from 5%.  40% of fitness dvd market.  14.7k store within store, whose infrastructure is incredibly valuable.  I don’t think target or walmart are going to start their own fitness videos, but one never knows.  They also create digital store-within-store at hulu/nflx/youtube/amazon/etc.  Ahead of their time.  They also sign a licensing agreement with reebok (pre-cross fit).

-          2011.  Big acquisition at year end of vivendi entertainment, 7^th largest non-theatrical media distributor in the US (Hallmark channel, Jim Henson, WWE, fraggle rock, Nat Geo, Discovery, etc).  They sold no shares to fund the $13.4m acquisition, which they believe can add $25m of incremental income on an annualized basis (q4 ’11 cc) (can increase distribution and strip out costs).  They used some debt, most of which is already paid down.  Gaiam now becomes the largest independent and 3^rd largest overall non-theatrical media distributor in the US (7k titles).  Only independent distributor with direct relationship with target/walmart/kmart/youtube/hulu/amzn/nflx/etc.  Store within a store is flat, mostly due to borders bankruptcy which was material (strong growth ex-borders).   

-          They also launch an upscale yoga brand (more accessible than lulu) and a rehabilitative line (think foam roller). 

-          The beginning of GaiamTV, Jirka’s baby.  This is an unlimited streaming model for a monthly fee (think nflx).  Apple/android compatibility.  Instead of buying fitness dvd’s which can lead to boredom, you’ll have access to the largest fitness media company’s offerings accessible 24/7.  They will also have spiritual offerings and other offerings that fit the lohas lifestyle.  Some people that live a truly lohas lifestyle may pick GaiamTV over nflx, but others will do both.  They like to own media because they have a great digital delivery/store-within-store/retail presence (ie distribution system).  Their digital platforms (technology to stream) is very valuable as well.  So now when they acquire media they have 1x streams available at major digital distributors (nflx/hulu/youtube/etc), physical presence at retailers, physical presence at store-in-store, and they’re own monthly streaming service.  Lots of leverage on acquired media assets. 

-          $5.2m cf, which is more meaningful than income because of massive goodwill writedowns due to stock price and also deconsolidation of the solar subsidiary.  Spent a couple million on buybacks. 

-          2012: $13m fcf (w/c flat despite 25% increase in margins, business is becoming higher quality, transition is working).  Large cash flow growth.  Still no equity dilution despite the massive increase in fcf.  Income statement hides this because this is when they wrote their now very value accretive solar holdings down to $0.  Ebitda would have been $18.7m runrate if you back out the $6m GaiamTV investment (still losing money on rollout).  Store-within-store hits 15k, new record, adding sears and sports authority (which both are capable of selling yoga products, yoga clothing, fitness dvd’s, foam rollers, etc).  The Rehabilitative line increased revs 3x.  Their direct-tv sales took a big hit as they pulled back that particular ad spend quite a bit, due to increased costs due to the Olympics and presidential election.  This is prudent imo.  They hired the chief marketer from crocs as brand president, a newly created position.  This is positive, esp as lulu loses its step, who they are now competing with at a slightly lower price point…

-          GaiamTV will lose $6m in 2013, but will break even by April 2014

-          2013: q1: $.2m of operating income.  If you back out the $1.8m GaiamTV investment (still on track to be profitable in 2014); it’s $2m.  They also had a $1m investment into brand research that goes down to $300k the rest of the year (they have an ongoing program but paid a one-time consultant).  So fully adjusted it was $2.7m of operating income.  $6.2m cf.  Annualized we’re talking about a company that is doing $11m of core operating income on a $90m ev (if you factor in the real estate accretion or shareholdings accretion it’s almost $75m). 

-          Oh; and $34m of NOLs, pretty much without restriction (which they can use when selling their RSOL shares). 

7)      Conclusion.

-          Management that has a track record of success.  He has skin in the game.  He is cheaper than I am which says a lot.  He does not dilute his equity.  He understands how to make a business higher quality.  He barely takes a salary.  He genuinely cares about this company’s success, he is not going anywhere.  He does what he loves.  He is a proven money maker. 

-          This company is growing adjusted rev/income/cf, and have continued to invest in the company to achieve that, all while not diluting shares, offering dividends when possible, and opportunistically buys back shares. 

-          The business is changing to a higher quality business. 

-          Today they’re running at adjusted $11m of core operating earnings with a $90m ev.  This doesn’t factor in a sale-leaseback (active discussion).  This doesn’t include a profitable GaiamTV, which is still on track to be profitable in 2014, which is a very scalable and leveraged business (fixed costs with recurring revenue).  You have $120 of nta to protect the $90 ev.  They’ve had $20m fcf ltm. 

8)      Anecdotal. 

-          Jirka also started crystal market, which he sold to Mike Gilliland, who turned it into the first wild oats.  He considers Jirka to be “brilliant”

-          While he was a fortune 500 ceo, he was sleeping in a sleeping bag in a tiny cabin in the woods with no plumbing. 

-          Was an international hurdler. 

-          Spent time living in the mountains of the Czech, spending days only meditating and picking berries. 

-          Bought into a corporate office supplies company, because his Czech friend Pavel Bouska (was running a major software-development shop in Germany) created a next-gen computerized sales-and-inventory-tracking system that gave them a competitive advantage.  (Jirka is an engineer by study himself). 

-          His solar company is a solar installer.  They’ve basically broken even the last few years, not bad considering the industry.  They do installs and maintenance, so picking up customers can have annuity-like dynamics.  The thesis is that this is a mom-and-pop business.  Solar costs are going down.  Electricity costs are going up.  The payback on investment is getting more and more attractive, to the point where solar can become mainstream.  The glut of solar panels only makes installs cheaper; which again feeds into the RSOL business model (solar should get cheaper and cheaper).  Do you want your install and lifetime maintenance with a mom-and-pop doing this for a quick buck?  Who might shut down?  Or work with a nationally recognized company that has the longest history of these installs in the country?  Jirka; you did it again.  I’m glad we still have those 4.1m shares. 

-          How well does he understand business?... “By centralizing functions and eliminating redundant facilities, Corporate Express has improved operating margins by as much as 6%, according to Alex. Brown's analyst Chris Vroom. Such efficiencies are fairly common in corporate mergers across the broad landscape of American business, of course. For Rysavy, however, the most significant changes -- worth an additional 5% or so in improved operating margins -- went well beyond the standard fare. In fact, changes in the merchandising plan and in the computer system effected a complete metamorphosis of the Seattle operation.

Most office-supply companies, including Trick & Murray before it was merged into Corporate Express, give customers a catalog of 15,000 to 25,000 items from which to order. That requires the supplier to maintain a broad inventory, which is costly both because of that inventory's size and because it moves slowly. (The industry standard turnover is about four to eight times a year.) Because most suppliers are small, few of them have the scale to buy much more than half their items directly from manufacturers. Most of their inventory comes from wholesalers, who pass along a hefty markup.

Rysavy brought a far more focused merchandising strategy to the Seattle operation. What the company calls its "in-stock catalog" lists about 5,000 items, not the traditional 25,000. Customers can get everything they need, but the variety within any category is somewhat circumscribed -- perhaps the staplers do not come in emerald green, or you can't get them from every manufacturer that makes them. If a customer asks for a product that Corporate Express does not carry, the company's computer system automatically suggests a suitable alternative from the in-stock catalog. As a last resort, customers can still order from a larger, more traditional catalog, but the prices for those items typically run higher because the company obtains them from wholesalers. About 85% of Corporate Express's sales come from its in-stock catalog.

Many good things flow from that focused strategy. Corporate Express generates huge sales volumes from just 5,000 products, enabling it to negotiate bulk purchases directly from the manufacturers. According to Vroom, the company thereby gains about a 10% cost advantage -- even after passing savings on to customers -- against competitors who must buy primarily from wholesalers. With higher fill rates and lower prices than those of competitors, Corporate Express has grown not just through acquisitions but through double-digit increases in sales.

Corporate Express also gains several big advantages in its inventory. With most orders coming from its in-stock catalog, the company is able to deliver about 99% of all orders by the next business day, a percentage that's far higher than the industry norm and a key element in satisfying customers. At many companies, says Rysavy, "salespeople have to call customers and explain why the order isn't being filled quickly. That adds lots to costs, and it's a frustration for customers."

Rysavy's inventory doesn't stick around long. High volume on fewer products means faster inventory turnover. After it took over Trick & Murray, Corporate Express increased inventory turns from about 8 a year to 16. That produces fireworks on the bottom line: with inventory leaving the warehouse in about 23 days but Corporate Express paying for it in 40, the manufacturers finance not only the inventory but also much of the warehouse operations.

If Rysavy created the merchandising strategy, it was Pavel Bouska who brought the computer system to life. The system confers on Corporate Express a major advantage in the marketplace. Bo Cheadle, a senior analyst with Montgomery Securities, calls the company's inventory-control system the best in the industry. Why is that so important? "The items we sell are tiny in dollar value," says Bouska. "So we can't spend much money processing an order."

Customers can order office products by traditional means -- by phone or by fax -- or through an on-line hookup with the company. In every instance, a computer checks the items in the order against the inventory in the warehouse. If the items are in inventory, as they usually are, the order goes electronically to the warehouse, indicating to employees the location of each item. Another copy moves electronically to the billing department. If any item is not in stock, the system automatically checks the on-line catalogs of two wholesalers, choosing the one with the lowest price. The wholesaler usually delivers the item to Corporate Express the same day.”

Catalyst