Many of you might remember Crocs (Nasdaq: CROX) as the growth stock darling that ran up several hundred percent before falling like a stone and nearly having its shares delisted. A bearish collapse like this can become seared in the mind of any trader, causing many to swear off the stock for good.
To be sure, Crocs had some very serious problems that almost put the company out of business. Supply chain issues made it difficult for the company to keep shoes on retailers' shelves, and this was during a period of high demand.
Following its near extinction, shares rebounded from less than $1 in 2008 to a high above $32 in July 2011. Since that time, however, CROX has once again been pressured, falling more than 50%.
The stock has been largely challenged by management's inability to build on its brand. Over the past year, operating margins have been cut by a third as management focused on expanding the company's global footprint. Revenue growth has also been disappointing, with the most recent quarterly report showing a year-over-year sales decline of 2.4%.
So why, with this poor track record, would I be recommending a bullish income opportunity for this underperforming company? The answer lies with the Blackstone Group (NYSE: BX), which recently took an interest in Crocs.
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Blackstone is a private equity firm that has a great track record investing in turnaround stories. The group could be considered an "activist investor" in that it typically makes investments in stocks (sometimes buying out the entire company), and then uses its management skill to make changes. Over time, Blackstone has been successful in helping companies restore profitability, ultimately giving Blackstone a healthy return on invested capital.
Late last year, Blackstone said it was making an investment in Crocs. Specifically, Blackstone was investing $200 million by purchasing convertible bonds. These bonds can convert to shares in three years depending on where CROX is trading at the time. For now, the cash will be used to repurchase shares of CROX, reducing the number of shares outstanding and resulting in higher earnings per share.
The share repurchase may have an effect on the company's share price, but Blackstone's big weapon is actually not the cash injection. Instead, it is the management expertise that it brings to the table. The private equity company has said it will focus on operational improvements and boosting profitability.
At this point, Blackstone appears willing to give up some potential revenue growth in return for higher margins on its existing revenue. This can be done by more carefully targeting marketing dollars, improving distribution strategies and avoiding the costs of store openings for now.
If Blackstone is successful in restoring operating margins from just a year ago, it would result in a roughly 50% increase in operating profits. This increase could have a material impact on shares, in addition to the share buyback program that is already in the works.
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Investors have already responded by pushing the stock higher. Right now, CROX is trading just below $15, and I want to create income with a put-selling strategy. Specifically, I'm interested in selling the March $15 puts, which are currently trading for $0.95.
By selling these puts, we are obligating ourselves to buy the stock at $15, provided it stays below this level when the calls expire on March 22. To satisfy this obligation, we need to set aside $15 a share in capital to purchase the stock. Since we will receive $0.95 a share from selling the puts, or $95 per contract (which controls 100 shares), we need to use only $1,405 of our own capital.
Action to Take --> There are two ways this trade can work out.
If CROX is above $15 when the options expire, we will be able to keep the $95 and have no further obligation. Since we set aside $1,405 of our own capital, this represents a 6.8% profit over the next 45 days. On a per-year basis, this represents a 55% rate of return.
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If CROX is below the $15 strike price when the March puts expire, shares would be assigned and we would use the capital we set aside to buy them. Considering the turnaround opportunity and Blackstone's skill in managing this type of situation, I would be more than happy to take this position.
Also, keep in mind that our net cost for the shares would be $14.05 because of the premium we received from the calls. This means we are getting a 6% discount to the current price, another benefit of this put-selling strategy.
This article was originally published at ProfitableTrading.com:
Turnaround Story Offers Income Traders a Shot at 55% Per Year