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Internet-Proof Retailer Trading at a Distressed Price Creates Opportunity

Build-A-Bear Workshop Inc. (NYSE:BBW) is an Amazon-resistant, hands-on interactive retailer that allows customers to "make your own stuffed animal" and offers related products. The company is managed in three segments: direct-to-consumer, international franchising and commercial. It operates 371 stores globally and 104 franchise locations. The hands-on, interactive experience makes the company Amazon (NASDAQ:AMZN) and internet-resistant.


Summary

Build-A-Bear is moving the correct levers (productivity, profitability and capital structure) to drive a higher future return on equity and stock price.

It has historical and relative extreme deep-value discounts for sales, book value and gross profit.The stock has declined about 35% over the past 52 weeks.

It is continuing to implement a successful business strategy push toward lower capital requirements and revenue diversification by leveraging the brand. This profitable plan is projected to be fully realized during 2020 and includes the sizable addressable market, growing commercial segment, international and domestic franchising, Walmart (NYSE:WMT) expansion, store within a store concept, vacation spots, e-commerce and other initiatives.

Lower future lease costs and impact on earnings before interest, taxes, depreciation and amortization expansion is material. The opportunity is driven by a 70% expiration of existing store leases over the next three years. Further negotiating strength is from Build-A-Bear as a marquee tenant. The Walmart expansion and store within a store strategy reduce or eliminate many lease expenses.

Year-end tax-loss selling and temporary pressure from opportunistic shorts create a buying opportunity.

A Yelp search shows countless detailed positive reviews from fanatical customers. Parents and kids love the experience. Build-A-Bear's brand awareness is in line with much larger companies without the same market value.

Fundamentals are improving from the company's evolving strategy. Fiscal 2020 should recognize returns from investments and strategy focus versus current extreme negative valuation. The current value is priced for near-term death.

The company also has motivated, shareholder-oriented owners. Insider ownership is around 7%. Board member David Kanen filed a 13D reporting a 9.70% stake. Steven Cohen (Trades, Portfolio)'s Point72 Asset Management reduced its 14% position to 6%.

The capital structure has improved, reducing the share count by 12.50% from December 2014 balance of 17.37 million to 15.22 million in the most recent quarter. Total liabilities over the same period declined by 26.30%, or $114.43 million, as of December 2014 to $84.34 million (excluding long-term leases) for the most recent quarter.

Valuation

The current share price is $2.69, with an enterprise value of $189.30 million, or $58.90 million excluding lease obligations. The market capitalization is $40.94 million.

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Summary comments on the table above include the obvious 15-year low valuations. The current market capitalization of $40.90 million compares favorably to $142.20 million in trailing 12 months of gross profit, $335 million in sales, $81.90 million in equity, $6.20 million in cash and no debt or credit line borrowings. The current tangible and intangible value does not reconcile with -43.01% 12-month stock return trading near a 52-week low for a successful differentiated brand name retailer. Also note the negative attributes of the Altman Z and Piotroski F scores.

Third-quarter 2019 and related valuation commentary

In the third quarter, Build-A-Bear reported sales growth in direct-to-consumer and commercial segments, coupled with improved gross margins. The operating loss improved by $2.3 million. It also reported zero debt, no credit line borrowings and $6 million in cash.

The Build-A-Bear brand has remarkable recognition, with over 90% of mothers being familiar with its services. Further, over 8 million people joined its email club and it has 4 million active loyalty members. Retail locations attracted 45 million visitors and have an added 110 million digital connections.

The profitability strategy includes diversification beyond the traditional retail model. Commercial revenue from third parties requires no startup store capital, rent or labor, coupled with the opportunity to leverage retail in tourist locations. Additional diversification includes shops inside shops and select Walmart locations. These business decisions support leveraging real estate plans and expands the brand to a broader consumer base, with approximately 60% of new shoppers registering for the bonus club. Walmart has 22 locations in operation, with additional locations planned to open during the next fiscal year.

The company's goals are to continue building revenue beyond the traditional retail model, diversify retail locations to broaden consumer accessibility and outbound licensing, wholesale and entertainment. Nearly 70% of store leases expire over the next three years, providing additional negotiating leverage is the Walmart and store within a store relationship.

As of the most recent quarter, 54 locations with third-party retail relationships include Carnival Cruise Lines (NYSE:CCL), Great Wolf Lodge Resorts, Landry's Inc. and Beaches Family Resorts. It also opened its first two locations within a military base. Only the portion paid for the products, supplies and fixtures are reported as revenue.

Additional monetization of the Build-A-Bear brand includes commercial revenue segment, which increased by nearly 20%, and continue to execute against recent agreements tied to entertainment and content development with Warner Music, Sony Pictures, The Hallmark Channel and iHeartMedia (NASDAQ:IHRT). The company expects to realize financial gains from these new entertainment initiatives starting later in 2020.

Conclusion and investment thesis summary

Build-A-Bear is moving the correct levers to drive a higher future ROE and stock price. The evolving brand strategy requires fewer assets, diversifies revenue sources and retail locations.

The 12.5% share count reduction from December 2014 and 26.30% total liabilities over the same period demonstrate the management team is shareholder-friendly and is aware of the critical role capital structure plays for shareholders.

The main short-term risks are continued trouble in the U.K., if the Walmart rollout fails and a further decline in mall locations.

Disclosure: Long Build-A-Bear.

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This article first appeared on GuruFocus.