How to invest

It’s 2am and you can’t sleep. You get up, go to the kitchen, grab a drink, turned on the T.V., flip through the channels and come across someone rotating their torso on the latest ab machine. You tell yourself to turn it off, but your brain is numb and hypnotized and you just keep watching those abs crunch..

24hr home shopping – that’s the name of the game for ValueVision Media Inc (VVTV), so grab yourself a cuppa because this analysis is a loooong one.

(You can also skip the whole business part and go straight to the valuation)

Business Summary

VVTV operates in television home shopping, e-commerce, direct mail and online marketing. The company’s live 24 hour every day television programming is distributed primarily through cable and satellite affiliation agreements and the purchase of month to month full and part time lease agreements of cable and broadcast television time.

In addition, VVTV distributes its programming through a company owned full power television station in Boston, Massachusetts. It also markets and sells an array of merchandise through Internet retailing websites, www.shopnbc.com and www.shopnbc.tv.

The company has an exclusive license agreement with NBC Universal (NBCU), for the worldwide use of an NBC branded name and peacock image through May 2011.

The products sold through the company’s electronic media segment is made up of jewelry, watches, computers and other electronics, housewares, apparel, health and beauty aids, fitness products, giftware, collectibles, seasonal items and other merchandise.

Growth Strategy

Congratulations, you’ve made it past the boring business summary. The way you felt as you read that first section pretty much sums up the business. Frustrating, boring, no growth.

The truth is, home shopping is just so…. 80’s. No wonder the company has been operating at a loss for the past 6 years and that probably won’t change anytime soon.

Although the company is undergoing a restructuring, I don’t believe the amount of fat trimming will be enough to produce a consistent yearly profit. The company has reduced its workforce by 10%, consolidated its distribution and fulfillment operations into a single warehouse and closed a retail outlet store.

“The company’s organization structure was simplified and streamlined(??) to focus on profitability.”

I don’t see this as anything more than just cost cutting from external pressures.

But surely there must be a company or growth strategy, right?. Here is what the quarterly report had to say:

• optimize mix of product categories offered on television and the internet in order to appeal to a broader population of potential customers
• continue the growth of the internet business through the innovative use of technology and marketing efforts
• obtain cost-effective distribution agreements for our television programming with cable and satellite operators, as well as pursuing other means of reaching customers such as through webcasting, internet videos and internet-based broadcasting networks
• increase the productivity of each hour of television programming by focusing on ways to maximize margin dollars per hour and increase the number of customers within the households
• enhance our television broadcast quality, programming, website features and customer support
• leverage the strong recognition of the NBC brand name
• change the product mix to focus on the female, repeat-purchaser core customer. Reduce high ticket items such as electronics that drives one time customers, but not repeat business.

Of the six strategies, I am dismissing all of them but the last one. I could be blind, but I don’t see anything that Amazon, Google, Home Shopping Network or any other retailer hasn’t already done.

Competitive Moat

If VVTV was a true retailing business, it’s competitive advantage and moat would be nil. However, VVTV is also a broadcaster with its network as its main assets. Nevertheless, competition is a nightmare. It may have the assets of a broadcaster, but the market in which it competes consists of brick and mortar stores, discount stores, warehouse stores, other television home shopping networks, internet retailers, infomercial companies, catalog and mail order retailer and other direct sellers.

Its main competitor however is QVC Network and Home Shopping Network. Both these competitors are much larger in terms of revenue and customers and reaches a broader range of households. VVTV reaches 72 million households.

The average selling price, or ASP, per unit was $224 in the 2008 second quarter and $233 in fiscal 2007. This is about 4x higer than its bigger rivals, but it also means there are more high ticket one time purchasers than repeat customers.

Bottom line – No moat in retailing. Narrow moat in the network business due to the high costs of startup.

Risks

• A majority of VVTV’s cable and satellite distribution agreements are due to expire at the end of 2008

If VVTV is unable to get favorable terms for a new distribution agreement, extra contract fees could eat away at the cash supply.

• History of losses and high fixed cost operating base.

With this company, a loss is more likely than a profit. However, if a majority of their customers switch to digital, operating costs should go down.

• The company may be required to issue warrants to purchase a substantial number of shares of NBCU in 2008 and 2009 for renewals or extensions of cable and satellite distribution agreements.

A specific number on the warrants is not provided, but if does happen, shareholder dilution will be high.

• GE Equity and NBCU hold the largest stake and controls a lot of what goes on

• VVTV has to pay in cash, the class A redeemable convertible preferred stock issued to GE Equity which has a redemption price of $8.29 per share.

Since the current stock price is 50c, there is no chance that these preferred stock will be converted to common stock. If GE Equity redeems it for cash on March 8, 2009, the cost of all the preferred stock is $44 million. Bye bye cash, hello debt.

Management

From the current state of the company, I can only deduce that management is not in touch with the operations of the business. To get to the point where the company is worth less than its office building is just astonishing.

Insider ownership is at around 5% which is a decent number but it is mostly all through stock options. Even at such fire sale prices, no one seems to be interested in buying.

In fiscal 2007, the company bought back 3.6 million shares amounting to $27 million at an average price of $7.46. I like that management is spending the money to repurchase shares rather than squander it on useless attempts to gain profits.

On Sept 11, 2008, the board of directors announced it had appointed a special committee of independent directors to review strategic alternatives to maximize stockholder value. The key words here are “announced” and “review”. This implies talk without action for the time being.

My views seem to be correct as expressed through this letter by J. Carlos Cannell to the board. In the Oct 27, 2008 letter, Cannell asked that the board declare a $1.20 special dividend to shareholders so that he could liquidate his position rather than live with the current board.

But this is unlikely as

“pursuant to the shareholder agreement we have with GE Equity, we are prohibited from paying dividends in excess of 5% of our market capitalization in any quarter.” – quarterly report.

Valuation

On November 2, 2007, a fund manager by the name of Jaime Lester of Soundpost Partners wrote a letter to management in which he concluded that the current share price of $4.68 was underpricing the company and he believed the value to be around $6.

On September 24, 2008, fund manager J. Carlo Cannell of Cannell Capital LLC also submitted a letter stating that the current share price of $2.20 was severely underpriced. Cannell also believes the company to be worth closer to $6.

So let’s take a look at a couple of metrics on which we can valuate the company. Keep in mind, with these broadcasting companies, it’s important to calculate their cash flows and assets rather than earnings.

1. Sales from Full Time Equivalent households (FTE; households receiving 24hr programming)
2. Net Net Working Capital and tangible assets

Sales Per FTE

A quick way to look at VVTV is by their net sales per FTE. VVTV reaches 72 million households with the average net sales being $7.92 per household. But since people are not spending much nowadays, I’ll assume a low ball net sales of $4 per household. Even this low figure gives a value of $288 million (4×72=288) to the network, which is still 16 times more than its current $18 million market cap.

Net Net Working Capital and Tangible Assets

Net Net Working Capital = Cash and short-term investments + (0.75 * accounts receivable) + (0.5 * inventory) – total liabilities

The following numbers are from the latest quarterly report on August 2nd with adjustments to fit the above formula.

ValueVision is currently being sold for 30% of its cash holdings and 32% of its NNWC value which satisfies Ben Graham’s huge 66% margin of safety. This is rarely achieved. The NNWC per share value is $1.65 compared to the stock price of $0.53.

However, the NNWC does not include ValueVision’s main assets which is its FCC license, NBC license and its owned property.

Let’s assume the property of ValueVision was affected by the housing crisis by 20%. Reduce the $25 million quoted by Mr Jaime Lester in his letter by 20% to give the office real estate in Minnesota a value of $20 million. Add in the FCC, NBC license and property to NNWC to get the following;

The current market cap is currently only 15% of its low end value. Unbelievable.

Opinion

The company’s fundamentals and its industry is unattractive, growth isn’t something to rely on, its moat is very narrow, it is risky in the short term due to its obligations, and management seems slow to react. However, all this bad news has already been heavily factored in. The current market cap is worth less than its property or licensing or network or cash. From the market’s point of view, VVTV is doomed to fail.

With no long term debt, this is a true asset play with a potentially huge upside if given enough time. But even if it doesn’t, current valuations and prices indicate a fire sale even if the company was to go bankrupt.

A company being mispriced for 15c to the dollar, you don’t see this very often.

I see a big, fat, straight pitch coming my way.

Disclosure

No positions in any stocks as of this writing.

[tags]VVTV, valuevision, stock analysis[/tags]