LQW.TO - Liquidation World

[doc75]

I mentioned this one a while back and the general response was "it's a turd!".  I was more-or-less tempted to agree at the time.  I'm bringing it up again because the story has unfolded quite positively since last mention.

 

Briefly:  I originally got interested in LQW because Francis Chou had put some money there.  I followed him with a (very) small investment because at the time I was a naive copycat.  For the past 5 or more years, LQW has been a "turnaround" story.  It looked like it had turned the corner in 2006, but then the trouble really began.  They've been losing margin & money since.  In 2009 they were taken over by Talon Capital, the principals of which were behind the Big Lots turnaround in the US.  So the new management has positive experience in the close-out space.  This is what originally got me interested.

 

The new plan is three-fold:  (1) focus on better purchasing, so as to increase inventory from rock-bottom levels, (2) focus on merchandising to increase average basket size and margins, and (3) to "rebrand" a number of the stores with a cleaner look and close down non-performing outlets.

 

Parts (1) and (3) require lots of capital, and as a result LQW currently finds itself with some pretty expensive debt. This certainly adds to the risk.  If the plan doesn't start hitting the bottom-line soon, they'll be in some trouble.

 

Despite the plan taking longer than management expected to unfold, there are some recent signs of success.  Gross margins are increasing across the board, and the revamped stores are observing sales increases between 15 and 20%. (I believe older stores are experiencing slight declines in sales.)  Only about 1/3 of the stores have been revamped.  It will be very interesting over the next couple quarters to see if this is just a blip in consumer's curiosity about the fresh new stores, or if the turnaround has any staying power.

 

The shares have rocketed from 0.65 to over 1.20, but I expect them to settle back down since it's been a crazy run in the last couple days. 

 

In any case, LQW may be worth a look... even if the discount/closeout space is a grungy place to be.  Gross margins are approaching 40% and they'll probably do 150M-175M of sales this fiscal year, with a 18-20M market cap and about the same debt.  Negative cash flows are a real concern but are mostly due to quickly increasing inventory, which is part of management's plan.

 

Disclosure:  I have a small position in LQW, average cost around 0.90.

 

 

 

[stahleyp]

It's an interesting idea, but it also looks like Chou has been a seller. He sold off almost 40% of his stake in q2...which the stock then doubled. 

[doc75]

It's an interesting idea, but it also looks like Chou has been a seller. He sold off almost 40% of his stake in q2...which the stock then doubled. 

 

Yes - I noticed that (forgot to mention in my post).

 

I was very surprised to see that he had held onto it for so long and then let go when the numbers had finally started to turn.  Do you know for sure that he got rid of it in Q2?  I can only see his Dec 31/09 and Jun 30/10 holdings in the RRSP fund.  Perhaps he sold in Q1 when he saw that LQW's Christmas season numbers hadn't improved over the previous year. 

 

Or maybe he just needed to raise a little cash to put into Mega Brands. :)

 

Or maybe it will go to zero and I'll forever regret betting opposite to Francis.

 

 

[jjsto]

Where are you guys getting the info on Chou buy/sells?

[stahleyp]

It's an interesting idea, but it also looks like Chou has been a seller. He sold off almost 40% of his stake in q2...which the stock then doubled.  

 

Yes - I noticed that (forgot to mention in my post).

 

I was very surprised to see that he had held onto it for so long and then let go when the numbers had finally started to turn.  Do you know for sure that he got rid of it in Q2?  I can only see his Dec 31/09 and Jun 30/10 holdings in the RRSP fund.  Perhaps he sold in Q1 when he saw that LQW's Christmas season numbers hadn't improved over the previous year.  

 

Or maybe he just needed to raise a little cash to put into Mega Brands. :)

 

Or maybe it will go to zero and I'll forever regret betting opposite to Francis.

 

 

 

Well, it's double since he's sold it. So, maybe you're the next Watsa! ;)

 

I found the information on Morningstar. From what it says there, he sold it by the end of q2.

[Mark Jr.]

I've been watching these guys as well. Their losses have been narrowing and this reads almost like a textbook "turnaround" story.

 

To me they seem uniquely positioned, a rare Canadian company seeing benefits from a stronger loonie: they source their inventory in the US, where the recession / slow economy is hitting harder, and then bringing the merchandise up here and liquidating it.

 

 

 

 

[doc75]

I've been watching these guys as well. Their losses have been narrowing and this reads almost like a textbook "turnaround" story.

 

To me they seem uniquely positioned, a rare Canadian company seeing benefits from a stronger loonie: they source their inventory in the US, where the recession / slow economy is hitting harder, and then bringing the merchandise up here and liquidating it.

 

 

 

 

 

My thoughts exactly.  I think the business model is very sound, particularly with a high $.  The only question is whether they're competent to revitalize the stores and draw more people through.  It requires capital and is a big bet, but it sounds like they're doing a good job.  I only wish I could check for myself.  My local LQW stores are the old-school variety, and they're just damn awful.  The next couple quarters are key.  So far, margins have improved but top-line growth hasn't.  I think it will come...

 

I've been a little concerned about how well management has been compensating themselves for running a retailer that isn't turning a profit.  But the bulk of the compensation is via options, and the CEO really only starts making out like a bandit once EBITDA reaches a certain level.  So I think it's safe to say that the guys running the place are strongly motivated to make this work.  (I've been watching insider trading as best I can, and it appears that nobody has been cashing out on the cheap options even with the doubling share price.  It also appears that Eric Beutel has put another $1 mil in the game.  I regard that as some extra validation of the turnaround plan.)

 

 

 

[Mark Jr.]

I just went through the 2010 Q3 filing. How do all these new shares being issued factor in, they can't be included in the currently reported figures, can they?

 

If you look online, their shares out are reported as around 18 million, which is what I seem to remember it being earlier in the summer when I last looked. However, they did a private placement in June for 2.2M shares and then a whopper in August for 11M shares, that's over 14M newly issued shares? Did everybody else just take a near 50% dilution?

 

The lockup on those 11M shares expires December 6th, if the current bull run continues I would expect a wave of selling into this spike as it would amount to a 50% (or better) gain to all those who participated in the August private placement at .85, not bad for a few month's work.

 

To be honest, my read of the Q3 filing has actually cooled me somewhat. I'm just sensing a focus on investor appetite for newly issued stock, where I'd rather see the focus on consumer appetite for their actual wares. Maybe that's just me being crusty. I need to go look at the Big Lots turnaround to see what Talon did there.

[doc75]

 

Yes - I was not too impressed by the August fundraising.  I bet they weren't either.  Their float was 18M, and they issued another 11.75M at 0.85 when the shares were trading over 1.00.  Moreover, the lead agents walked away with 7.5% of the total funds raised, PLUS another 880K warrants with a strike of 0.95 exercisable for 2 years.  I don't know much about what's usual in these settings, but it seems to me the agents got paid *very* well and LQW took it hard.

 

All that said, their turnaround plan is capital intensive.  If it doesn't work out, then LQW will likely be liquidated itself (in some sort of infinite recursion?).  But if it works then the financing will seem worth it in the end.  In fairness, 0.85 was well above the 52-day trading average of the shares at that point... and I can see how asking someone for money so you can buy a bunch of "stuff" that other people couldn't sell might not go over so well.

 

As for the turnaround...

 

A  huge failure of LQW in its downturn was that stores were running with horridly low/outdated inventory and became messy junk shops.  One part of the turnaround is to refresh stores so they're brighter and more inviting, with better merchandise layout etc. etc.  The other part is actually having something to put on the shelves.

 

On the "messy stores" issue, frankly ANYTHING would be an improvement.  The local stores here are just a jumble of sh*t, totally disorganized, messy etc.  People don't have patience for that.  And they never used to be like that years back when LQW was doing well.  From all I can gather, the new stores are much improved.  Time will tell if the same store sales increases are a one-time wonder.

 

On the inventory improvement issue, I'm less convinced, even though this is supposed to be the new management's strength.  They have indeed improved margins.  But I've been told that all the stores (including the old ones) get the same inventory, and if my local stores are any indication then not much has changed.  It's still full of stuff that looks like it's been there for years, and I don't even know why they bother with all the clothing racks when items aren't even separated between boys/girls!  I hope this is actually a new vs old store thing. 

 

Their web site (lwstores.com) is interesting and not well advertised.  There's lots of stuff that I consider to be junk, but collectibles like Swarovski crystal appear on there and they sell like hotcakes at a big discount.  Electronic gadgets also seem to sell out quickly.

 

 

 

It will be interesting to see where things go.  I think they'll make it work, but my cost base is pretty low and I wouldn't buy more at over $1 until I see more progress and committed leadership.  I expect shares to trend down pending a substantive progress update. 

 

 

 

[Mark Jr.]

Well it seems to have broken out this week on 10X the average daily trading volume the last four days, picking up about 35%. I went in last week at 1.05 but since I timed my entry using technical indicators, I didn't think anybody here would be interested in hearing about it.

[doc75]

Well it seems to have broken out this week on 10X the average daily trading volume the last four days, picking up about 35%. I went in last week at 1.05 but since I timed my entry using technical indicators, I didn't think anybody here would be interested in hearing about it.

 

I planned on buying more the next time it went under $1, but didn't have an order in and missed it before the steep runup. 

[doc75]

I figured I should give an update here:  Just look at the chart and you'll barf.

 

I dodged a bullet and got out after seeing their margins get killed last quarter.

 

LQW announced yesterday that their Q1 numbers (typically the strongest, with Christmas season) amount to a loss in the $6M range.  Based on their revenue figure, their Q1 margins were also hideous.  They recently announced another financing --- $7M of convertible debs at 10%, with a conversion price based on recent trading range (hence plenty more dilution possible).  Yesterday they announced they're looking into additional financing, or acquisition or divestiture, after noting "interest in the Canadian retail landscape". 

 

Interesting that the management crew here has history at Big Lots... and Big Lots is also in play:

 

http://www.bloomberg.com/news/2011-02-10/big-lots-in-play-poised-to-bring-1-billion-shareholder-windfall-real-m-a.html

 

 

[Uccmal]

I took a really close look at this one just after Christmas.  Even went into one of their renovated stores and saw lots of junk.  I even made a purchase and felt kind of sorry for the cashier who also has to stock shelves. 

 

The proxy circular is what really turned me off though.  I forget the numbers exactly but the bonuses that would go to the CEO and CFO added up to 1/3 of net profit if the profit exceeded 1-2 M.  The result was that for profits up to 6 million a dead zone was created for shareholders.  If you back this number out - 6 m - you realize that they will never sell enough with post 2006 margins to reach it.  Their margins cratered and I think it has to do with the Walmart/costco/Winners/Canadian Tire effect.  Everyone of those chains sells the same stuff and is vastly busier, and the price differential is not enough to make a difference. 

 

They dont own their locations so there is no asset in the business so when the shares go to zero that is really zero.  The inventory on the balance sheet is worth probably 30% less in a resale situation if they bankrupt since they will suddenly flood the markets with more junk.  I was willing to overlook some of these issues but the pay to the CEO.CFO was the real kicker to me.  It was obscene and shareholder unfriendly.

[doc75]

I took a really close look at this one just after Christmas.  Even went into one of their renovated stores and saw lots of junk.  I even made a purchase and felt kind of sorry for the cashier who also has to stock shelves. 

 

The proxy circular is what really turned me off though.  I forget the numbers exactly but the bonuses that would go to the CEO and CFO added up to 1/3 of net profit if the profit exceeded 1-2 M.  The result was that for profits up to 6 million a dead zone was created for shareholders.  If you back this number out - 6 m - you realize that they will never sell enough with post 2006 margins to reach it.  Their margins cratered and I think it has to do with the Walmart/costco/Winners/Canadian Tire effect.   Everyone of those chains sells the same stuff and is vastly busier, and the price differential is not enough to make a difference. 

 

They dont own their locations so there is no asset in the business so when the shares go to zero that is really zero.  The inventory on the balance sheet is worth probably 30% less in a resale situation if they bankrupt since they will suddenly flood the markets with more junk.  I was willing to overlook some of these issues but the pay to the CEO.CFO was the real kicker to me.  It was obscene and shareholder unfriendly.

 

Thanks for the notes.  I came to some of the same conclusions, though I should have more careful than I was with CEO/CFO remuneration.  (I'm so often amazed by this that I guess I got complacent.)

 

I was lucky to make good money and get out with the horrid margins last Q.  I discovered this Christmas that it was exactly the same junk inventory at the new stores as the old stores... and then I heard a quote from someone in management who proudly proclaimed they would buy "anything" (as inventory) if the price was low enough.  Since Christmas they've been having "80% off" clearance sales, so they're pretty desperate to clear some crap away.

 

I'm not sure if it was the Walmart effect that killed this business, or if they simply got crowded out of the liquidation/closeout space by bigger players like overstock (in terms of their purchasing ability).  It still seems to me there is a viable opportunity in this space, particularly with a high $. 

 

Long in the past, I could routinely find very good deals on reasonable quality products at their stores; it was true closeout inventory, not mass-purchased junk.  On an early CC this management team even indicated that they had to get back to the "roots" of being a closeout retailer.  Seems they've changed their minds.

 

Anyway... onto the scrap heap it goes!

[Mark Jr.]

Yeah, it looked interesting for awhile, but I think what has happened lately is the stock was "run up" ahead of the lockup expiry (December 18th I think) on that highly dilutive financing and those shares are being sold off.

 

I don't have confidence in management and think those financings last year were pretty one-sided.

[Mark Jr.]

Funny, I got my copy of Mohnish Pabrai's "Mosaic" today and I randomly flipped it open and there's Liquidation World, cited in his essay "The Sure Bet of Corporate Morticians". I think I read here somewhere (on this board) that he had long ago exited LQW.

[Mark Jr.]

What an ignominious end to the long odyssey. Liquidation World to be purchased by Big Lots for 6 cents / share + assumption of debt.

 

http://www.reuters.com/article/2011/05/26/us-biglots-idUSTRE74P35720110526?feedType=RSS&feedName=globalMarketsNews&rpc=43

 

Is this completely kosher?

 

Didn't Seth Marks used to run Big Lots? And then his own Talon Capital lent money to LQW, they did those highly dilutive financings which seemed to run the stock price up, then seemingly on cue, as soon as the lockup on those private placements expires: the price tanks. Now Marks' former company buys  his present one, and assumes the debt owed to his financial company?

 

Am I the only one who finds this disingenuous?

[Uccmal]

Almost illegal wouldn't you say?  Hopefully everyone dodged this one.

 

I wonder if Mr. Marks has ownership stakes in Big Lots that enable him to swing this deal? 

 

I am guessing that LQW is in for liquidation rather than refurbishing.  1.8 Million plus debt is probably covered by inventory.