ByDeep Value One:
TRANSFORMATION IN DECLINE
My Thesis & A Little History
The deep undervaluation of
Trans World Entertainment Corporation
("Trans World") (
) presents a great opportunity for smaller value-focused
investors/funds. The company is a specialty retailer of
entertainment products and was founded in 1972 by its current
CEO/Chairman Bob Higgins. Mr. Higgins is also the largest
shareholder in the company with over a 50% ownership interest.
The company has been buffeted by the digital entertainment
revolution and has been forced to institute dramatic changes to its
product mix, lease portfolio and corporate strategy. These
fundamental changes are now bearing fruit. I believe the stock
market is not valuing Trans World fairly as its equity is trading
below not only its tangible book value but also its net cash
What Has Happened?
The credit crisis accelerated the negative impact of the digital
revolution on the physical entertainment retail business. The
management of Trans World quickly recognized the structural decline
of physical entertainment sales and aimed to cut costs faster than
sales dropped to avoid the fate that befell its specialty retail
competitors. And in this decline, management focused on
transforming the business model to give Trans World an opportunity
to profit as the sole nationally-based entertainment retailer.
It aggressively reduced its store count by over 60% from nearly
1000 stores in 2007 to the current 358 stores. In addition, it
diversified the product mix away from collapsing music sales to the
growing areas of "trend" merchandise (clothing, novelty items,
etc.). Music, which made up nearly 80% of sales in 2000 and over
50% of sales in 2006, was reduced to less than 30% of sales in the
most recent quarter. In the same period, trend & electronics
sales have jumped from 9% to 16% and most recently, to 24% of
Comparable store sales growth
: The transformation has led to a dramatic like-for-like
: Large and consistent improvement as competitors' space for
SG&A as % of Sales
: Substantial reduction in operating expenses as business was
Net Margin/Net Income
: Better product mix in fewer stores has led to a jump in
Where Is The Business Now?
Trans World has stabilized its core business and now is
benefiting from its position as the sole nationally-based mall
retailer of diverse entertainment products. Shelf space for CDs and
DVDs in big-box retailers is shrinking and specialty retail
competition has all but disappeared. This drop in supply is helping
Trans World and allows it to maximize returns as the drop in demand
for physical music and video decelerates. Additionally, gross
margins should continue to improve as its used entertainment
business increases and suppliers continue to support the last
national specialty entertainment retailer.
I believe Trans World's potential will be recognized as it
continues to leverage its lease portfolio and national distribution
network to diversify its product mix. Trans World's strategy of
expanding more into sales of trend and other items as music and
video sales slowly decline should prove to extend its life span far
into the future. With about 300 mall-based stores (remainder are
free-standing stores), Trans World is optimally situated for such
traditionally "impulse" purchases.
What Is The Investment Opportunity?
Currently, the equity market value of Trans World is $113 MM.
The company has $2 MM of long-term debt (a capital lease) and has
not used its line of credit since October 2010. And as of February
2013, the company holds $133 MM of cash. Thus the stock trades at
nearly a 15% discount to its net cash balance.
Cash and inventory comprise nearly 95% of the roughly $305 MM in
asset value. And current liabilities (primarily accounts payables
and accrued expenses) make up about 80% of total liabilities.
Additionally, a substantial portion of inventory can be returned to
suppliers for credit drastically reducing the risk of obsolescence
and large inventory write-downs. The "net-net" value, or current
assets less total liabilities, of the company is roughly $160 MM.
The stock trades at nearly a 30% discount to this net-net
And finally, the book equity value of the company is roughly
$177 MM. Again on the asset side, the balance sheet only shows
value for cash, inventory and minor fixed assets. The company
trades at over a 35% discount to this book value. Notably, there is
no value given for its nationally-based store footprint, its
distribution network or management's proven competency.
What Are The Risks?
There is the risk that Trans World will not be able to manage a
sudden reacceleration of the decline in "bricks-and-mortar"
entertainment sales. However, the management has demonstrated the
ability to reduce costs and store count faster than the drop in
sales. It was able to achieve profitability even as total U.S.
physical entertainment media sales dropped from $41 BN in 2008 to
$22 BN in 2011 (TWMC filings). Additionally, the decline in rate of
music and video sales has dramatically moderated as U.S. internet
adoption has flat-lined at slightly below 80% of the population
since 2008 (Pew Internet & American Life Project Surveys, March
2000 - August 2011).
It seems there is still some time to go before the last CD and
DVD is played. More importantly, the collapse of specialty
entertainment retailers, especially in malls in the face of digital
competition, has created a profitable and uncontested niche for
Trans World. The company is successfully using this tumultuous
period to transition into a broader specialty product retailer.
Another risk is the potential for operating lease liabilities to
limit Trans World's flexibility to manage sudden shifts in industry
conditions. Fortunately, about 75% of its leases are up for renewal
or termination by the end of 2014. Trans World has maintained a
similar lease profile over its history and is a major factor in its
ability to quickly adapt to industry shifts. Management has
demonstrated discipline in avoiding lease arrangements that
threaten profitability. Additionally, the lack of any
nationally-based specialty entertainment retailer has allowed the
company to negotiate favorable lease terms. Mall owners like the
customer diversity that Trans World brings.
Though the management has demonstrated its commitment to
pursuing profitability and investment returns over growth, there
may be fears over future strategy. Firstly, I believe that the
reason that Trans World has survived is that Mr. Higgins is such a
significant shareholder of the company. He is strongly incentivized
to keep the company viable and profitable. Secondly, recent new
store openings (even as net store count has dropped) seem to only
have been done when profitability is immediately assured.
Management has emphasized that this will continue to be their
strategy with new stores. And finally, management has proven that
they recognize the adverse economic realities of physical
entertainment sales and have been very conservative in their
Capital distribution risk:
One concern is that the Chairman (Mr. Higgins) and the Board of
Directors do not pay out the excess cash to shareholders in a
reasonable time period. I have calculated that the company holds
roughly $80 to $100 MM in excess cash as it has not used its line
of credit since 2010 when it had about 50% more stores. However, I
believe this concern is overblown since the Board authorized its
first special dividend of $15 MM or $0.47/share just a few months
ago. In the recent earnings call, management emphasized that the
company's "strong financial position provides [it] many options to
enhance shareholder value." I believe this statement shows their
commitment to returning excess cash. Additionally, large investors
have been agitating for the continuation and acceleration of
significant cash distributions.
I believe that Trans World has several years left to make
significant profits and cash flows for its investors. And as
importantly, it has the flexibility to adjust to more adverse
outcomes without endangering current shareholder value.
In my base case scenario, the decline in music and video sales
is balanced by the growth in trend and other sales with stability
in gross margins and cost ratios. This should allow Trans World to
continue operating its current store portfolio for several more
years. In this scenario, I see profitability continue at recent
levels leading to cash-adjusted return on book equity of about 10%.
If such an outcome prevails, I believe fair value is multiples of
current market value.
In my adverse case scenario, a sudden acceleration in the
decline of entertainment media sales overwhelms the growth in trend
and other sales. In such a scenario, I believe that store closures
will continue but margins should be maintained as Trans World
continues outperforming other bricks-and-mortar entertainment
retailers. However, dollar profits will shrink with sales and
corporate overhead will have to be significantly reduced. I believe
this scenario would force management to pursue a liquidation
strategy. Such a scenario would probably take three to five years
to unfold. Similar to the recent period of drastic store closures,
cash balances should grow as inventory is monetized and stores are
closed. If this outcome prevails, I believe management will
continue paying out large special dividends as the cash balance
builds. The book equity value of about $177 MM or net-net value of
$160 MM becomes a more relevant fair value measure in such a
Overall, I believe Trans World is substantially undervalued by
the market. The last two years of profitability has demonstrated
that there is consumer demand for physical entertainment media and
trend merchandise. Additionally, with no competition in its
specific mall-based niche, Trans World has the potential to
generate several years of sustainable returns. Therefore, the
current below-liquidation market valuation of the company is
unjustified. And I am confident that this discount will be
corrected as the management returns cash to investors and the
market realizes that this retailer has been transformed.
I own/control shares in Trans World Entertainment Corp. ("Trans
World") and will profit if the stock price increases. I may change
my views on Trans World and the value of Trans World's shares at
any time and for any reason. I disclaim any obligation to publicly
notify of any such changes. Although I believe this presentation is
substantially accurate in all material respects and does not omit
to state material facts necessary to make the statements therein
not misleading, I make no representation or warranty, express or
implied, as to the accuracy or completeness of this presentation or
any other written or oral communication it makes with respect to
Trans World, and I expressly disclaim any liability relating to
this presentation or such communications (or any inaccuracies or
omissions therein). Thus, shareholders and others should conduct
their own independent investigation and analysis of this
presentation and of Trans World and other companies mentioned. This
presentation is not investment advice or recommendation or
solicitation to buy or sell any securities. Except where otherwise
indicated, this presentation speaks as of the date hereof, and I
undertake no obligation to correct, update or revise this
presentation or to otherwise provide any additional materials. I
also undertake no commitment to take or refrain from taking any
action with respect with Trans World or any other company.
I am long [[TWMC]]. I wrote this article myself, and it expresses
my own opinions. I am not receiving compensation for it. I have no
business relationship with any company whose stock is mentioned in
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