Saturday, November 16, 2013

Crocs goes private? (an IPO story)

A company that makes one kind of trendy shoe might not be a good company to invest in.

When I was in Law School, we studied Economics and Corporate law, and I learned a little bit how Corporations work - or at least how they are supposed to.   One thing that puzzled me - and puzzles me to this day - is how a company that pays no dividends, ever, could be worth anything at all, to the small investor.

Our professor explained about "retained earnings" and how a company, instead of paying out dividends (which are taxable as income) could keep these earnings on the books, and thus the value of the company stock would be worth more.   If shareholders sold stock, they would make a profit, and thus pay taxes at the capital gains rate (which is usually lower).

This sounded all nice in theory, but the problem is, most stocks are horrifically overvalued to begin with.   The vaunted "market cap" of a stock (multiplying the stock price times the number of shares) is well above what the actual liquidation value of the company would be - even with these "retained earnings".

Even after the professor's explanation, it all seemed, well, sort of a scam.    And to some extent, we were both right.   Companies that go public and never pay any dividends, really are sort of a scheme, in that to keep the scheme going, it relies on people continually viewing the value of the company as increasing - even if the company will never "pay out" in cash, its actual value, either in dividends or in liquidation.

Crocs, the company (CROX) is poised to go private - again.  The company was founded by three individuals who bought out a Canadian company which made the closed-cell foam shoes.   They brought the shoes to the boat show in Ft. Lauderdale, and the rest was history - at least for a while.

Crocs became a sensation overnight.   People raved that they were good on your feet and that the soft foam design was great for people who worked standing up all day.  Suddenly, it seemed, everyone had a pair.

But the fad lasted only about two years.   And just as suddenly as people started to love Crocs, just as suddenly many people decided to hate them.   They are ugly and weird looking, to be sure.   And they seem to cater to the child within all of us - the one too fat and lazy to tie his own shoes, or even be able to reach down that far.

Crocs and America's Obesity Epidemic were made for each other.

Unfortunately, despite a number of acquisitions of smaller shoe companies, the company never really expanded beyond its original product line - in any significant way.   And so, about six years after its IPO, the rumor is the company will again go private.

Was buying CROX stock a good investment?   Not really, unless you could time the market (that pesky broken time machine, again) and buy it at its nadir and sell at the peak.   The company never really paid a dividend, except in connection with a one-time 2:1 stock split.

The chart below illustrates the problems with CROX:

CROX, unlike a lot of other IPO stocks, did not "pop" out the gate, but took a couple of years to peak in price.   It was hammered in the recession of 2009 and then slightly recovered.   Sales have slacked off, though, and the company wasn't able to expand beyond its single-product offerings.

From Wikipedia:

Crocs completed the initial public offering of its common stock in February 2006. It began trading on the NASDAQ Stock Market under the symbol CROX. On October 31, 2007 the stock CROX dropped from $75 per share to slightly under $40 (its value six months  previously) when the company announced decreased revenue projections. On April 14, 2008, during the midst of the Credit crunch of 2008, the stock dropped 30% in after-hours trading after the company issued a press release in which they significantly guided down earnings estimates for the first quarter. In the same statement they also said they would lay off its 600 Quebec City factory employees as retailers have been reducing orders, though about 100 sales and marketing positions would remain. "The retail environment in the U.S. has become increasingly challenging as consumer spending and traffic levels have slowed," Chief Executive Officer Ron Snyder said. During the financial crisis, CROX dropped to as low as $0.79 before rebounding ($15.50 by November 2010). On October 18, 2011, Crocs stock suffered a single day drop of about 39.4% on lowered earnings and revenues forecast. In June 2013, Crocs reported a 42.5% decrease in net profits from a year before. As a result the stock fell 20.2% in one day.

When the stock went public at the IPO, the IPO Price was $21.  As you can see, the market yawned, at least initially.  However, as the shoes became more popular, people started bidding up the stock - to a high of $75 a share.   The shoes suddenly seemed everywhere, and once again, people confused popularity with profitability.   When something is mentioned in the media a lot, people bid up the stock.

But then the stock crashed, as high profits were not realized.   The crash of 2009 hammered the stock further.  It recovered later on, briefly hitting $30 a share, until it dropped to about $10 a share today.  Quite a roller coaster ride!

Was this a good investment?   If you bought at the IPO price of $21 a share, you are now looking to be bought out at $13 - losing about half your initial investment.  Unless you sold out at $75 a share, or bought at the nadir in 2009, you are poised to lose a lot of money on this stock, or at best, break-even (which is akin to losing money, if you held the stock for eight years).

In other words, the only way you could have "made money" on CROX was to time the market - know in advance when the stock price would peak and valley - and the profit from the losses of other buyers and sellers in the marketplace.   Timing the market is akin to gambling.   Unless you cheated (knew insider information about the profit forecasts) you are just playing with numbers.   And in most cases, gamblers lose.

And the shoe business is murder.   Back in 1968, my Dad looked into buying a shoe company in Paris, Illinois.   The amount of debt he would have had to take on would have been staggering.  And the business was one of margins, even back then.   If you had the right fashions and styles, you might be able to charge premium prices.   Otherwise, you had to compete on price -which means keeping a very tight ship and finding your profits in marginal cost savings.

Since those days, the shoe business has gotten worse.    The Chinese and Koreans control most of the market, manufacturing shoes even for American shoe makers.   Very few American companies make shoes in the USA anymore, other than a few artisan shoe makers and New Balance.  There are no easy profits in shoes, unless, like Nike, you can create a "must-have" shoe and sell it for $200, when the costs are less than $20.

Crocs does have a few Patents on their shoes (Design and Utility) which issued around 2006 (and thus will not expire until about 2020 or so).  And they have used ITC actions to go after knock-off artists who are importing cheap look-alike shoes.   In theory, they should be able to maintain a monopoly on these types of shoes.  But the problem with that business model is this:  The knock-off artists made and sold look-alike shoes when they were trendy and hip.   Once the hip factor wore off, well, they were all to happy to fold their tent and move on to the next hula-hoop.  Patents are of little use for trendy products.

Yes hula-hoop.  I said it.   Have you seen anyone wearing Crocs lately?   If you have, you remember it because they just are not as omnipresent as they once were.  The fad has faded, and it is hard to believe that Crocs will again be as ubiquitous as they once were - except perhaps as a retro fad in 20 years.

So who makes out in this deal?   Well, the founders of the company undoubtedly sold some stock along the way.  Given what they paid for the initial company and what they sold their shares for, they probably made out.   And even at the price of $13 a share, the founders still make out like a bandit.  Out of about 40 million shares of stock, only about 10 million were sold in the IPO, which means the founders and insiders kept about 75% of the company (how foolish, Martha Stewart kept 96% of hers, Facebook kept 95%!).

Why would they go private now?  Sales are down, the fad is over, and the founders want to sell out:

Crocs posted a 2 percent decline in sales for the third quarter, hurt by weakness in the Americas and Japan. The company said it saw less discretionary spending for footwear, apparel and other consumer goods in the U.S.
 "I wish I could tell you we were expecting a big improvement in consumer confidence in the U.S. throughout the year, but we are not," Crocs Chief Executive John McCarvel told analysts on the company's earnings call last month.
The last comment is telling.   Consumer confidence and spending IS WAY UP since 2009, and people are buying more junk again.   However, consumers want the next big thing, not some shoe they already have in their closet, or already had, and found it made their feet sweaty.

           This satirical Kelly cartoon from The Onion came out about the time CROX stock peaked.

For every Groupon, ZipCar, Crocs, or other hyped IPO, there is always Google - the IPO that keeps the true believers believing.  The difference between Google and, say, Twitter, is that Google is a hugely profitable company and has a very rational P/E ratio of 29.69 even though the stock is over $1,000 per share.

To put that in perspective, if Google had Linked-In's P/E ratio, Google stock would be trading at $25,000 a share.

CROX, on the other hand, has a very rational P/E ratio of about 12.   A low P/E ratio, of course, it not always as good as it sounds.   If the company is profitable, people will bid up the stock to a P/E ratio of about 20 or so - as the rate of return mirrors that of the market in general.   However, if people are pessimistic about the future of the company, this may bid the stock price down, and the P/E ratio as well.

But that really isn't of much help to the small investor.   People who "invested" in this stock because they liked the shoes, likely got their ass handed to them on a platter.   The only folks who made out in this stock are the founders, who used the stock to cash out at least part of their investment, and perhaps the Venture Capitalists, who may turn around the company and make money from it.   The big people win, the small people lose.  Maybe a few lucky gamblers win - but a hoard of others lose.   It balances out.

And this is why, as I get older, I am buying more conservative, dividend-paying stocks in traditional ventures - companies that actually make things, earn profits, and pay back their shareholders.   I don't have to sit and wonder why the company's share price spikes and falls - it is tied to the profitability of the venture, not speculation by the marketplace.  And even if the share price fluctuates, I have the consolation of cashing all those nice dividend checks every quarter.

These may not be "sexy" investments, and the shouting guy on the TeeVee never mentions them.  And yes, sometimes "old line" companies like GM can go bankrupt and wipe out shareholders.   But if you held that stock for a number of years, you likely made back your investment in dividends, over time.

I guess the smoke-and-mirrors of non-income stocks is one reason I always sell such stocks when they go up in value.   When AVIS spiked from 74 cents to $20, you can bet I sold half of it.   When my Access National stock, doubled in value, I sold half of it.   Better to get your money back, while you can, than to double-down your bet by seeing how high it will go.

But "bet" is the operative word here.   Buying non-income stocks is really just gambling - gambling that some other chump down the road will think the stock is worth even more than you did - even though neither of you have any rational reason to value the stock as you did.

POSTSCRIPT:   Winn-Dixie and Dell

As I noted in an earlier post, I made some money buying Winn-Dixie stock for about $8 a share and then selling it, when it went private, at $12 a share.   What made me do this?   Well, in the classic sense, I was investing based on familiarity with the brand.  I shopped in their stores and just prior to the buyout, Winn-Dixie shed a lot of its manufacturing facilities and poured money into the stores, updating them considerably.

So, foolishly, I thought, "Gee, this seems like a good stock" and I got lucky when the buyout came a few months later.   Never confuse getting lucky with being brilliant.   This was a classic "struck by lighting" investment, like my spectacular AVIS buy.   But for every Winn-Dixie and AVIS, there is a General Motors, Fleetwood,  CREE, or Syntroleum.   Buying stocks based on the news media is a really bad idea - as I have learned firsthand.

When I say buying Pop Stocks is a bad idea, I say this with the authority of having been there and done that - and learning a few painful lessons in the process.  Compare the Winn-Dixie stock price chart below with the CROX chart above - they are almost exact matches.

Winn-Dixie's Post-Bankruptcy IPO followed a very familiar pattern!

When the buyout came, a lot of people who bought at $20 a share and up were upset, as the buyout was for about $12 a share.  A few people like me made out well, because we bought at the nadir.   We timed the market, but it was more by luck than by design.   Never confuse getting lucky with being brilliant.   The buyout could have been at $6 - or the company could have gone bankrupt again.

I still have a trading account with Fidelity (moved over from e*trade) but I do not do a lot of buying and selling of stocks.   Why is this?  Well, I have a collection of about 50 stocks in that account, and it is sort of like a mutual fund at this point (and often out-performs my actual mutual funds).

Another "Getting Lucky" stock pick was DELL.   Why did I buy Dell?  Well, people were hammering the stock and claiming that since the company didn't have a presence in the tablet business, it was going to go belly-up in no time.   But I thought about it and came to a few conclusions:

1.  Despite the popularity of tablets, there will always be a demand for real computers.  You may be reading this on a tablet, but there is no way I could have TYPED it on one.

2.   Just because Dell isn't big in the tablet business doesn't mean it never will be.   In fact, their new Christmas catalog is chock full of tablets.

3.  The media hypes Apple as the end-all to creation, even though they have a minority share of the marketplace for PCs, Laptops, Smart Phones, and Tablets.   What's more, Apple's market share will again shrink as cheap counterparts to these products become popular.

So I took a flyer on Dell and it paid off.  I invested the whopping sum or $2800 and sold out to management for $4125, making about $1325 in the process..  As you can see, I am a big-time "playa".

Which also illustrates the other half of my philosophy - never place too big a bet on any one stock.  And yes, I said "bet" - because when you are buying stocks, as an individual, you are gambling to a large extent.   Why?  Because no matter how much research you do on a given stock (which is easier today, thanks to the Internet) there are armies of people out there who have done far more research and know a lot more than you or I.

But that is why my stock trading portfolio is less than 1/10th of my overall portfolio - about the same amount I have invested in whole Life Insurance.   The rest is in mutual funds and a huge chunk is still in un-mortgaged Real Estate.

In fact, this trading account originally was invested in mutual funds, and I decided many years ago to roll it over into a self-directed e*trade account, thinking that I could do better than those fund managers - and at least know what I was invested in.   The net result was predictable - I invested in a lot of dumb things early on (stuff hyped on the television) and lost my shirt.  I also invested in some blue-chip and dividend-paying stocks, which seemed to hold their value more.    When my annual dividends came in, it was often enough to buy more stock (which is how I ended up with the Winn-Dixie and Dell stocks, and how I ended up with 50 different stocks in the account).

If I had it to do all over again, I am not sure I would do it all over again - or if I did, I would do it differently.   However, backward-looking investing is never useful, unless you have a time machine - and mine's broken.   So, in reality, you can't go back, and if you did, you'd end up doing the same dumb things.

So if you are going to "play the market" I wish you luck.   Diversify your bets and don't put any significant chunk of your portfolio into stock-picking.   And if you'd rather just invest in mutual funds, don't feel you are being "left out" of the exciting world of stock-picking and IPOs.   Chances are, your mutual funds will do a lot better than your own half-assed picks.


  1. Closed-cell foam, which is used for the soles of most sneakers, does suffer from one big problem - compression.

    I learned about this while writing Patents for Nike. The Nike "AIR" (tm) insert solves this problem by providing an inflated bladder which does not lose its elasticity over time.

    Most ordinary sneakers or closed-cell foam shoes will compress over time, usually within a year or so, to the point where they provide no elasticity, even though they are not "worn out" per se.

    I wonder if Crocs, the shoe, lost its appeal after about two years because they lost their elasticity and compression at about the same time.

    Just a thought. Shoes are made so cheaply overseas these days (for about $10 a pair) - and yet we pay about $100 a pair here in the States.

    The shoe business has always been a racket from the get-go.

  2. Note that just because DELL went private does not mean one can't invest in it. DELL issued a number of BONDS at 7% and above, to finance the buyout. So you can go from shareholder to bondholder, if you want to.

    As I noted in another posting, being a bondholder has its advantages, as if the company goes bankrupt, you end up as a debtor-in-possession, whereas Shareholders end up with NOTHING.

    In most cases, your bond debt would be converted to shares in the new company, if it is not liquidated. If the company is liquidated, you might get some cash back (usually pennies on the dollar).

    Bondholders of bankrupt GM, for example, got a lot more than Shareholders did. Well, anything is better than ZERO, ain't it?

    In this era of no-dividends or low-dividends, some corporate debt is an interesting option.


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