Commentary

Summary

• FIVE’s valuation multiples are higher than historical multiples of other successful concepts in their growth phases. We compare FIVE’s multiples to those of several brands highlighted by a sellside analyst
• Morgan Stanley’s initiating coverage report last week is relatively bearish. Given lack of secular growth drivers and valuation above high-growth peers, MS does not believe FIVE’s current valuation is compelling
• Teen retail faces numerous headwinds, with too many specialty retailers competing for teen discretionary spending. Many teen retailers are closing stores and trying to recover from SSS declines in 2013
• FIVE will face increasing threats from e-commerce. It has mistimed its plans to build a national brick-and-mortar business as the industry experiences a paradigm shift towards consumers shopping more online…

As we described in our last article, Five Below (FIVE) trades at too high of a valuation for a discount retailer with mediocre same-store sales growth, average margins, and an insufficiently differentiated business model. The company’s current valuation of $2.0 billion is far too high for a retailer that generated only $76m of adjusted EBITDA over the last twelve months. We think it’s highly improbable that FIVE can meet the very lofty expectations that are built into the company’s sky-high 50x LTM P/E multiple…

We believe that Five Below (FIVE) is highly overvalued. FIVE is a specialty value retailer that offers merchandise targeted to teens, pre-teens and their parents in a concept that we view as a glorified dollar / toy store. Its valuation multiples of 3x+ LTM revenue and 25x LTM EBITDA are far too high for a company with mediocre same-store sales growth operating in the brutally competitive discount segment of the retail industry. Same-store sales growth (SSSG) has declined dramatically over the past three years, with SSSG for Q4 2013 falling to an anemic 0.4% and overall forward year guidance projected to be a modest 4%. Additionally, we expect the company’s long-term margins to be pressured by the wave of competition flooding the discount retail sector, whether it be due to the 5% to 7% annual unit expansion of Dollar General, Dollar Tree or Family Dollar, or the 2,000+ Walmart Express small-format stores expected to open over the next five years; additionally, discount retailers rarely boast impressive profit margins due to their lack of brand name products. Finally, FIVE’s catalogue is biased towards trendy/fad items that are targeted for a fickle teenage demographic and its sales are disproportionately weighted towards the holiday season, factors which both translate to increased volatility in year-to-year results…

Summary

• BOFI’s recently announced, widely expected acquisition of H&R Block’s bank deposits boosts its earnings but does not address the long-term pressures that will drive down the company’s currently inflated profitability. At almost 4x book value, as we have previously argued, BOFI’s super-premium valuation remains unwarranted.

• At least five serious bidders besides BOFI vetted the H&R Block transaction, yet BOFI emerged as the winner despite a complete lack of cost synergies. We question how valuable an asset the H&R Block business can be when no one was willing to pay a single dollar for it.

• One of BOFI’s responsibilities under the new agreement is to serve as the issuing bank for H&R Block’s prepaid debit card. Looking at the two major issuing banks already operating in this space supports our concerns about BOFI’s high valuation and unsustainable earnings: they trade at half of BOFI’s price-to-tangible-book-value multiple, generate 35% lower net interest margins, and earn almost 50% lower returns on equity. In a highly competitive market in which BOFI has little experience, its returns should be weaker than those of the leading players. This peer comparison again highlights the fact that BOFI is over-earning and will suffer long-term deterioration in its NIM and ROE…

It’s been a sensational year for investors in Plug Power (PLUG), with shares rising from pennies to more than $10. But now, it appears the party has ended, as investors are starting to cut through the promotional hype that has enveloped the company to rediscover the business’s less than promising fundamental outlook. We expect shares to continue declining sharply in coming weeks. In particular, it’s hard to imagine a company that no one wanted to buy at 15 cents a share last year is now worth $7.50. Plug Power, contrary to the bullish hype, faces severe competition, has a weak and unproven business model, and likely lacks in the research capability to innovate its way out of its current precarious financial situation…

As we have written in prior articles, we believe that Unilife (UNIS) does not have a viable business model, will never generate meaningful revenue, and is highly overvalued at what is now a $580m market capitalization.

Over the past week, two new developments reinforced our thesis. First, its Chief Financial Officer resigned, most likely because he wants to monetize his shares while they still have value and to sever ties with Unilife before its product claims are shown to be overhyped. Second, the company entered into a debt financing agreement last week that not only provides additional support for the company’s bleak business prospects, but also saddles the company with onerous debt that will accelerate the Unilife’s demise…

It’s certainly been a year to remember for investors, with the benchmark S&P 500 up 30%, the tech-heavy NASDAQ-100 up 37%, and many sectors, including cloud computing, rising further yet. Last year provided great opportunities to make money, as every dip in the market has been an excellent buying opportunity.

But the tech euphoria has gotten out of hand in certain sectors. In many ways, the investing community seems to be repeating its mistakes from the irrational exuberance of the late 1990s. Many investors are buying stocks not due to fundamentals, but rather due to sexy-sounding stories of future growth combined with momentum: as in that previous internet tech era, people are again buying stocks principally because the stocks are already rising and have garnered investor enthusiasm…

Yesterday, ServiceNow’s (NOW) largest shareholder, Sequoia, filed a Form 4 disclosing its first major divestiture of NOW shares.  The May 1st filing discloses a 6m share distribution that Sequoia quietly made to its limited partners on Monday (April 29th). This reduced Sequoia’s stake to 18.3m shares and transferred ownership of the 6m shares to an assortment of pension funds, endowments, and fund-of-funds that make up Sequoia’s limited partner base. While a direct share distribution partially absolves Sequoia from market timing decisions, it can place heavy selling pressure on a stock. This is because limited partners are typically not equipped to analyze individual public securities, preferring to instead sell shares immediately upon receipt. Since Monday’s 6m share distribution, NOW’s share prices has fallen by 7.8% on an average of daily volume of 2.4m. It can then be argued that this abnormal volume and price activity is the direct result of Sequoia’s distribution. As Monday’s distribution only represented 25% of Sequoia’s total ownership stake, additional forced selling may lie ahead…

Over the past few weeks, we’ve shared our EZCH investment opinion in a pair of articles, outlining our belief that EZCH’s $717m market capitalization, 8.0x 2013E revenue multiple, and 32.7x 2013E GAAP P/E (adjusted to include $0.39/share of stock-based compensation) are wholly unjustified. The Bull case depends on EZCH growing well in excess of the overall router market thorough 2016, a challenge we believe is unrealistic given an avalanche of near- and long-term business risks. Customer concentration is dangerously high, newly introduced competition from Broadcom could pressure design wins, Huawei’s recent order delay proves that in-house design risk is ever present, and weak end-market demand will pressure EZCH’s self-imposed 30% revenue growth hurdle (slide 8). To justify EZCH’s almost 2x valuation premium to the S&P 500, it must overcome this hurdle each and every year through 2016. Most EZCH investors discount these risks, instead trusting a management team that has over-promised and under-delivered for years, growing the revenue by just 11% annualized between 2009 and 2012. But since some took the time to reply to our article, we feel a response is due…

Mellanox (MLNX), a stock that we’ve previously written up as a short recommendation, announced disappointing Q4 2012 results yesterday and gave catastrophic Q1 2013 revenue guidance. Though the stock initially dropped 22% after hours to $41, MLNX shares eventually rallied to $51 signifying a mere 1.4% decline for the day. Given three quarters of massive revenue declines ($157m in Q3 2012, $122m in Q4 2012, and ~$80m for Q1 2013) this is a stock that should be trading at a much lower level. With analysts having issued downgrades en masse and no longer supporting the stock with blind optimism, MLNX should reverse its intraday gains and fall to the $30s…

In September, we will be giving a presentation at the 6th Global Forum on Investing in Distressed Debt on the topic of “Distressed Debt Activism In The Age Of Electronic Media”. We’ll focus on how activist investors in distressed situations are increasingly using internet communication to achieve faster and more meaningful impacts on their targets.

Given that we publish an active blog, we’ll also write posts on the case studies that we’ll be profiling at the conference. We will discuss three examples where the internet has allowed distressed activists to share their analyses with a broader audience, recruit new investors and ultimately increase pressure on their intended targets. Our first case study, which we will profile in this post, is the battle between Pershing Square, T2 Partners and Hovde Capital over…