Stocks I'm Looking At - Craftmade

I have not been as regular with these pieces as I had originally hoped, so apologies for that.

Craftmade (CRFT.PK) is a stock that I have watched off an on for a very long time, but it slid off my radar during the post-housing bubble implosion. Now I come back and find that it is not even a regular listed stock anymore (note the "PK" that comes with the ticker these days).

Even though this company and stock has gotten knocked around a bit, it looks interesting to me. Still, there is a particular concern I have that I will get to later.

What They Do
First things first - Craftmade is largely in the business of designing home furnishings like ceiling fans, lighting, and patio furniture. All in all, patio furniture was close to 60% of sales in the last 10-K.

Craftmade runs an "asset light model"; the company handles design and distribution, and relies upon Chinese and Mexican manufacturers for that step. Lowe's (NYSE: LOW) is far and away the biggest customer, but the company also lists Bed, Bath, and Beyond (Nasdaq: BBBY), Costco (Nasdaq: COST), and Wal-Mart (NYSE: WMT) as customers. Notably, Home Depot (NYSE: HD) is NOT a customer ... presumably they have some sort of exclusive relationship with one of Craftmade's rivals.


Where They Are At Today
Unfortunately, while the housing crash has been bad news for the company, it is not as though things were great before then. Sales growth has been pretty erratic throughout the last ten years, and I tend to like companies with a much steadier progression.

Still, this is a real business trading for less than book value, even though accounts receivable are 140% of the company's equity.

What really intrigued me about this stock was that the valuation is baking in very little progress or improvement in the business. The company has historically turned about 7% of its sales into free cash flow. If you assume 6% revenue growth for the next five years (the 10-yr avg is about 6.5%), and a free cash flow yield moving from 0% this year to 5% in five years (so, still below the long-term average), 5% free cash flow growth for five years after that, tapering down to 3% and then 1.5%, and discount it at 13%, you get a price target of $10.75.

That is quite attractive relative to today's $5.76 share price, right?

Here is where things get weird.

The Shadow of Litex
The company is being actively pursued by Litex Industries - a private competitor. The history of this is sort of typical - Litex came in with a lowball offer ($3.25/sh), created a lot of publicity, and got rebuffed. Then Litex tried a $5.75/sh hostile tender. That did not work either.

Toward the end of the tender, apparently Litex quietly approached the company and said they might offer more than $7/sh. Craftmade said "no", but offered a confidentially agreement as a precondition to some further negotiations. Litex did not take that offer, and then made a verbal offer for $7.50/sh, which the company also refused.

This is where it gets interesting - apparently Craftmade said they would consider $8.75/sh. Since then, Litex apparently has talked about offering $8/sh, but has not sat down with Craftmade and attempted to meet their requirements.

The Final Question
Okay, I apologize for that digression, but it raises my biggest concern - my model suggests the stock is worth almost $11/sh, but the company is willing to sell for $8.75. Does this mean my estimates are too opimtistic, or is this a case where the board at CRFT would settle for less for the certainty of a deal?

After all, CRFT's business is not consistent, and the company does not produce reliably great ROIC. Moreover, if anything goes wrong in the Lowe's relationship, the company is in deep trouble.

So, I suppose it is back to the drawing board here on valuation. I still think this opportunity is intriguing (even notwithstanding the irritation of a possibly insincere or opportunistic would-be acquirer). But when the board of a company is indicating that the company is worth about 20% less than you initially thought it was, that is certainly reason for pause and reflection.