Saturday's Wall Street Journal [subscription required] featured a must-read interview with Stephen A. Cohen. Cohen heads S.A.C. Capital Management (SAC), a $10 billion hedge fund. His net worth is estimated at $3 billion and since 1992 SAC's biggest fund has averaged a 43.5% average annual return after subtracting a 3% management fee and 50% of the profits -- far more than the 2% and 20% charged by most managers. Moreover, in the last two years Cohen earned $1 billion, some of which went to expand -- to 32,000 square feet -- the house on his 14-acre Greenwich, CT estate.
SAC's most recent bet is on arts and crafts. Specifically, on August 16, SAC filed a 13-G with the SEC announcing that it had acquired a 5.3% stake (1.05 million shares) in AC Moore Arts & Crafts Inc. (NASDAQ: ACMR). (In a quarterly filing earlier this year SAC owned 52,000 shares). ACMR operates 114 arts and crafts stores in the Eastern US and on July 20 it posted a second quarter loss of $1.8 million -- which included expenses for employee stock options, recruitment and severance -- compared to a $50,000 loss in the prior year. Revenue rose 14.4% to $129.8 million from $113.5 million the year before and same-store sales climbed 3%.
Why would SAC buy into this money losing company? (If I really knew how Cohen makes investment decisions, the square footage of my home would be much closer to 32,000.) But my guess is that there are three reasons: timing, undervaluation, and seasonality.
Let's look at each in turn:
- Timing. Cohen has traditionally held stocks for a very short period of time. However, one analyst calculated that when his stake exceeds 5%, Cohen holds the shares for 11 to 14 months. If Cohen does this with ACMR and he purchased his shares in early August at, say, $15; then he already has an unrealized profit of 25% (ACMR rose 5% last Friday on no news I could find). Moreover, the day Cohen's 5.3% ACMR SEC filing was made public, August 29, the stock rose 4%. If we are assuming that Cohen has not taken his profits already, this begs the question of why he would invest in a money losing company.
- Undervaluation. When ACMR was trading at $15, it looked undervalued. Six analysts covering the stock expected ACMR to earn 63 cents a share in 2006 and 91 cents per share in 2007. This 44% earnings growth might warrant a P/E of 44 (assuming a Price/Earnings to Growth (PEG) ratio of 1). When ACMR traded at $15, its P/E on 2006 earnings was 24 and at its Friday close of $18.92 its P/E was 30. This would yield an ACMR price target, assuming the earnings estimates are correct, of about $28.
- Seasonality. A quick peek at ACMR's earnings history suggests that it tends to make its money for the year in the fourth quarter. For example, in 2005 ACMR made 53 cents a share in the fourth quarter and lost 13 cents a share in all the other quarters combined. (Memo to ACMR's board: look into shutting down the operation for the first nine months of every year.) For 2006, ACMR is forecast to lose 5 cents a share in the current quarter and make 71 cents a share in the fourth quarter -- a 34% pop over 2005. It's possible that investors not familiar with its seasonal pattern may have oversold the stock on ACMR's traditionally weak spring and summer results.
There are plenty of risks here -- ACMR has $23 million in debt (albeit a modest debt/equity ratio of 13% compared to 46% for the industry) and its cash balance declined 47% from $47 mm in the first quarter to $25 million in the second. Furthermore, the earnings forecasts I cited could be overly optimistic.
But if this analysis is correct, then ACMR still has about 48% more to go before it would be fully valued -- leaving Cohen with enough profit from his arts and crafts bet to defray some of the costs of keeping his Greenwich estate in tip-top shape.
Peter Cohan is President of Peter S. Cohan & Associates, a management consulting and venture capital firm, and a Professor of Management at Babson College. He has no financial interest in A. C. Moore.
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