Paul Foster says that options activity in salon company Regis Corporation (NYSE: RGS) indicates the stock is likely to have non-directional price movements over the short-term, following the company's announcement of a stock and debt offering. That could very well be true, but I think the short-term is overanalyzed, and the long-term story here is much clearer -- and Regis offers two important lessons about how to better-analyze the financing and operations of a company.
I was first introduced to Regis about a year ago, when the stock was part of a portfolio of about 35 positions I inherited responsibility for. As I went through the holdings and segmented them out into categories of attractiveness, Regis was consistently ranked near the bottom. The industry itself was unattractive, and the way the company implemented its strategy seemed to leave it particularly vulnerable to adverse financial markets.
Regis' problem, from my perspective, was that the company's debt-funded growth strategy had over-levered the company to a low-to-middle class market at a time when consumer spending was going to fall off a cliff. Regis had more than $300 million in debt that was due to be rolled over, and the credit markets had seized. The company's credit rating had been cut to speculative grade, and at a time when "tangible common equity" was still in its early stages of becoming a buzzword, Regis' was negative.
The equity offering priced by the company will raise over $140 million, and the convertible debt offering will raise another $150 million. Those two measures give the company an adequate liquidity cushion, and should boost tangible equity into the positive -- but at what cost? The total shares offered is over 30% of the previous base outstanding, and that doesn't include the effects of the convertible, which brings the total closer to 50%. It's serious dilution, and is the reason the stock has fallen more than 30% this month.
As Regis works to correct its poor financial structure, the nagging issue of operations remains. Although a hair salon might seem like a simple business, the actual profit center is less clear. Inspecting Regis' earnings break-out shows that the actual profit comes not from cutting hair, but from selling hair care products in the salons at extremely high markups -- often 100%. This is a business model, then, that is extremely exposed to consumers becoming cost-conscious.
The capital raise may have bought time, but it still doesn't help that Regis is in a highly competitive business that doesn't really allow for great returns. Unless and until there is evidence that high-end hair care products continue to sell well at a company that increasingly geared itself toward lower-earning customers, investors should remain highly suspicious that this stock won't give their portfolio value a haircut as well.
James Cullen also edits and writes at CollegeAnalysts.com. He has no personal position in the stocks mentioned above.
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