Tweeter Home Entertainment
By Max Olson
Much of the information in this article is now out of date as the situation regarding the company has changed rapidly. The author, Max Olson, submitted this update to precede the original text. It is the policy of this site not to delete any article simply because of subsequent events; this policy can lead a careless reader to assume the current situation regarding a stock or company is similar to the situation as described in the article. Please do not make this mistake. Thank you.
- Geoff Gannon, Editor "Gannon On Investing" (Dated: June 12, 2007)
Added Comment From the Author:
"On June 11, Tweeter Home Entertainment announced they would be filing for Chapter 11 bankruptcy. With the amount of money they were already losing, and the most recent financial burden of the store closings (getting out of leases, etc.), it was inevitable that something had to be done. Whether that came in the form of new financing arrangements, Chapter 11, or a complete restructuring, was unclear at first. Hopefully while in bankruptcy, and with the new $60 million credit facility from GE Capital, Tweeter will be able to turn itself around and emerge as a much leaner, money making operation. I also hope that management gets their act together and finds a successful strategy without having to compete head-to-head with the bigger home electronics retailers. If not, I would love for a distressed investor to come along and do what Eddie Lampert did to Kmart when it was in bankruptcy."
(Dated: June 11, 2007)
Original Article:
Tweeter Home Entertainment (TWTR) recently announced it will sell one third of its 153 retail stores and lay off over 650 workers. Although such cuts are never good news, these actions may constitute a necessary step for Tweeter to take to further its turnaround effort. With a 2006 net loss of $0.66 per share, Tweeter needs to be as lean and competitive as possible. The company hasn't turned a profit since 2001; clearly something needed to be done.
Management still has a lot more to do to turn things around, and I blame them for Tweeter’s poor performance in recent years. They are not as bad as some others I've seen. They just seem stuck on the idea that people will keep coming to their stores for all their home entertainment needs, regardless of price. A sign in their store reads: “Price should never be a reason to not do business with us.”
Carving a Niche
When you have places like Costco (COST), Best Buy (BBY), and Circuit City (CC) undercutting them on TV prices, it's hard to convince customers to buy from Tweeter. The company can’t compete with the category killers and discount retailers on price. A quick online example: A Panasonic 50” Plasma HDTV is on sale at Tweeter, Best Buy, and Circuit City where it sells for $2,498, $1,999.99, and $1,999.99 respectively.
Just because you can’t win on price doesn’t mean you’re dead in the water. Many customers would be willing to pay more for the same products at Tweeter, if Tweeter provided much better service and helped customers solve their problems. This is how Tweeter differentiates itself: by offering consumers an enriched experience, expert information, in-home installation, and an assurance they will be taken care of in the future.
Walgreens (WAG) can price consumer durables at much higher prices than their equivalents at Wal-Mart (WMT) and Costco because they give customers something the discounters don't: convenience and speed. Someone who needs a prescription in the middle of the night or a tube of toothpaste isn’t going to make the trip to a discount superstore when there's a Walgreens right around the corner. But, this kind of “service” differentiation only goes so far.
Paying an extra dollar for toothpaste isn’t bad. But, when you’re shelling out a couple grand on a flat-screen TV, saving $500 means a lot. Some home entertainment buyers would like the extra service and knowledge that comes from buying at Tweeter. But, apparently the cost of providing this service is more than the premium charged for that service.
In an article announcing the store closings, the Associated Press wrote:
"[CEO Joe] McGuire said Tweeter wants to focus on its strengths, which include seven new ‘playground stores’ featuring simulated home room setups displaying high-end equipment in various installation possibilities."
Read "Tweeter Opens New CE Playground"
For Costco or Home Depot (HD), opening a few "concept" stores to test some new retail ideas is fine. But, I don't think Tweeter can afford to take that kind of risk right now.
Having seen pictures of the store, I'll be the first to admit I would love to go in one just to take a look around. But, can Tweeter generate enough profit per square foot from these "showcases" to justify the investment? I have a hard time believing it can.
The Numbers
Tweeter's combined opportunity cost for the real estate (about $13 per square foot) and working capital for the stores (about $2 per square foot) comes to $15 per square foot. So, Tweeter needs to generate over $15 per square foot of retail space in operating income (before rent expense) to justify the investment. For 2006, that threshold was about $11 per square foot, including excess depreciation.
That's not too bad. $11 per square foot is slightly higher than Sears/Kmart at the moment – however, Sears Holdings (SHLD) has a much lower real estate cost. Compare this to Best Buy who has sales of $930 per square foot (vs. Tweeter's $457) and operating income before rent expense of $72 per square foot – which is over six times Tweeter’s profit per square foot.
With the right management team (or a completely different view from the current team) Tweeter could be very successful – both with its stores and with its shareholders. Right now, the stock is trading at approximately 53% of tangible book value. By my calculations, if the company achieved a 1.9% or greater pre-tax free cash flow margin, each share of Tweeter would be worth at least double today's price of $1.71.
Max Olson runs an investment partnership that follows a deep value approach to investing. His articles focus on general principles of value investing as well as specific applications of those principles. Max can be reached at max@maxcapitalcorp.com.