POL - How Tarnished Is Polished?

2023-05-10 15:58:01 ET

Summary

• Online appliance retailer Polished is a high-risk and illiquid delinquent filer and may disclose audited financials in the next 3 months.
• There are a range of outcomes from acquisition to bankruptcy, but it seems reasonably probable that the stock ends 2023 above the current price.
• Disclosure of audited financials (or not) before July 31, 2023, should be a major catalyst for the stock.
• Breadcrumbs from management suggest the issues facing the company and recent financial performance as less bad than feared.

This is a hairier micro-cap idea than most. Online appliance retailer Polished.com (POL) has seen a rocky reverse merger, a CEO departure, triggering a corporate investigation that is focusing on hiring practices and inventory management, and then major accounting delays that aren't yet resolved.

However, perhaps predictably holders are fed up after a price decline of over 95% and the company may well be inexpensive. I see a range of outcomes. Importantly, on an expected value basis I believe the shares could more than double from here.

The company just reported some early and unaudited numbers for 2022-23 offering a strong hint that the delinquent financial reports will be filed on or before July 31, 2023. That's because in order to be comfortable disclosing revenues and high-level margins, they presumably have pieced together the bulk of their accounts (otherwise they'd be taking a big risk in disclosure).

It's also possible, in my opinion, that the company is acquired in 2023, the management team are not long-term executives and have financial incentives to make a deal happen. However, it's almost certain that the release of audited financials would be a pre-requisite to any deal.

I think the easiest way to walk through the investment case is to discuss the core scenarios.

Acquisition

The first is acquisition, the company released this statement in January "Following the receipt of multiple private expressions of interest in acquiring all or part of the Company, Polished engaged Jefferies as our financial advisor to help us evaluate credible potential transactions. The Board and management team remain open to all pathways for maximizing value, including a sale of the Company.".

Historical comps for small cap retail acquisitions typically come at 0.8x-1.3x sales. Given a checkered history and lower margins, Polished may fall at the low-end of that range or below it, one example would be American Apparel being acquired for 0.4x sales in 2017 by Gildan Activewear when American Apparel was bankrupt. Now assuming that sales come in at the low-end of 2023 guidance at $480M that 0.4x multiple would represent a price per share of $1.84/share or approximately 4x the current price. I certainly don't think an acquisition is the base case, but it is clearly something management are exploring and may offer a return to shareholders. You might ask why an acquisition is taking so long, I think the reason is it's virtually impossible to run an acquisition process without audited accounts, I think when and if audited accounts are released, and management say this will happen before the end of July 2023, an acquisition is a possibility and could present an attractive exit for stockholders. If such an acquisition seems far-fetched remember that G&A costs appear to be around $20M and even credit card fees are running at a relatively high 4% of sales (again on unaudited accounts). So, there is room for the right acquirer to drive some cost efficiencies if the operations can be combined with similar assets.

Bankruptcy

We no longer have audited reports that we can rely on. Management stated that as of September 2022 cash was at a similar level to March and the $40M revolver was undrawn and also that in 2023 the company expects to be cashflow positive. Net debt was $28M as of March 2022. If the company is delivering low single digit EBITDA on sales of $480M then debt is clearly manageable. However, maybe due to terrible 2022 results debt has ballooned to the point where the company is at risk of bankruptcy. This seems unlikely, but of course, without audited reports anything is possible so until we see audited numbers we can't rule out bankruptcy or major dilution.

Going Concern On Current Guidance

Guidance for 2023 implies low-end sales of $480M and low to mid-single digit EBITDA margins. We'll call that a range of 3% to 4% margins of $15M to $20M EBITDA, assuming interest expense of $4M and capex of $10M that suggests net income of $6M to $1M. Not great, but consistent with management's belief that 2023 will be cashflow positive. Then putting that on a 15x multiple gets us a price of $90M to $15M or somewhere in the range of $0.15-$0.90/share.

Resumption Of Prior Performance

There is a better going concern scenario, which is that the company gets back to performance before the crisis happened. Again, we must trust accounts that could see restatements and other issues, but if 6.5% EBITDA margins can be (re)gained then we might see net income of perhaps $14M suggesting a $210M market cap on a 15x multiple or a $2 share price.

Conclusion

Now if we put that all together. I think the chance of an acquisition is possible, but will take some work. I would give a 20% probability of that occurring and if it does I think shareholders will be rewarded. Then on the other extreme, bankruptcy cannot be ruled out given the accounting delays, but given the breadcrumbs management have given over the past 12 months or so it appears the business is not severely impaired, so the chance of the company running out of funds or needed to raise major equity or debt appears relatively low. Symmetrically with acquisition I would give that a 20% probability.

Then as the third option we have the company remaining as an independent going concern. I think 2023 is understandably not going to be a great year given everything the business is going through, but I see a mid-point value there of around the current price.

However, the company may be able to deliver stronger performance in 2024 and beyond if prior performance can be relied upon, for example operating margins were (apparently) 6.5% before the company hit its current issues. That's materially ahead of the 3%-4% we might see in 2023 and could lead to a share price closer to $2/share.

Thus, we have:

20% x $1.84/share (acquisition).

20% x $0/share (bankruptcy).

30% x $0.525/share (going concern on 2023 guidance).

30% x $2/share (going concern reaching prior operating margins).

This all suggests an expected value of $1.13/share though with a 20% chance of wipeout. Well above the current price, albeit with some risk of wipeout.

Another way to think about it, is to back into the current price, which might imply that the market currently broadly believes 2023 guidance and that audited numbers will be uneventful but sees an acquisition or improving operating performance into 2024 as unlikely. So, the market assumes the company survives, but isn't assuming much beyond that.

Catalysts

The key thing is the publication of accounts, that should occur on or before July 31, 2023. That will hopefully show a balance sheet and operating performance that removes the threat of bankruptcy and enable a meaningful bidding process for the company (I don't believe a definitive offer is likely without audited financials). If not, then 2023 guidance should be relatively conservative and the company should be set for a period of outperformance as it can get back to something close to its performance of 2021.

Warrants

As another angle to this trade, POL does also have warrants that are well out of the money with a $2.25/share strike. There's a hypothesis that in an acquisition scenario these warrants should pay out at Black-Scholes fair value. Personally, I don't know if an acquisition occurs or if the logic of fair value payout will hold, but that's another way to play this situation with more torque. Personally, I do not own warrants currently.

Risks

• The primary risk is a lack of audited accounts. Until audited accounts are released anything could happen, and indeed audited accounts may never be released. The equity could also be delisted.
• This is not a business where we have a long history of operating performance, it's unclear that this business is a great compounder over the long term, and as such this is more of a trading opportunity.
• Appliances are somewhat cyclical and have links to the housing market, which is softening. As such sluggish final demand may be a drag on the stock.
• This is a smaller and less liquid stock and carries greater risk as a result.

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