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Introduction
“I’m going to make him an offer he can’t refuse.” Marlon Brando, playing Don Vito Corleone in the movie The Godfather utters those words, and it may be the most famous line ever delivered in a movie. It came straight from Mario Puzo’s novel with the same title and is often referred to as a Godfather Offer. Investopedia defines a Godfather offer as follows:
A Godfather offer is an irrefutable takeover bid made to a target company by an acquirer. Typically, the offer is priced at an extremely generous premium compared with the target’s prevailing share price, making it difficult for management to reject the bid without angering shareholders and being accused of breaching their fiduciary duty.
PFSweb (NASDAQ:PFSW) received exactly such an offer, an offer that couldn’t be refused, for its LiveArea Labs business in the middle of last year. In fact, at the time of the offer for LiveArea, the $250 million proposal exceeded the market capitalization of the entire company. Obviously, PFSweb management accepted the offer. The company also announced that it expected net proceeds from the sale to range between $185 million and $200 million, that it would “pay down in full its senior financing facilities” and that it had retained Raymond James to explore strategic alternatives for the use of the proceeds.
Apparently Raymond James hasn’t come up with much in the way of alternatives. Instead, PFSweb recently announced that it would be paying a dividend of $4.50. The company’s third quarter 10Q filed on November 3rd, showed that PFSweb had “22,644,199 shares of registrant’s common stock outstanding.” The 10Q also showed that PFSweb had just over $140 million of cash and cash equivalents as of September 30th. For those keeping score, that dividend will utilize just under $101.9 million, leaving $25-$30 million of cash on the company’s books.
Disclosures
Seeking Alpha requires contributors to make certain disclosures regarding their positions that could influence their recommendations. I have often struggled with how much to disclose. It’s not a matter of whether or not I own a particular stock, or intend to buy or sell a particular position. I rarely write about stocks that I don’t own, but my historical ownership, and whether I have made or lost money on the position, could distort my perspective. For PFSweb, that history goes back more than two decades and the company’s intended IPO.
I first acquired a stake in PFSweb during the Internet bubble. Rather than buying shares directly, I bought a company called DaisyTek, which was in the process of spinning out its stake in PFSweb. That stake was being valued at more than the entire market cap of DaisyTek. My plan was to short PFSweb and cover the short position with the distributed shares from DaisyTek. Unfortunately, too many other traders had the same idea and PFSweb shares were impossible to borrow. Bottom line? The dot-com bubble imploded before I was able to unwind the positions.
I would eventually sell most of those original positions at a loss, although I continued to follow PFSweb because I thought it had an interesting business model – providing order fulfillment and shipping services for other entities. Their list of high profile customers grew, and they would take a few steps forward with client wins that included the US Mint, L’Oréal USA, Champion and Ralph Lauren. I found the growth prospects encouraging and added to our holdings.
The company would continue to be in the news for other reasons. An activist shareholder, Engine Capital, sent a letter to both PFSweb and Speed Commerce, outlining reasons why it believed that a merger of the two companies (in which it held 3% and 4% stakes) would benefit shareholders. That obviously didn’t happen. Later, PFSweb sold a 19% stake to a Japanese entity called transcosmos, and the arrangement seemed like it would open doors to markets in Asia. As far as I have been able to determine, the Asian market opportunity never resulted in the gain of new clients.
A year and a half ago I wrote my first article on the company in several years because I thought the company could reap some benefit from an increase in on-line shopping tied to the COVID-19 pandemic. That turned out to be a timely – and lucky – “Buy” recommendation, but not due to significant sales boosts from the pandemic. That recommendation turned into a solid winner after an announcement that the company had received a $250 million offer for its Live Area business, which gets to the heart of this disclosure.
When the sale of its Live Area Labs was announced, I sold short duration covered calls against our positions at strike prices of $12.50 and $15.00. The $15.00 calls expired worthless and I subsequently sold additional calls at $12.50. Those calls were eventually exercised and left us with only 240 shares spread over four accounts. Based on recent prices of approximately $11.00, it seems like selling those calls was the correct move.
I intend to hold onto the remaining shares for the foreseeable future, but it will have no impact on my rating of the stock.
Analysis
This analysis will be brief. The executive team has been in place for a long time, and so far it hasn’t demonstrated an ability to run a consistently profitable company. According to his LinkedIn profile, the CEO, Mike Willoughby, has been with PFSweb for 23 years, a VERY long time, having a list of titles that included:
- Vice President – President eCommerce – December 1999-October 2002
- Chief Information Officer – October 2002 – May 2006
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Chief Information Officer and President, Priority Fulfillment Services May 2006 – Sep 2010
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President and Chief Information Officer, 2010-2013
- CEO, 2013-Present
Included in the press release about the Q3 results was an announcement
…that Michael Willoughby will take on the role of Executive Director of the Board of Directors, in addition to his CEO role. In this position, he will primarily focus on the strategic alternatives process while transitioning management responsibilities to COO Zach Thomann. Thomann is expected to take on the CEO role in 2023.
According to LinkedIn, Thomann has been with PFSweb for almost 15 years, so it seems unlikely that this transition will result in any material changes to the company, its business, or its P&L. And, that’s the problem with owning this stock.
Their Q3 2022 results for the remaining business (compared to Q3 2021) were mixed, including
- Total revenues increased 7% to $65.5 million.
- PFS Operations service fee equivalent [SFE] revenue (a non-GAAP measure defined and reconciled below) increased 4% to $43.7 million.
- PFS Operations service fee gross margin, excluding certain LiveArea-related activity, was 23% compared to 24%.
- Net loss from continuing operations was $6.1 million or $(0.27) per share, compared to net loss from continuing operations of $6.8 million or $(0.32) per share.
- Consolidated adjusted EBITDA from continuing operations (a non-GAAP measure defined and reconciled below) improved significantly to $0.2 million compared to $(1.3) million.
- PFS Operations adjusted EBITDA from continuing operations (a non-GAAP measure defined and reconciled below) increased 30% to $4.9 million compared to $3.8 million.
As shown above, the revenue measure increased by 4%, but the gross margin fell to 23% from 24%. More importantly, although the Q3 net loss from continuing operations narrowed, it still came in at a significant ($0.27) per share. If, as I expect, more shoppers return to malls this holiday season, how will the company move from operating losses to a positive bottom line?
One way may be to add more clients to their portfolio, and this has been continuing. During the Q3 conference call management reported that they had 9 new bookings worth an estimated $19 million in annual contract value in Q3 and that the year to date total was 26 bookings worth $37 million. Much less clear is the impact of these incremental bookings on the bottom line, and how long it will take to arrive at a breakeven point.
And none of this addresses the elephants in the room. Despite gains in automating much of the fulfillment process, how much more can be squeezed out of the cost structure? Much of the business that’s left remains labor intensive, won’t benefit from economies of scale and will likely be subject to increased inflationary labor cost pressures.
Finally, there is the question about how the company will use the remaining $25 million windfall from the LiveArea sale. Clearly, a portion of it (and perhaps all of it) will be used to fund ongoing losses until the company can reach breakeven. If Raymond James has come up with any worthwhile ideas, the management of PFSweb is choosing not to disclose it at the current time.
Rating
I will continue to hold onto our remaining shares, at least through the ex-dividend date. Beyond that date, I am also likely to hold, mostly out of curiosity about whether or not the company can adapt to its new business structure and eventually turn a profit.
I am, however, facing a minor issue with the ratings system. I will be measured by how the price of the stock changes relative to its price at the time of article publication. It is clear that the stock will drop significantly once the mid-December ex-dividend date passes. So, despite my own actions or inaction, I have chosen to rate this a strong sell for that reason – the price will drop by the $4.50 special dividend once the ex-dividend date passes.
Longer term, I don’t see how a company that continues to bleed this much cash will survive.
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