This column should "shut the door" on a small-cap holding of ours that was written about in TheStreet.com a little over a year ago: Morgan Products (MGN) .
was in its infancy then, therefore many of you probably weren't around for The $10 Store, featuring stocks at that price or below. The stock was at 5 and change when the article was
written and is now in the process of accepting a "bear hug" acquisition offer at 4 per share.
First, a little history: Morgan had two businesses: door manufacturing and building-products distribution. The stock was in the low 20s once, when the manufacturing business was humming and distribution was fine, but then the 1990-91 recession hit, the balance sheet was in poor shape and -- fast-forwarding to 1996 -- we had a $5 stock.
I had eyeballed the company a few times over the years, and the mere whiff of the situation had driven me away. But when a client in the building-materials industry called me and said that Morgan had new management, that there was a 180-degree difference in how they were approaching the business and that he had bought some for his personal account, I thought the stock merited a closer look.
The basic problem at the company was that the door-manufacturing business was a bleeding nightmare, but the distribution side was conceptually a decent business in a consolidating industry. If Morgan could sell the manufacturing business for almost anything, it would clean up its balance sheet and suddenly be earning 60-ish cents, not too shabby for a $5 stock selling at book value.
The board brought in Larry Robinette, a senior line manager from
(now part of
), as CEO. We met with Larry, and he was a very straightforward "Newell guy." If you have looked at Newell's stock over the last decade, this lends excellent credibility. Robinette's plan was to sell the manufacturing business and buy mom-and-pop distributors, bringing superior management, information systems and so on to the table. Voila! We had a "cheap" stock and a catalyst to unlock value and grow the company. So we bought the stock at 5 and change in 1996.
Alas, the manufacturing business needed just "a little tweaking" before a full value could be realized. Meanwhile, the stock climbed to over 8 by early 1997, but we were getting a bit worried about the pace and cost of the "tweaking." We fortuitously sold our position at $8 and Morgan shortly thereafter dropped the bomb that manufacturing was such a mess that it couldn't be given away. That meant more money and more losses. We breathed an audible sigh of relief, and turned our attention to other matters.
A year later, we got the press release from Morgan detailing the sale of the door-manufacturing business and we picked up the phone. Yes, it was painful, but Morgan finally blew out the door business, the balance sheet was cleaned up, housing starts were cranking along and management was ready to turn to its original task: consolidation in the building-products industry.
So we bought it again in the spring of 1998 at 5, and
wrote its piece shortly thereafter. I think it took
all of about 6 minutes to rebut the piece on the home page: something to the effect that only a moron of the worst kind would be looking at a company like this when you could buy any Internet stock in the world at nearly any price and make money. Naturally, I responded in kind, and we warily concluded that that's how markets are made.
Being a long-term investor, I often don't win round one, so I was modestly surprised when Morgan reported solid quarterly earnings a month later and laid out "the plan" on a conference call. The stock rallied 20%, but it didn't last for long.
Here's what I have learned since then. Distribution is more complicated than it appears. While Morgan was still in the "two-step" distribution mode (shipping from manufacturer to distributor to end-distributor) the industry is being overrun by "one-step" distribution. So my estimate of what distribution margins would be in the new company were off by a mere 2.5 percentage points, which in the distribution business is like saying that if my hair were darker, I would look like
Phase II of my learning curve was that Morgan's big claim to fame is that it is the largest distributor of
windows and frames, which "is the high-quality name in the industry." What is also true is that until very recently, Andersen has been one of the worst-run companies in the industry and has lost market share like the emperor with no clothes and a pocket full of nickels.
So while Morgan's cash flow has been decent as the balance sheet improved, and better management systems were installed, earnings have been fairly rotten. Nor has it been easy to make acquisitions -- and we don't have to go into how badly small-cap stocks have done, do we?
As a result, the stock bottomed near 2 (at 45% of book value) during the fall market debacle and started to gently move north. In the midst of all this, Mssr. Cramer himself showed up in an SEC 13-d indicating that he owned 5%-plus of the company.
"What the heck was he doing?" was my immediate thought. We emailed a bit back and forth and agreed that Morgan was "the essence of cheap" to little avail.
But then Morgan recently announced what looks to be a terrific acquisition of
, which had a reputation of being a very solid outfit. It would double the size of Morgan at a reasonable price, and with the housing/construction industry in very good health, the timing seemed terrific. Meanwhile, Andersen has a new CEO running the show, and its operative plan is to consolidate distribution, effectively knighting Morgan as the instrument of choice. A fairly rational case could again be made for improving returns -- 70 cents in earnings and a high single-digit stock price.
But Andersen was obviously just as close to the numbers as we were and announced a $4 cash takeover, which the company is accepting. This truly pathetic number, which is below book value, will probably close uncontested on June 15, because unfortunately, Andersen holds all the cards. If Morgan gets indignant and shops itself to other buyers, Andersen can threaten to ixnay Morgan as a distributor of its products, which would be semi-catastrophic. The same goes for a "just say no" defense. Any number of obscenities are appropriate here.
To add insult to injury, most of management's options, according to the last proxy statement, have strike prices from 5 to 6. Care to guess what will show up in the yet-to-be-released 10-K? A repricing to $3 that was agreed upon late in the fourth quarter and still has not been officially announced. While management is also getting the rug pulled out from underneath it, this remains tantamount to a 15-yard personal foul.
What are the lessons to be learned from all this? One: Distribution is a tough business, and a little wrong can do a lot of damage. Two: Turnarounds
take 3 quarters longer than you think.
Third, and last: There is an unpleasant trend developing in the small-cap world. Predatory bids in the small-cap world of very cheap stocks can succeed, thanks to benign neglect by the institutions. Life ain't always fair.
Jeffrey Bronchick is chief investment officer at Reed Conner & Birdwell, a Los Angeles-based money management firm with about $1 billion of assets under management for institutions and taxable individuals. Bronchick also manages the RCB Small Cap Value Fund. At time of publication, RCB was long Morgan Products, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Bronchick appreciates your feedback at