The buyout binge sweeping across the retail landscape recently spread to the battered-down home furnishings sector, with Linens 'n Things ( LIN) getting scooped up in November. Will Pier 1 Imports ( PIR) be next? Pier 1 has more in common with Linens 'n Things now than just decorative pillows and aromatic candles. Last week, Jakup a Dul Jacobsen, the Danish investor who disclosed a stake in Linens 'n Things before it agreed to be acquired by a private equity group, revealed a 10% stake in Pier 1. Jacobsen, a European retail magnate and chairman of an Iceland-based firm called Lagerinn ehf, franchises Jysk stores (pronounced yoo-sk), a home furnishings chain that's known as the Danish version of IKEA. Jacobsen's chain has 1,000 stores worldwide, with 23 stores in Canada and two in New Jersey under the name Inspiration. Some investors see his interest in Linens 'n Things, which has now shifted to Pier 1, as a sign that he is looking for a cheap acquisition to expand his reach in the U.S. -- the consumer capital of the world. "It's entirely possible that he views Pier 1 as a potential takeover target," says Morningstar analyst Anthony Chukumba. "Acquiring Pier 1 would give him entry into the U.S. with a company that has a fairly well-known and well-respected name brand, a nationwide store presence and a decent amount of scale." The presence of Jacobsen at Pier 1 adds one more wrinkle to a value play that has already attracted legendary investor Warren Buffett, whose Berkshire Hathaway ( BRKA) disclosed a 9% stake in 2004. Buffett cut his stake in half as the retailer floundered, and Berkshire now owns about 3 million shares. Shares of Pier 1 have declined about 50% over the last two years as its sales and earnings have consistently slowed and disappointed Wall Street. So far this year, the stock has shown some signs of life after dipping below $9 in December. Despite a dreary holiday performance, shares are now up 29% for 2006, and with a major merchandise overhaul in the works, investors are starting to look at it as a glass-half-full situation.
Sanford Bernstein analyst Colin McGranahan says an investment in Pier 1 is speculative, as it is currently trading at about 86 times earnings estimates reported by Thomson First Call through 2006. But he also says the upside reward potential far outweighs the downside risk. "It's a very cheap stock with massive potential upside if any kind of turnaround ever materialized," McGranahan said. "It looks like the downside, especially with this guy Jacobsen poking around, is minimal. The stock has bottomed out at around $9 on a few occasions." McGranahan holds an outperform rating on Pier 1. He doesn't own the stock and his firm has no investment banking relationship with the company. To be sure, if Pier 1 can't pull out of its tailspin and no buyer ever emerges as a bailout, investors could get burned. The company raised hopes on Wall Street that a turnaround may be near when it reported that its January same-store sales rose 8.2%. That marked a sharp reversal from a string of declines that culminated in a negative 4.8% same-store sales figure for December, the height of the selling season. Still, the company predicted its same-store sales, or sales at stores open at least a year, would turn negative again in February. "All January proved is that if you mark stuff down far enough, you can always get rid of it," McGranahan says. "It did an excellent job clearing out stuff that nobody wanted. We already knew no one wanted it because the December comp was so bad. In January, it successfully cleared out its inventory, which is the purpose of January for a retailer like this. It was a successful clearance, but I don't think it says anything about what matters, which is whether anyone will want the new stuff that will be arriving next month."
Things have certainly changed since Pier 1's heyday in 2002 and 2003. Now, it's got more competition from Wal-Mart ( WMT) and Target ( TGT). Both discounting giants have expanded their home furnishing offerings at the low end of the consumer spectrum, while stores such as Williams Sonoma's ( WSM) namesake chain and its Pottery Barn unit dominate the higher end. Meanwhile, Pier 1, with about 1,200 stores, is running out of room to grow. "Pier 1 believes that North America can support as many as 2,000 of its stores, but we doubt that the firm can operate that many without cannibalizing sales of older stores, hurting store productivity and profitability," Chukumba said in a recent research note. The result of all these factors has been a decline in profit margins and earnings over the last two years, and now the company appears to be burning through cash. According to its third-quarter results released in December, Pier 1's cash balances were at $21.3 million as of Nov. 26, 2005, down from $94.7 million in November 2004. After the stock vaulted 6.6% last Tuesday on the news about Jacobsen's investment in the company, the shares plunged 7% the following day when Pier 1 announced a debt offering to remedy its deteriorating cash pile. The company started a private offering of $150 million in convertible senior notes due in 2036. The same day, Standard & Poor's lowered its credit rating on the retailer further into junk, saying it expects weakening results for the fourth quarter ending Feb. 28. "Pier 1 has not been able to make progress in turning around its negative sales trends and there has been a significant decline in credit protection measures," S&P said in a statement. Coming on the heels of Jacobsen's disclosure, UBS analyst Brian Nagel said the debt sale may be "a tactic by management to thwart a potential takeout of the company." Other observers rejected that idea. McGranahan, for one, says the debt offering is an attempt by Pier 1 to provide a cheap financial cushion for the company in case things go badly with February's new merchandise rollout. "It's optimistic about the new merchandise, but no one really knows how things are going to turn out," he says. "It's going to the debt market to raise money when it doesn't really need it, because it will be much easier and cheaper to do it now rather than wait for a situation to develop where it really needs the money."