Lessons about leases and liquidation value: a bebe stores, inc case study

I got a comment in the BEBE analysis post related to their $186M in operating lease obligation and what my view was as the company announced that they are closing down all their remaining stores. As I started to write an answer in the commentary section I came to realize that this might be a good time to put my view about operating leases into print. Also, as the BEBE situation is currently playing out in real-time it makes it a good live case study for how to view operating leases when it comes to investing in net-nets and companies selling below liquidation value. At least I hope it makes the post about operating leases a bit more interesting.

Off-balance-sheet financing & operating leases

Before diving into the more interesting stuff, lets first remind ourself what we are talking about. First off, what is off-balance sheet financing? Well, in broad terms it refer to assets or liabilities that we can’t find on a company’s balance sheet but nonetheless are forms of assets or liabilities of the company. The reason why I say “forms of” is because there exist some nuances, but for the most part they fit the assets and liabilities definitions. Lets remind ourself of the definitions for asset and liabiliy:

Asset: Resources controlled by the entity as a result of past events and from which future economic benefits are expected to flow the entity.

Liability: Present obligations of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefit.

The most common reason for not capitalizing an asset or a liability on to the balance sheet is that it misses on the first part of the above definitions. Resources controlled as it concerns assets and present obligation as it concern liabilities. In other words, the company is not the recognized legal owner of an asset or does not have direct legal responsibility of the liability.

Operating leases is probably the most common type of off-balance sheet financing and it’s also the oldest form of off-balance-sheet financing. In 2014 listed companies using IFRS or US GAAP disclosed almost US$3 trillion of off-balance sheet lease commitments. Yes, that’s trillion with a T. An operating lease is a contract between two companies where one company is allowed to use the asset (lessee), but where the rights of ownership of the asset stays with the other company (lessor).  So an operating lease represents an off-balance sheet financing of an asset, where the leased asset (future benefits) and associated liabilities of future rent payments (outflow of cash) are not capitalized on the balance sheet of the company using the asset. In other words, provided both parties are behaving rationally, the economic substance of this arrangement is that the lessor has made a loan to the lessee that is equal to the capital value of the leased asset. The lease payments will be equivalent to the loan repayments on that loan plus the interest that would have been charged.

So whats the problem?

A distorted view

Since operating leases are found off the balance sheet they distort the view that you would get of a company’s financial position and performance if you were looking through a screener. The same would apply if you were only looking at the financial statements presented in an annual report or 10-K. Primarily, a company with a big operating lease obligation will look a lot slimmer than it actually is. As you can imagine, a number of important key ratios, such as equity ratio and return on total assets, would therefore be quite different if the company decides to put it on or off the balance sheet. However, with a quick search for “operating leases” in the annual report or 10-K you would find the following note:

lease bebe.png

With this note you could be guide in your division for what is to be regarded as current assets and liabilities (< 1 year) and non-current assets and liabilities (>1 year). Therefor it could be argued that it is not rocket science in order to get a more fair view, just add-on the numbers back on the balance sheet. However, both IASB and FASB would argue against me and as I will later demonstrate with the case of BEBE this is not even the whole truth…

New lease standards from IASB (IFRS) & FASB (US GAAP)

About a year ago both IASB and FASB announced that they had issued new lease standards. It was stated that the new standard from IASB will come into play as of 1 January 2019 and the standard from FASB as of 15 december 2018. There are minor differences between the two standards but the main change and effect of the new standard is the same. That is, all leases, except short-term leases (< 1 year), must be capitalised, i.e. put on the balance sheet. As a result, the expense for operating leases will be moved from operating costs and divided into one part depreciation and one part interest, similar to a regular assets and liabilities.

ifrs 16

ifrs 16 incom.png

One should also note following regarding the effect on cash flow stated by the IASB:

Changes in accounting requirements do not change amount of cash transferred between the parties to a lease.

Consequently, IFRS 16 will not have any effect on the total amount of cash flows reported. However, IFRS 16 is expected to have an effect on the presentation of cash flows related to former off balance sheet leases.

IFRS 16 is expected to reduce operating cash outflows, with a corresponding increase in financing cash out flows, compared to the amounts reported applying IAS 17. This is because, applying IAS 17, companies presented cash out flows on former off balance sheet leases as operating activities. In contrast, applying IFRS 16, principal repayments on all lease liabilities are included within financing activities. Interest payments can also be included within financing activities applying IFRS.

The net-net formula and operating leases

If you are still reading at this point give yourself a pat on the back. Now let’s get into the more interesting stuff for how the above relates to investing in companies that are selling below liquidation value.

If you had asked for my opinion about operating leases, as it relates to net-nets, just a few months ago I would have given you a completely different answer than what I will give you today. Back then I would have said something like “all backtesting that I have ever come across doesn’t take operating leases into account and the returns are still awesome”. While this is true I would now argue that I don’t think this is a healthy approach to investing. Also it’s not what Benjamin Graham thought of when he initially stated the approach for how to invest in companies selling below liquidation value:

A good part of our own operations on Wall Street had been concentrated on the purchase of bargain issues easily identified as such by the fact that they were selling at less than their share in the net current assets (working capital) alone, not counting the plant account and other assets, and after deducting all liabilities ahead of the stock. It is clear that these issues were selling at a price well below the value of the enterprise as a private business. No proprietor or majority holder would think of selling what he owned at so ridiculously low a figure. – Benjamin Graham (The intelligent Investor)

Specifically note the bold text related to liabilities and ask yourself: would Graham include off-balance sheet financing in a net-net calculation if he lived today? I’m sure he would. So while the quantitive approach to net-net investing from a balance sheet approach has proven to be a solid strategy for generating alpha it also deviates from the wise words once written by Graham in the Intelligent Investor. On this note one should remember what Graham stressed above all everything else: margin of safety. So what I have come to realize is that you shouldn’t let a backtests sway you away from the true meaning behind the concept of margin of safety as it relates to the liquidation value approach of investing. In other words, just because something doesn’t show up on a screen it doesn’t mean it does not exist and should not be accounted for as a future inflow or outflow of cash, i.e. asset/liability. This epiphany has become even more relevant as of the new lease standards that will soon come into play for both US GAAP and IFRS.

So now you might think that the correct way to calculate the liquidation value for BEBE is just to add the $186M of operating leases into the net-net calculation. Well, unfortunately it’s not that easy if you aim for a fair estimate of a liquidation value. With the help of the current situation in BEBE I will try to demonstrate this. But before I do that I would like to set the stage by presenting two important quotes from two of my favorite investors, Marty Whitman & Seth Klarman.

We do net nets based more on common sense. As, for example, you have an asset, a Class A office building, financed with recourse finance, fully tenanted by credit-worthy tenants, that, for accounting purposes, is classified as a fixed asset, but, given such a building, you pick up the telephone and sell it, and really it’s more current than K-Mart’s inventories, for example, which is classified as a current asset. – Marty Whitman

As long as working capital is not overstated and operations are not rapidly consuming cash, a company could liquidate its assets, extinguish all liabilities, and still distribute proceeds in excess of the market price to investors. Ongoing business losses can, however, quickly erode net-net working capital. Investors must therefore always consider the state of a company’s current operations before buying. Investors should also consider any off-balance sheet or contingent liabilities that might be incurred in the course of an actual liquidation, such as plant closing and environmental laws. – Seth Klarman

Lessons about leases and liquidation value

With the situation in BEBE I will try to demonstrate three lessons that I have acquired via my previous quantitative approach to investing in net-nets. All three could be summarised under the lesson that the quantitative net-net calculation is a strict theoretical valuation method not based on common sense. In recent time I have therefore decided to leave my previous quantitive approach behind me and apply a more semi-rule based approach for investing in companies selling below liquidation value. I will write an additional blog post about this new approach and the implications for other factors than just the valuation aspect some time in the future.

Lesson 1: Operating leases ≠ 100 % future outflow of cash

Remember the $186M in operating leases obligation that BEBE had stated in its note from the latest 10-K? In other words, the same $186M that the new lease standards wants us to put directly on the company’s balance sheet:

lease bebe

Well, it turns out that it’s not a $186M obligation. The actual liability (future outflow of cash) as it relates to the company’s operating leases (leased stores) is more in the ballpark of $60-65M.

The Company has hired a real estate consultant to negotiate with its landlords to terminate existing leases and the Company will have to make payments in order to close all of its retail stores. While the Company does not know the exact amount of such termination payments it believes the payments will be in the range of approximately $60 to $65 million. – Q3 2017

In the table attached above it is important to highlight the word noncancellable leases. Reason being is that this gives us the answer for the difference between the total minimum leases payments that is “noncancellable” (the obligation that the new standards will require the company’s in the future to put on the balance sheet) and the actual liability (actual outflow of cash) as a result of the termination of the company’s leased store contracts. I want you to read with full attention now: It is named noncancellable but it be cancelable. But only when:

A lease which is cancelable (i) only upon the occurrence of some remote contingency, (ii) only with the permission of the lessor, (iii) only if the lessee enters into a new lease with the same less, or *iv) only upon payment by the lessee of a penalty in an amount such that continuation of the lease appears, at inception, reasonably assured.

If significant enough, a penalty for cancellation may result in a conclusion that continuation of the lease appears, at lease commencement, to be reasonably certain. If so, it should be considered noncancelable for any periods in which the penalty exists.

The lesson here is that the actual liability (outflow of cash) as it concerns operating leases is likely to be lower than what is stated in the note and what in the future will be stated in the liability section of the balance sheet. Remember that the company does not have direct legal responsibility (liability) of the leased asset. This will not change even when the new standard comes into play.

While the information about $60-65M was quite recently announced (2017-05-16) I will demonstrate how one could obtain this information already in March 2017. If we take a look at this  8-K the following could be noted:

On March 28, 2017, bebe stores, inc. (the “Company”) committed to close 21 bebe store locations. As a result, the Company will incur an impairment charge related to the closed stores of approximately $2.0 million and will make a termination payment to the landlord of approximately $7.4 million. The Company is continuing to explore options with respect to its remaining stores.

If we use these figures above and apply it to the 151 stores that BEBE had not closed at that point in time we get the following total termination payment:

$7,4M / 21 stores = $352,000 x 151 stores = $53M –> $53M + $7,4M = $60,4M.

This fits perfectly into the ballpark of the $60-65M stated above.

 Lesson 2: Operating leases ≠ asset

The next lesson is a direct outcome of the situation in BEBE. While the new lease standards requires operating leases to be capitalised both on the liability side and the asset side of the balance sheet this is in my opinion not a fair view. Remember why operating leases did not fit the real asset definition? Yes that’s right, the company is not the recognized legal owner (asset). From this we can draw the following conclusion, the liquidation value of operating leased asset is zero. Or really its negative considering the termination payments that the company will incur in a situation similar to BEBE’s. So when calculating a liquidation value you should in my opinion attach no value to the “asset” leased. Reason being that the company will not be able to sell the asset and therefore there is now future inflow of cash. This is especially important to take into consideration when screening for companies in the future since operating leased assets then will be part of the company’s total current asset position.

Lesson 3: The importance of readily ascertainable net asset value (raNAV)

The third lesson relates to the a concept of liquidation value that Marty Whitman has coined. It is explained in the book The Aggressive Conservative Investor but also in the quote I presented earlier in this post. I will try to demonstrate the importance of using raNAV instead of NCAV by presenting the valuations of BEBE from both perspectives as of Q3 2017. BEBE is also a perfect example for the fun side of the equation when it comes to off-balance sheet items. That is, off-balance sheet assets.

If we take a look at the Q3 2017 report from BEBE that has just been published the following net-net calculation would be made from a strict quantitative approach:

‘000 $
Cash  26 755
Recieviables  7 862
Inventory  28 413
Assets held for sale  25 796
Prepaid and other  8 491
Current assets  97 317
Total liabilities -46 482
NCAV  50 835
NCAV per share  6,3

In relation to the share price of $4,82 that would give us a P/NCAV = 0,76x which is pretty good. However, if we dig into the Q3 report and other announcements made there are some interesting facts that should be taken into consideration when trying to get a fair view of BEBE’s liquidation value. So let’s try to get the whole picture sorted out regarding the situation in BEBE. In connection I will also state what conclusions I draw from the facts as these will be built into the valuation for the raNAV calculation that I present below.

1. BEBE has announced that its closing all stores. The cash outflow because of this economic event is by the company stated to be $60-65M. As I have displayed by my earlier calculation of lease termination payments I believe that the final amount will be at the lower end of the stated spectrum ~$60M. This amount has been used in my raNAV calculation below.

The Company has hired a real estate consultant to negotiate with its landlords to terminate existing leases and the Company will have to make payments in order to close all of its retail stores. While the Company does not know the exact amount of such termination payments it believes the payments will be in the range of approximately $60 to $65 million. – Q3 2017

2. As a result of the termination of stores the company has also announced that it will terminate the employment of all store personnel and will therefore incur a termination payment of $7-10M. As I have no further insight into this so I will use the ~$10M as my estimate for employee termination payments in the raNAV calculation.

the Company expects that it will then cease to have any retail operations and will instead manage its investment in the Joint Venture. As a result, the Company expects to terminate the employment of all or substantially all of its employees over the coming months as its operations wind-down and to pay severance, accrued vacation and stay-on bonuses in the range of approximately $7 to $10 million to such employees expected to be paid over the next two fiscal quarters. – Q3 2017

3. BEBE has previously provided information about the value of a joint venture with a company called Bluestar. Also, in the Q3 report the company state what the company intends to do going forward. I regard to the remaining 50 % ownership in the joint venture to have a value of ~$35M since Bluestar paid this amount quite recently, June 2016, but also since BEBE still holds licence for two important markets, USA and Canada.

Strategic partnership. During the fourth quarter of fiscal 2016, we entered into a strategic joint venture arrangement with Bluestar Alliance LLC (Bluestar). Under this partnership, bebe contributed all of its trademarks, trademark license arrangements (described in the next paragraph) and related intellectual property, including certain domain names, to a newly formed joint venture (the Joint Venture) and received just over 50% ownership interest in the joint venture. Bluestar contributed $35 million to the newly formed joint venture that was then paid to bebe and received just under 50% ownership interest in the joint venture. – Q3 2017

In connection with this initiative, bebe retained a royalty-free perpetual license to utilize the bebe brand and trademarks within the United States, including its territories and possessions, and Canada which enables us to continue our existing business. – Q3 2017

The Company also intends to transfer the http://www.bebe.com domain name, its social media accounts and its international wholesale agreements to the Joint Venture. The Joint Venture in turn intends to license them to one or more third parties.  – Q3 2017

4. BEBE has previously announced that a liquidator had been appointed to sell all of the company’s inventory and FF&E. As a result I have applied a 50 % discount on the company’s inventory value in my calculation for raNAV value. I have not done the same for FF&E (included in PP&E on the balance sheet) since the value as of today (Q3 2017) has already been impaired by a large amount taken this into consideration. Therefore I will use the $9,935 stated on the balance sheet as it relates to other assets that the company is going to sell.

On April 18, 2017, bebe stores, inc. (the “Company”) entered into a Consulting Agreement (the “Agreement”) with Great American Group, LLC, an affiliate of B. Riley & Co., the Company’s financial advisor, and Tiger Capital Group, LLC (collectively, “Consultant”), to, among other things, sell (i) all merchandise and inventory owned by the Company and certain of its subsidiaries located in its existing retail stores (the “Stores”) and (ii) certain furnishings, trade fixtures, equipment and improvements to real property with respect to the Stores. We may incur a loss in connection with this sale of our merchandise and inventory, but we cannot estimate such loss at this time. Consultant will be paid $550,000 in consideration for its services, plus reimbursement for certain expenses, and will receive an additional fee of 15% of the gross proceeds generated from the sale of the furnishings, trade fixtures, equipment and improvements to real property.

5. BEBE has also stated that it intends to sell its owned real estate:

The Company intends to sell its real estate holdings consisting of a distribution center in Benicia CA, a design studio and production facility in Los Angeles CA and two condominium units in Los Angeles CA. The Company has decided that it no longer needs these properties because it is shutting down its operations. The Company will use the proceeds from sale of the buildings to fund the costs of wind down including lease termination costs, severance and other costs. The Company does not expect to incur a loss on the sale of its real estate holdings.

The real estate is currently found under the FSLI “held for sale” for current assets at a value of $25,796. One should note the following regarding the valuation method as it concerns held for sale assets: measured at the lower of carrying amount and fair value less costs to sell

From previous 10-K’s and the note “Property and Equipment” I have gathered the following information about these real estate properties:

In December 2008, we acquired two condominium units in Los Angeles, California for use as short-term executive accommodations with approximately 3,400 total square footage.

The purchase price for the two condominium units was $1,705.

We also purchased our 144,000 square foot distribution center in Benicia, California in May 2012.

The purchase price for the distribution center was $18,000.

In fiscal 2004, we acquired a 50,000 square foot design studio and production facility in Los Angeles, California that houses our design, merchandising and production activities.

The purchase price for the design studio and production facility was $10,942.

The total price paid for the owned real estate adds up to $30,647. Naturally this is higher than the held for sale number value because of depreciation (see valuation definition above for held for sale assets). Although there might be some hidden value in the real estate (fair value) I have only assumed that BEBE at least will get the similar amount of money back as they once have paid. Therefor I have used $30,647 in my raNAV calculation.

6. The company has a large amount of net operating losses (NOL’s), $298,600 or $36,9 per share. NOL’s are found off the balance sheet but could be regarded as an asset. Especially by a company that would potentially acquire BEBE. This is because the acquiring company can use the NOL’s to lower their taxes paid. However, the valuation of NOL’s is truly rocket science. It all depends on the potential value of the NOL’s that an acquiring company can use. In other words, since the NOL’s expire over a period of time a more profitable company would assign higher value to the NOL’s than a less profitable company. Therefor I have made four assumptions as it concerns the value of BEBE’s NOL’s. [EDIT: 2017-05-26, see comments regarding NOL’s]

As of July 2, 2016, the Company has federal, state and foreign gross net operating loss carryovers of approximately $169.2 million, $122.1 million and $5.9 million, respectively. If not used, these carry forwards will expire at various dates from fiscal year 2016 to fiscal year 2036. The Company also has foreign tax credit and state tax credit carry forwards of approximately $1.6 million and $0.2 million, respectively, which will be available to offset future taxable income. If not used, the foreign tax credit carry forwards will expire at various dates from 2017 to 2026 and the state tax credit will expire from 2020 to 2022.

  NOL’s Discount
  298600 0%
per share 36,9  
  149300 50%
per share 18,4  
  89580 30%
per share 11,1  
  29860 10%
per share 3,7  

7. Before providing you with my calculation of raNAV based on what I have presented above I should also present my view about the company’s future (you might want to compare this with what the company has stated, see point 3 above).

I don’t think that BEBE will continue as a company under the joint venture. I think the company is going to be sold as there is still value in the brand of BEBE (see point 3 above) but also considering the amount of NOL’s that the company has. This is also based on the fact that the company’s has rushed into the termination of all lease contracts and personal and appointed a liquidator of inventory and FF&E and that have decided to sell all their real estate. Moreover, the CEO Manny Mashouf announced in June 2015 that he intended to sell of his then 59 % position in the company. However, as of today he still holds about 57 % of the shares outstanding. I would argue that he has decided to look for a deal where the whole company gets acquired rather than to sell his position gradually on the market. One final note, a very important one, is that Lloyd Miller III seems to be invest on a similar story. Since this story has evolved he has repeatedly and more aggressively increased his stake in BEBE. He now owns 10 % of the company. But enough speculation, here is the raNAV calculation of BEBE as of Q3 2017:

‘000 $ Comments
Cash  26 755
Receivables  7 862
Inventory  14 207 See point 4.
Assets held for sale  30 647 See point 5.
Prepaid and other  8 491
Adjusted current assets  87 962
Total liabilities -46 482
Adjusted NCAV  41 480
Adjusted NCAV per share  5,1
Lease termination payment -60 400 See point 1
Employee termination payment -10 000 See point 2
PP&E  9 935 See point 4.
50 % JV ownership  35 000 See point 3.
raNAV  16 015
raNAV per share  2,0

On top of the $2 USD per share of raNAV that I have calculated is the value of NOL’s that one must also take into consideration. I find it hard to believe that an acquirer will pay $1 for every $1 of BEBE’s NOL’s. I also think is it is fair to assume that they will likely pay more than 10 cent for every $1 of NOL’s. My guess is that it is likely going to be in the ballpark of 10-30 cent for every dollar of NOL. But my honest answer is I don’t know. However assuming a 10-30 cent for every dollar of NOL on top of the other $2 per share would give us a raNAV value of $5,7 – 13,1 USD per share. Based on the current price of $4,82 that would give us the following multiples of P/raNAV = 0,85x – 0,37x. [EDIT: 2017-05-26, see comments regarding NOL’s]

As of today I have not increased my position in BEBE but will most likely do so if the stock tumbles back below $4. [EDIT: 2017-05-26, as a result of my misstake regarding NOL’s, see comments]

Disclosure: The author is long NASDAQ:BEBE when this analysis is published. Also note that NASDAQ:BEBE is a nano-cap stock (40 M$ in market capitalization). The trading is illiquid.

29 thoughts on “Lessons about leases and liquidation value: a bebe stores, inc case study

  1. I see several things wrong with your valuation, although it was a fine attempt.

    1. NOL’s are worth 4% of their value per ICR S. 382 if an ownership change of 50% or more occurs.
    2. Some of their properties were purchased at the height of the housing bubble. County Assessor records place their fair value less than what the company books, approx. $23 mil.
    3. The $35 mil. you include in your analysis for the 50% ownership of the joint venture was already paid to bebe and accounted for in their books past quarter. They’ve spent nearly all of it.
    4. The $9.9 mil. booked as PP&E is comprised of computers, fixtures, and leasehold improvements. They carry a lifespan of 3, 5, and 10 years. They are valueless and are considered a negotiating tool for purposes of decreasing their lease obligations.
    5. Along with several more issues. The true tangible equity of the business is approx. $0.25 per share.


    1. Thanks for your reply and insights James, as you point out there are some serious flaws in my analysis!

      1. You are correct. A lack of knowledge from my side.

      2. Again a lack of knowledge from my side, never heard of a county assessor before. I saw the pictures you sent me on twitter. My argument for a higher value than “held for sale” or the pictures that you have sent me from the county assessor is based on this statement “The Company does not expect to incur a loss on the sale of its real estate holdings.”. Thoughts?

      3. I’m talking about the other 50 % of the joint venture, the 50 % that BEBE still owns. Also, that BEBE still hold the perpetual license for the US and Canada markets. In this context it should be noted that I have not taken any consideration for the potential value of the BEBE trademark that a potential acquirer is willing to pay for.

      4. I don’t consider them worthless since a liquidator has been appointed to sell them and considering the $28M that was impaired during Q3 2017 related to long-lived assets at the corporate head offices, distribution centre and its store fleet. So I would argue there is already a margin of safety in the $9,9M. But again I could be wrong.

      5. Thoughts on why Lloyd Miller III is has over the last couple of weeks repeatedly and aggressively bought BEBE stock?

      Again thanks for pointing out my mistakes!


      1. 2. I don’t believe they’ll take a loss, either however, California real-estate market is currently in decline. Supply outweighs demand. The assets at cost (pre-depreciation) are $29.478 mil. I can’t see them selling for more than $40 mil. on their best day.

        3. “In the fourth quarter of fiscal 2016, the Company contributed its intellectual property including trademarks, tradenames and certain domain names, along with all of its royalty license arrangements to a newly formed Joint Venture with Bluestar Alliance LLC (BlueStar). In exchange, bebe received cash proceeds of $35 million from Bluestar and a 50.0000000001% ownership interest in the Joint Venture (Bluestar owns the remaining interest). The Company recorded a gain on the sale of assets, net computed as follows for the fiscal year ended July 2, 2016 (in thousands)”.

        This is a clever way of saying that they sold these items for $35 mil. and are temporarily allowed to continue using them until they’ve wound-down their business, obviously for legal reasons. After the liquidation, shareholders won’t have any rights to this new entity. The reality is, they simply sold their intellectual property and trademarks for $35 mil., received the money, and nearly spent it already because they’re burning cash at a rapid pace; which is why they need to close their doors now.

        However, if you were to double count the $35 mil., it still wouldn’t be enough to create value for the shareholder.

        4. Light bulbs, carpet, paint, nails, screws, old computers…. who do you suppose will buy them, and furthermore, how much will a bunch of curtain rods and carpeting fetch? In liquidation, unless you “own” the building, none of these items are worth a penny. Nobody is going to rip up the carpet and sell it, and the leaseholder wouldn’t allow that. Nobody is going to purchase pre-owned lightbulbs. Nobody is going to purchase out-dated computers, especially when new ones are a few hundred dollars. The $9.9 mil. in these items are absolutely worthless, I promise you.

        The liquidator’s primary job is to sell their inventory and receive a 15% commission for doing so. Here in the U.S., we’re famous for 60% off sales when a clothing company goes out of business. Happens all the time and I prefer to shop that way. Inventory, which is made up primarily of finished goods, will be no different.

        To me, this is a classic value trap.

        I never invest based on what the other guy is doing so I couldn’t tell you. In addition, I’ve never heard of him. Bill Ackman owns common shares of Fannie Mae while the rest of us own preferred shares. I have no idea why he holds commons when there’s no doubt in my mind that he’ll lose his entire investment. I never try to rationalize why someone else invests the way they do. But then again, I only know why I do.


      2. Note: It’s important to note that the statement of operations are “consolidated”. All value from the interests they own are accounted for per GAAP rules. So by including $35 million in your analysis, you are double counting what has already been consolidated in the records.


  2. The current “Long Term Exempt Rate” is currently 2.09%, not 5%. Furthermore, S. 382 states “if the new loss corporation doss not continue the business enterprise of the old loss corporation at all times during the 2-year period beginning on the change date, the section 382 limitation for any post-change year shall zero”.

    Pretty difficult to continue operations of a business that has liquidated its assets and terminated leasehold contracts.

    In the footnotes of the last 10-k, the company expressly stated that they do not expect to recover the value of their DTA’s/NOL’s. They are worthless.


  3. Thanks for your comment Andrew and your insights!

    1. As I replied to James, this is a mistake in the analysis based on lack of knowledge from my side.

    2. That’s interesting, never seen or heard anything about that! Then a op lease could be regarded as an asset for at least some companies 😉


  4. In respons to your latest comment James (WordPress does a lousy job connecting longer discussions in the commentary section):

    3. Thats one way to look at it. However, I think you are misstaken the sale of assets to the JV for $35M with the fact that BEBE still own/control 50 % of the JV (+ still has the perpetual license for the US and Canada markets). In other word, there are no more assets to put into the JV (except the perpetual license for the US and Canada markets) but without the other 50 % ownership portion Bluestar is not the majority owner and in control of the JV. This is why I argue for the fact that there is still another $35M in value that should be attached to BEBE’s ownership in the JV, its not double counting its about control over the assets in the JV. But I guess time will tell if I’m misstaken.

    4. Again I disagree, considering my earlier statement about impairment. Also note that I have discounted inventory by 50 % as a result of the appointment of liquidator. Again time will tell if I’m misstaken.

    5. I agree that you shouldn’t base an investment decision on what other people tell you. However, in this case a well known deep value investor seems to put his money into BEBE repeatedly over the last couple of weeks and to me thats an interesting sign from my point of view. He now owns 10 % of BEBE! You can read about him in this post (its in Swedish so you might want to use google translate): https://vardebyran.wordpress.com/2016/01/20/vem-ar-lloyd-miller/


    1. 3. Without Bluestar, there’s no online retail operation management. The value of the intellectual property is similar to patents and trademarks. It is the cash flow that can be generated from them. The initial monetary value of them has already been paid for.

      Again, including the $35 mil. (which is not an asset who’s monetary value is readily available…I own Whitman’s books too) still does not create a substantial amount of equity for the shareholder. This is a fire-sale. If it weren’t, they’d burn through the rest of their cash in 4.5 months. They have very little time.

      4. $20 million of the impairment charge taken was an actual loss. Only $8 million of it was a non-cash charge. Depreciation is a non-cash charge too, but as Buffett points out… sometimes it’s real. I argue that this is one of those times.

      Say a company spends $1 million to paint the interior of their leased building. Are they going to scrape it off the walls and sell it to someone when they move? They tack down a carpet that is custom fit to a room they lease. Are they going to rip it up and sell it? Silliness. Of course they can’t. We know what these items are. They’re listed in the 10-k. I guarantee my 25 year investing career that they’re are worthless. I am as sure about it as I am their liquid cash in the bank. They’re worthless.

      I looked him up. I remember hearing of him before. I don’t follow him. I’m still on Schloss. Will be for the next 20 years I imagine.


      1. I think we have reached the end of this discussion James and that we just have to disagree on some points as of now. However, I would again like to thank you for reaching out and pointing out the misstakes I did in the calculation of NOL’s, it has provided me with good knowledge. I’ll guess we will hear from each in the future when the whole situation in BEBE has played out 🙂

        Liked by 1 person

  5. Very interesting work and discussion. My own estimate of liquidation value is quite similiar.

    Regarding the 50% + one share ownership in the joint venture, bebe stated in their 2016 annual report: “As of July 2, 2016, the Company had approximately 50% ownership interest in the Joint Venture with a book value of $1.1 million.”

    So I think the value of the bebe stake in the joint venture is not fully recognized but may be less than $35M. They transfered license agreements that “represented 1.0% of net sales in fiscal 2016”, so about $4M.

    From what I know now I am sure that bebe stores won’t be a netnet anymore in a few month (at todays price). Any thoughts how profitable the transformed bebe operation might be? What do we get for todays valuation of $43.5M?


    1. From July 10-K, page 21: “The total of our investments in the Joint Venture are recorded in Other Assets on the consolidated balance sheets.”

      April 10-Q, Page 3: Other assets $2.351M


    2. Thanks for your comment UncleFry!

      My short answer is that I don’t know. I think BEBE will be unsuccessful in a turn-around if thats what they are trying to pull off. However, the likelihood of a sale of the company is still valid from my point of view. But considering the misstake I did in this analysis regarding NOL’s I will be less inclined to increase my position in BEBE since my calculation of raNAV < share price. The small position that I have in BEBE, bought earlier on a quantitative basis, I will continue to hold. Time will tell if it will be a lesson with a positive or negative outcome 😉


  6. This post is brilliant!! It ties together improved real world techniques on finding deep value ideas supported by the often-overlooked niches of knowledge from Graham, Whitman, and Klarman. Then, you logically question the new balance sheet reporting rules for lease obligation imposed by the international accounting standard boards.

    Over 10 years ago I kept finding my investments held by Lloyd Miller. I thought hey it’s not fair this Miller guy hacked by brokerage account. Now he was stealing my most obscure and best stock ideas (ha). Now it’s in Lloyd we trust. Well most times.

    The real-time BEBE case study is a powerful learning tool. Great visuals explaining the financial statement impact from the new accounting changes.

    Waiting for the new post related to your comments.
    “In recent time I have therefore decided to leave my previous quantitive approach behind me and apply a more semi-rule based approach for investing in companies selling below liquidation value. I will write an additional blog post about this new approach and the implications for other factors than just the valuation aspect some time in the future.”

    BTW are you a college professor. I won’t hold that against you, ha.

    I’m not a tax lawyer or tax anything but I’ve seen companies use these NOLs when it appeared it violated tax law. Specifically, I’m thinking of my investment with Warren Kanders’ Clarus Corp (CLRS).But I can’t know what the IRS allowed.

    Thanks again


    1. Warren Kanders’ Clarus Corp’s NOL’s were fresh when the transfer of ownership occurred. IRC 382 is specific in that there is a 3 year testing period in which the NOL’s need to exist during that period in order to meet the qualifications of the rule. BEBE meets that rule. CLRS did not. It was a shell company at the time.


    2. Thanks for your very kind words John and I’m glad you found the post worthy of reading 🙂

      Indeed, Mr Miller is an interesting investor whom I follow closely for idea generation, BEBE was one of those cases.

      I got to much on my plate at the moment so the post you are waiting for will probably won’t be published until July… Related to that notion, I’m obviously not an collage professor 😉

      Keep up the awesome work you do on your blog John, its one of the places I regularly visit for idea generation!


  7. Wow good stuff. thanks.

    I wrote up CLRS.PK on SeekingAlpha at $4.03. People gave me hard time for discussing a pink sheet with no operating business.You know the rest of the story..black diamond. I was LUCKY to double my money.


    Now I’m investing in Pendrell Corporation (PCO). Massive NOL and deep value deegistering their shares.


    This weekend I’ve got my eyes on ACTG.

    Liked by 1 person

  8. James too bad on closing ValueInvestorToday.com.

    Maybe consider recruiting online for intern(s)/volunteer(s) to do the time consuming administrative / document work. If it becomes a profitable venture, you can then offer some compensation. But regardless of pay it would be a great opportunity for an MBA, or undergrad accounting or finance student as one example. Or someone looking to learn. Where do I apply :).


    1. Not sure what oint you’re trying to make here. You’re definitely not the only MBA in the room. If I offended you with the fact that IRC 382 exists, and was created for the purpose to discourage NOL pirates, maybe you should become acquainted with the rule. It doesn’t apply to certain things like shell companies. It also changes depending on the value of the NOL’s. However, when the value of NOL’s are in excess of the value of the entire company, the rule is quite clear. Thousand upon thousands of pages written by universities available online that explain the rule. Like you and I, they have MBA’s too.


  9. James, I was not questioning any of your responses. But instead thanking you for the useful input. I’m not an MBA.

    My comments above on your old site was it could be resurected if you wanted using low cost outside help to reduce the work load. My comments were all complementary. Thanks


    1. I apologize. It seems I read your statement to have a completely opposite meaning of what they were intended to have.

      There are so many good blogs available online (this site being one of them) that a contribution from myself isn’t a needed thing, in my opinion. I actively engage in financial analysis on a full-time basis and it really takes up a lot of time on order to do it justice. If I were a better writer, and obviously an interpreter of what was being said, is probably have more interest in the matter.

      Liked by 1 person

  10. I am confused about rule 382. Isn’t it an annual limit. Meaning the acquire is limited to declaring 4%*market value of shares acquired every single year after acquisition assuming the NOLs haven’t expired. Shouldn’t it then be:

    Undiscounted value of NOLs = 4% x market value of shares x number of years


  11. Cigarrfimpar – Great analysis on operating leases. Definitely helpful for all future liquidation analysis.

    1. On the NOLs, it is correct that value will be lost if bebe is bought out or ownership changes more than 50% within 3 year period.

    But there are several options around this and NOLs still have value in the right hands:

    a. Instead of being acquired, bebe could acquire some other profitable company and then unlock value in the NOLs.
    They can raise money for acquisition via rights offering, cash on hand, debt and combination of all the above.

    b. Existing top shareholders could do private placement to raise capital and then acquire another company.

    2. You are correct that the value for the joint venture is not fully included in the balance sheet.

    The 10-K Note 2 (Gain on Sale of Intellectual Property and Equity Investment) shows that the total asset sold to Bluestar was valued at $1.6M on the balance sheet (Carrying value of contributed assets) and after sale of 50%, its listed retained interest as $0.8M on the balance sheet (Retained interest in contributed assets). One discrepancy : this note says $0.8M but “Other Assets” say $1M on the balance.

    Since Bluestar paid $35M for 50% ownership, we know that the retained interest on the balance sheet is undervalued. We can argue if the value of remaining 50% portion is $35M or $25M, but its definitely not $0.8M as listed on balance sheet.

    I think taking $35M as liquidation value is fine (it is roughly correct rather than precisely wrong). In a way, this is a hidden asset (i.e. not clearly visible just looking at balance sheet)


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