CCA Industries (ticker: CAW) reported earnings of only $0.18/share after recognizing about $0.06/share in expenses relating to the botched buyout by Dubilier & Co. Dubilier was unable to arrange financing for the buyout, and CCA Industries was left holding the bag in the form of $405,000 in expenses in the first quarter alone. In hindsight, it becomes clear why Dubilier executed a letter of intent rather than a definitive agreement, which may have included a reverse break-up fee.
An unexpected result of the end of the buyout is the appointment of Seth Hamot to the board. This move represents a long overdue generational update of the board, albeit at glacial speed. Until recently, only one of the seven board members was under age 70, and that has now doubled to two out of seven. The average age drops by four years to 69.
Seth Hamot runs Costa Brava Partnership III LP, an activist hedge fund, and has previously attacked CCA’s failed buyout due to the preferential treatment of Class A shares held by management over Class B shares owned by public shareholders. Not only do we like his hardball tactics, like his attacks on defense technology firm Telos Corp, but also his industry knowledge from his other board membership at Bradley Pharmaceuticals (ticker: BDY), as no less than its Chairman.
Normally, activists are invited to join the board in order to silence them. But Hamot may be able to deliver some value through industry insights, because he is the only board member who also sits on the board of another company active in the skin care field. There are conflicting studies about the value of board connectedness (Here, Here and Here From Down Under). We subscribe to the compromise view that too little is not enough, while too much of a good thing will do you harm. We acknowledge that Bradley’s skin care product lineup has no real overlap with CCA’s, because Bradley focuses on medical applications, where CCA specializes in cosmetics. Bradley sells primarily to doctor’s offices, whereas CCA sells mostly through Wal-Mart, CVS and other retail chains. With so few synergies, there is no point in speculating about a potential tie-up of CCA and Bradley, especially as the latter is currently going through its own buyout battle, and Hamot has said previously that he prefers organic growth for CCA.
Another area where we think CCA could do with Hamot’s help is the investment of its cash equivalents. At the moment, when you buy a share of CCA for $9, you are effectively buying $2.50 worth of a money market fund, as most its holdings are invested in T-Bills and other short-term instrument earning T-bill rates. Our own recommendation may be excessively biased toward one particular absolute return strategy, but maybe Hamot can make a more balanced contribution. We recognize that CCA may fall under rules of “inadvertent investment companies” if it holds too many non-government securities and makes too much return on them. Having your investment strategy dictated by legal counsel cannot be good for returns. One option would be a return of capital to shareholders, which would be the best solution. Another possibility takes us back to Hamot: he may suggest imitating Bradley’s strategy and acquire non-core brands from larger firms.
We are holding our breath while waiting for an improvement in next quarter’s returns and the announcement of CCA’s revamped strategy. Since management still wants liquidity for their shares, we would expect a buyback coupled with brand acquisitions as the most likely scenario. At the current price of $9, CCA is valued at only 6.5 x earnings (if you subtract $2.50 cash and add back $0.06 merger costs to earnings). Shareholders deserve a higher multiple than that, hopefully above the $13.80 all-time high.
Disclosure: The author manages the Pennsylvania Avenue Event-Driven Fund (PAEDX), which owns shares of CAW.