Does Parlux Smell Fishy?

Man, I love our discussion boards (free trial required). Drifting around some of my favorite places, I came across a gem on the Martian Chronicles board. Christian Bojlesen has been researching fragrance manufacturer Parlux (Nasdaq: PARL  ) . He posted some pretty impressive numbers, but prefaced his next remarks with "and then things get truly sickening."

Parlux, which currently trades at about $3.40 per share -- for a total market capitalization of about $30 million -- is the contract manufacturer for name brands Perry Ellis (Nasdaq: PERY  ) , Fed Hayman, and Jockey, though nearly 70% of revenues are tied to Perry Ellis.

A modest proposal
I'm guessing that the stock would double if the board of directors simply tossed CEO Ilia Lekach out on his ear. Fat chance of that happening -- Lekach either owns outright or controls more than 30% of the company's shares. Maybe we can appeal to his own self-interest, then: He could get out, let someone run the company for the benefit of shareholders, and get rich.

Keep in mind this is not a big company. As of the latest proxy, Parlux had 8.5 million shares outstanding. In the past six years, the company has repurchased more than 9 million shares on the open market, cutting the total outstanding by more than half. Someone who has held on to Parlux since 1997 has seen his stake in the company effectively double.

Fat lot of good that's done: The stock is almost precisely where it was in 1997. Over the same period, per-share book value has grown by 32%, to $5.79 per share, less than $1 of which is intangibles. So, why is Parlux trading so far below its tangible book value?

Ilia Lekach should be asking himself the same question. This past May, he led a group seeking to buy Parlux for $4 per share. Lekach, the board of directors (save one member), and Parlux were slapped with a class action shareholder suit almost as soon as Lekach uttered the words "take private." The takeover group, called Quality King, was unable to get bank financing and dropped its bid.

Management-led efforts to take a company private drive me bananas. They represent the point of sharpest contrast between the interests of insiders and those of minority shareholders. Think about it: When you're buying something, you want the price to be as low as possible. So, why not behave really badly, drive the stock price down, practice horrible corporate governance, and then offer to buy the company at a "premium" to a severely depressed price -- caused in no small part by, well, you.

How bad does this smell? Let me count the ways.
When a company trades below book value, there's usually one explanation: The market expects the company to destroy value, not create it. It is incumbent upon management to prove the market wrong, and one way to do so is to adopt a shareholder-friendly corporate governance stance. What we have instead at Parlux is a company that seems to be run for no one other than management. That's fine (arguably) for a private company. Given that this company is public, and that its economics are generally pretty good, I'd think the shareholders would want more.

Here's a few simple suggestions:

End massive stock grants.
I'd suggest that Mr. Lekach, owner of 30% of all outstanding shares, has plenty incentive to do things that will drive the share price. So when the company grants him 500,000 options in one year, totaling 71% of the options granted, that's a massive turn-off to outsiders. What, then, was the point of buying back all those shares? To re-grant them to the majority shareholder? By the way, the 600,000 options granted in 2002 represent a potential dilution of 7.1% (though the company does skip several years between grants -- it granted no options in 2001, for example). Given such poor performance, I'd question what standards the board used to grant options to management at all.

Be really careful with related party transactions. Lekach is also the largest shareholder and chairman of E Com Ventures (Nasdaq: ECMV  ) , which owns retail chain Perfumania. Perfumania is one of Parlux's largest customers, representing 17% of total revenues. That in itself, while slightly disturbing, is no big deal. What is a big deal is that of the company's $15.7 million in trade receivables, 72% is tied to Perfumania. A further $8.9 million of Parlux's revenues involve another company with close familiar relations to Mr. Lekach.

This isn't new. In 1999, Parlux developed a receivables balance of nearly $30 million due from Perfumania. Perfumania offset this in part by issuing 1.5 million shares of its stock at 90% of current market price to Parlux. Were this transaction between unrelated parties, it wouldn't be that big a deal. That both parties are controlled by the same guy naturally raises questions:

For whose benefit are any of the transactions between these companies? And why on earth would Parlux grant another insider-controlled (read: related) company substantially more lenient collection standards? For E Com's part, they say that they believe "that our purchases of merchandise from Parlux were on terms no less favorable to us than could reasonably be obtained in arm's length transactions with independent third parties." Yes, that's great for E Com shareholders, but what about Parlux?

And interestingly enough, shareholders of E Com Ventures have been put to by Lekach as well. E Com loaned money to Lekach, who then settled the debt in January 2002 by making payments in the form of 1 million shares of stock from a third company he controls, air taxi provider Nimbus Group (AMEX: NMC  ) . Seeing as Nimbus is a development-stage company just converted from a failed dot-com the previous September, this doesn't seem like that great of a deal for E Com shareholders, though it may have worked out just fine for Lekach.

By the way, I can't pass this up. In Nimbus' most recent quarterly report:

On May 19, 2003, We acquired from Omniscent Corp. certain rights to a portfolio of fragrance brands and Skincare line that include; The Cara Mia Swiss Formulated Skincare line, Phantom Women and Men Fragrances, as well as Ultra-E Fragrance for the Young Set.

I had to check the front of the filing three times to ensure that I was reading Nimbus' -- the air taxi company -- report, and not that of a fragrance company controlled by Lekach. What's an airline company with almost no money going to do with a fragrance brand? Nothing. You see, Nimbus is no longer an air taxi company. It's -- surprise!! -- now a fragrance company. Lekach has disposed of about 40% of his shares in Nimbus in the past month.

Where's the SEC?
I'm not a securities lawyer, but there doesn't appear to be anything illegal going on here. Companies operate for the benefit of whomever they want, just so it's disclosed -- and you can't accuse any of these companies of poor disclosure. This case just seems so, well, stupid. Were E Com and Parlux to clean up their acts, stop the awful stock option dilution, and demand that related party transactions be either abrogated or treated on the same level as transactions with unrelated parties, the stock just might find a level substantially higher than two times 1999 free cash flow.

Sadly, it seems that too many companies suffer managements that mistreat their outside shareholders in order to scalp a few extra bucks. Particularly in cases where they own large portions of the company, does it not make sense that clean, shareholder-friendly governance would make the stock more attractive and their fortunes that much larger? I doubt Parlux shareholders could get rid of Lekach even if they wanted to. Besides, if they did, Lekach's employment contract has a built-in covenant that awards him massive options and cash grants.

It's just a shame. When asked about the goings on at Nimbus, Lekach had this to say: "Nobody is going to take this away from me. I'm a hard man to take things away from." I'm sure that's true. But the cost of having Parlux under his control is a market that has little trust that he could or would ever generate any benefit to outside shareholders. The stock price trading so far below book value says as much loud and clear.

Fool on!
Bill Mann, TMFOtter on the Fool Discussion Boards.

While Bill Mann knows that "Shark Week" is supposed to educate us about sharks, it has the effect of making him never want to go near an ocean again. Bill owns none of the companies mentioned in this article. The Motley Fool is investors writing for investors.

What's not quite so scary is that The Motley Fool is celebrating its 10th anniversary this month with 10 Ways to Make More Money Now!


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