A teddy bear can melt a child's heart. And if it's actually made by the kid, the bear becomes that much more special. In a nutshell, profiting from that experience is what Build-a-Bear Workshop (NYSE:BBW), which became a publicly traded company via its recent initial public offering (IPO), is all about.
Just last week, my family visited the workshop in Greenville, S.C. We followed the company's official build-a-bear process:
Choose it, stuff it, give it a heart, fluff it, dress it, name it, and take it home.
It was simple and a lot of fun. Both my wife and my mother remarked that I needed to find out how to buy some shares. I was already one step ahead of them, but more on that later.
In the store, I noticed two things. First, it was packed. The queue for the stuffing machine was 10 to 15 people deep for the 1 1/2 hours we were there. Second, there seemed to be lots of pent-up demand. Birthday parties had been going on all day (we arrived around 7 p.m.), and you had to wait a week for the next opening.
She's one smart bear
It takes a good plan to generate that much demand, and the credit has to go to CEB Maxine Clark. That's right, CEB: She's known as the chief executive bear in the prospectus. A veteran of the retail business, she has taken retailtainment, a term I snickered at during one of my marketing courses, to a whole new level.
Think about it. Everyone chooses from the same set of available animals and materials, yet because it's created by its owner, each bear -- or dog, monkey, horse, etc. -- is more than unique: It carries a sense of attachment and exclusivity hard to match in a mass-produced companion. And to keep the new friends in style (and from becoming monotonous), Clark has developed relationships with Limited Too (NYSE:TOO) and Skechers (NYSE:SKX) to offer accessories.
Clark also makes sure you see the entire store before you leave. She does this by weaving the creation stations through walls laden with accessories. So the customer is forced to view all the available merchandise while creating his or her stuffed animal. Very effective.
And accessory prices are reasonable. Almost every price tag I checked was $10 or less. So at the end of our journey, we had Nerdy the dog, two outfits, two pairs of shoes, a pair of glasses, Nerdy's puppy, a dog bed, and a $25 gift certificate for a friend. This set me back $112, a small price to pay considering that Nerdy and my daughter are now inseparable. And the birth certificate was a nice finishing touch.
Two things come to mind. The first is Gillette's (NYSE:G) business model -- it's the blades, not the razors, that really drive sales. In Build-a-Bear's case, it's the accessories. Looking at the bill, I spent three times as much on accessories as I did on the dog itself. Second, the workshops remind me of the American Girls concept offered by Mattel (NYSE:MAT), an Inside Value newsletter recommendation. Everything centers on the experience, and the marketing is carefully thought out. Yep, there are some smart bears in Build-a-Bear Workshop's front office.
Baring the financials
Fortunately, I wasn't born in the woods. I know that you can have a great concept for a business and not have a business that creates value. So to see how efficiently management runs the business, let's look at the Foolish Flow Ratio and days of inventory (defined as (inventory/cost of goods sold) multiplied by 365 days).
| 2002 | 2003 | |
|---|---|---|
| Foolish Flow Ratio | 0.71 | 0.71 |
| Days of inventory | 87 | 70 |
These two metrics show that Build-a-Bear Workshop manages its working capital extremely well. A Flowie of less than 1 implies that a company gets paid for its current assets before it has to pay for its current liabilities and is a sign of operating efficiency. Notice that days of inventory has fallen from 87 to 70. This implies that Build-a-Bear Workshop is turning its inventory faster, a very good thing for a retailer.
Barely cash flow positive
I really like the concept of the business, and a quick look at some key financial metrics shows the business is operating well. The only thing left to do is to see if Build-a-Bear Workshop creates value along the way. Below is a table showing margins, free cash flows, and same-store sales growth.
| $s in millions | 2001 | 2002 | 2003 | 2004* |
|---|---|---|---|---|
| Number of stores | 71 | 108 | 150 | 157 |
| Gross margins | 46.8% | 46.3% | 45.4% | 48.2% |
| Operating margins | 1.8% | 3.5% | 3.7% | 7.5% |
| Free cash flow | -$8.8 | -$1.6 | $4.7 | $5.7 |
| Same-store sales growth | -6.7% | -9.7% | -15.9% | 13.8% |
* For the six months ended July 3, 2004
I do not like the fact that gross margins declined, with the exception of 2004, as new stores opened over time. You'd expect a retailer to generate purchasing economies of scale as it grows larger, which should drive costs down. Operating margins were thin, but trending in the right direction, and the company turned free cash flow positive in 2003. The most unbearable statistic was same-store sales, which declined sharply during the period, again except for 2004.
I find it interesting that everything turned around dramatically in the first six months of 2004. Management alluded to a better economy, more effective advertising, and better promotions in the prospectus. My only question is this: Why was so much money being left on the table before? I would think a group of managers with such an extensive retail background would have been able to use advertising and promotions much earlier than 2004. Personally, I am skeptical and would want to see how these numbers continue to trend.
I am even more cynical about the IPO. The company offered 1.5 million new shares to the public to raise additional funds. However, insiders sold just under 6 million of their shares, from which the company receives no benefit (see Page 1 of the prospectus, which is a large PDF file). Clearly, Build-a-Bear Workshop's IPO was about management starting to cash in on its shares. There's nothing wrong with that, of course. Managers created the business, so why shouldn't they reap the rewards of their toil? But potential investors need to remember that they are buying shares at a time when insiders want to maximize their return on investment. Assuming the current free cash flow (FCF) run rate, debt-free Build-a-Bear Workshop should end the year with about $12 million in FCF. A market cap approaching $500 million gives the company an enterprise value-to-free cash flow ratio around 40 -- too rich for my blood.
The bear necessities
In summary, I think Build-a-Bear Workshop has a great concept. It has brought a great deal of joy to many households. I shelled out some cash for its product and would be willing to do it again. However, I can't bear the thought of parting with cash to purchase shares. I want to see the positive trends continue and I want to see how well its new Friends 2B Made doll-making concept works out. So to new investors, I say: Be careful. Those looking at Google's (NASDAQ:GOOG) post-IPO price movement might think a quick buck is waiting on this table, too. It may well be, but considering the insider dumping and the still-evolving financial situation, I'd say it's best to wait before jumping on this bear bandwagon.
If it's value you seek, Philip Durell's Inside Value newsletter is the one for you. You can try it absolutely free for 30 days.
Fool contributor David Meier does not own shares in any of the companies mentioned. The Motley Fool has a disclosure policy.
