Insiders Scoop up Shares of Hard-Times Play: See What They’re Buying

By Michael Brush
Exclusively for InvestorIdeas.com
October 30, 2008

When times get tough, shoppers pull out all the stops in the hunt for bargains. One common strategy: Hit the thrift shops for “gently used” second hand items.

Believe it or not, there’s actually a publicly-traded play on this theme. And insiders have been buying – partly because the second-hand business is doing so well. They’re also buying because the business contains a hidden gem that could thrive and carry this company for years to come.

The company I’m talking about is called Winmark (WINA). Winmark franchises four value-oriented retail store concepts. The stores buy, sell and consign second-hand sports equipment, children’s clothing, teen wear and musical instruments.

You might not be surprised to know that business has been booming in the past two quarters -- as layoffs mount, investment accounts get decimated, and widespread panic has gripped consumers worried about how to make ends meet.

While many retailers have been reporting outright sales declines, in mid-October Winmark posted a 9.6% increase in its take of gross profits from its franchisees for the quarter ending September 27. Royalties grew to $5.7 million. That kind of strength contributed to a 20% increase in earnings per share to 24 cents for the quarter. Royalties grew 10% in the prior quarter.

The business model

How is Winmark performing this magic? Its business model is fairly simple. It charges franchisees $20,000 for the right to open a first store, after which they can open additional stores for a $15,000 franchise fee. Franchisees then pay weekly royalties of 3% to 5% of gross sales, depending on the kind of store they operate. The franchise agreements have an initial term of 10 years.

In exchange, Winmark offers orientation and training courses on how to purchase used goods and generally run the business. It offers field support on opening and running a store. Winmark requires franchisees to spend around 5% of gross sales on advertising and marketing. It also makes franchisees buy sales and office equipment from Winmark.

Winmark offers franchises on four kinds of stores.

• Play It Again Sports This was the original franchise, started in1988. These stores buy, sell and consign equipment used in sports like golf, baseball, softball, hockey, in-line skating, skateboarding, fitness, skiing and snowboarding. Royalties from this chain contribute around 38% of revenue.
• Once Upon A Child As the name suggests, this chain buys and sells children’s clothing, toys and furniture. It contributes about 16% of revenue.
• Plato’s Closet Launched in 1999, Plato’s Closet stores buy and sell used clothing and other stuff for teens and young adults. It contributes about 14% of revenue
• Music Go Round This one buys and sells musical instruments, amplifiers, speakers and electronics used by children, as well as amateur and professional musicians. It contributes about 4% of revenue.

Buy Winmark, get another business inside “for free”

Brian Bares of Bares Capital figures that the franchisee business is worth $17 a share. That means at current prices of around $15 a share, you get the franchise business at a $2 discount, and you get the rest of the business “for free.”

What else does Winmark do?

To understand this, you first need to know that chief John Morgan, who was among the recent insider buyers in the $14 to $17 range, has a solid record in the equipment-leasing business. He has built an equipment leasing company from the ground up and sold it for a healthy profit. He took over as chief of Winmark in 2000. When his non-compete on running an equipment leasing business expired, he started a division that does exactly this inside Winmark, in 2004.

Business has been booming. Leasing income grew 80% in the most recent quarter to $2 million. It grew over 100% in the prior quarter.

This division, called Winmark Capital Corporation, leases high-tech business equipment like computers, telecom equipment and point-of-sale systems. It targets businesses with annual revenue of $25 million or more. Lease transactions are generally larger than $250,000.

The company also has a division called Wirth Business Credit that franchises a financing business. It helps small companies make smaller purchases of business equipment.

The bottom line: Bares thinks the leasing business could eventually throw off $5 million to $6 million a year in free cash flow – suggesting the stock could double from here.

Disclaimer
At the time of publication, Michael Brush did not own or control shares in any of the companies listed in this column. Mr. Brush is an independent columnist for this web site.
For more on Insiders Corner disclosure, see the disclosure section in About Insiders Corner: http://www.investorideas.com/insiderscorner/. InvestorIdeas.com Disclaimer: www.InvestorIdeas.com/About/Disclaimer.asp. InvestorIdeas is not affiliated or compensated by the companies mentioned in this article.

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