Martha Stewart Living: 125% Upside Potential

We believe Martha Stewart Living is a compelling turnaround story with a very favorable risk/reward profile. While sporting an enterprise value of just $125.0 million, Martha Stewart Living brands include “Martha Stewart,” one of the world’s premier lifestyle name plates, as well as “Emeril Lagasse,” a premier culinary brand.

While Martha retains voting control, we believe there are important signs that she is beginning to cede key operating control to the new management team brought in 2011, following a revolving door of predecessors. Results in 2012 will mark the company's ninth consecutive year, excepting 2007, of operating losses; however, under new management installed mid-to-late 2011 – led by CEO Lisa Gersh, CFO Ken West and Chief Revenue Officer Joe Lagani – the company is now laser-focused on profitability, as opposed to simply maintaining platforms and brand building.

Lisa Gersh previously served as President of Strategic Initiatives at NBC Universal following her tenure as Co-Founder / President & Chief Operating Officer of the highly successful Oxygen Media network which NBC acquired for $925 million. Ken West previously served as Chief Financial Officer of Marvel Entertainment, where he was integral to the salvaging, resurrecting, significant growth and, ultimately, sale of the company to Disney for $5.0 billion in 2009. In November 2011, the company created the role of Chief Revenue Officer, filled by Joe Lagani. Drawing on extensive experience from top roles at various magazine publishers, Mr. Lagani has turned over many of the key ad sales positions in Publishing.

Evidencing management's commitment to profitability, fully $47 million has been cut from Broadcasting and Publishing. In Publishing, management made the difficult decision to eliminate the printing of two of the four titles; one will continue in digital form while the other will be sold or closed with some of the content repurposed.

We believe the growth of the Merchandising business, driven by new contracts with retail partners, and the elimination of Publishing and Broadcasting losses, will enable the company to return to profitability in 2013. Brand traction is strong and growing, as evidenced by a growing number of significant licensing contracts with major retailers, including Home Depot, Macy’s and, most recently, J.C. Penney.

Our model calls for a an Adjusted EBITDA profit in the seasonally favorable Q4 of ~$3.0m and $17.0 million in 2013, as contrasted with adjusted cash flow losses of ~$4.0 million in 2010 and 2011. On a fully-taxed basis, we estimate EPS from continuing operations for 2013 of $0.15, following a loss of $0.19 in 2012 and $0.28 in 2011. We note that the company remains burdened by corporate overhead in excess of $30 million, which we believe is in-line with an entity two-three times the size. Much of this overhead reflects Ms. Stewart's compensation, as well as the still substantive commitment to a perfectionist design approach.

We highlight that our Merchandising estimates reflect what we believe is a reasonable “worst-case” scenario as it allows for a poor resolution to the on-going litigation between Macy’s and Martha Stewart related to the J.C. Penney contract. Should the company fully prevail in the litigation, the recently expanded Penney contract value suggests 2013 revenues and EBITDA with this retail partner potentially higher by as much as $15.0 million and $10.5 million, respectively.

Growth Drivers
(1) Big Merchandising wins drive significant segment growth.
(2) New management team.
(3) Significant turn in Publishing forthcoming.
(4) Consolidation of Broadcasting division.
(5) Significant international Merchandising opportunity.
(6) Swing to Profitability.
(7) Strong financial position.

Valuation/Conclusion
Using the acquisition model of “brand house” Iconix, we value Martha Stewart Living’s Merchandising business at 5x estimated 2013 revenue or 7x 2013 EBITDA, translating to a midpoint of $320.0 million ($4.75 per share); on top of this, we value Publishing at ~30% of revenues (on the two surviving titles) and add the $52.0 million of cash. The Broadcasting unit has additional value, albeit more difficult to quantify. Management estimates the company has a library of 29,000 "how to" videos. In addition, the company has a Federal NOL of $119.0m.

Accordingly, our sum-of-the-parts analysis suggests a value for the company of ~$6.00 per share and, using our higher J.C. Penney contract value (subject to the resolution of the litigation), rises by another $1.00. New management is heavily incentivized through stock options that are virtually all out-of-the-money and go up to $12, thereby closely aligning their interests with that of outside shareholders.

At the same time, while Ms. Stewart, who continues to maintain her 42% ownership and voting control, is very highly compensated, she is now 71 and may well look towards an exit strategy. It appears near certain the company will be meaningfully profitable in 2013 despite the still bloated overhead.