Monday, April 09, 2007

Elliott Discloses 5.5% Stake in Pier 1 (PIR), Wants Significant Number of Stores Closed

In a 13D filing, Elliott Associates and Elliott International disclose a 5.5% stake in Pier 1 Imports, Inc. (NYSE: PIR) and suggested that the company close down a significant number of stores, "right-size" the corporate and divisional SG&A, lease part or all of the corporate headquarters, and add new members to the Board of Directors.

Elliott believes that these initiatives, if executed properly, will yield immense value to shareholders by creating a leaner, profitable company fit to navigate the intense competition of the future.

A Copy of the Letter:

Dear Members of the Board of Directors:

I write to you on behalf of Elliott Associates, L.P. and Elliott International, L.P. (“Elliott” or “we”), which collectively own approximately 5.5% of the common stock of Pier 1 Imports, Inc (the “Company” or “Pier 1”). Elliott is puzzled by the pace of cost-cutting and restructuring actions taken by the Company over the past two years. Whereas we believe a sense of urgency is appropriate, the Company has reacted at a glacial pace to the intensified competitive landscape that has developed in the US home furnishing retail industry over the past five to ten years. It is imperative that the Company immediately focus on executing cost-cutting and restructuring initiatives in order to stem its current cash bleed. We suggest Pier 1 close down a significant number of stores, “right-size” the corporate and divisional SG&A, lease part or all of the corporate headquarters, and add new independent members to the Board of Directors. Elliott believes that these initiatives, if executed properly, will yield immense value to shareholders by creating a leaner, profitable company fit to navigate the intense competition of the future.

Real Estate – Store Count

Pier 1’s store base has grown very rapidly over the past few years, increasing from 899 stores in March 2001 to 1,258 stores as of February 2005. This represents an average net increase of 90 stores per year, which is a meaningful acceleration from the 4-year period leading up to 2001 where the Company averaged 37 net new store openings per year. Since February 2005, the Company’s store base has remained fairly flat, as new openings have been mostly offset by the sale of the UK business and store closures.

Over the past ten years, and especially since the year 2000, there has been a significant increase in the number of home furnishing retail stores present in the US, as many of Pier 1’s competitors have aggressively accelerated their store rollout. It is our view that this high-velocity expansion of the home furnishing industry has resulted in a market that is significantly more competitive than ever before. It is also our belief that the industry should, and likely will, undergo significant rationalization over the next few years. The growth of Pier 1’s competitors has certainly had an impact on the operations of Pier 1. However, even as the Company’s competitors have grown their store count, Pier 1 still operates more stores than almost any home furnishing retailer. In fact, Elliott estimates that Pier 1 operates over 450 more stores than its largest competitor. These 450 stores represent 36 percent of the Company’s current store base.

The table below lists Pier 1’s stores under operation, sales per selling square foot, store occupancy costs as a percent of sales, and company operating margins. It is evident from this data that each of these metrics began to deteriorate once the Company’s store base grew beyond approximately 1,000 stores. Additionally, this deterioration has continued even as the growth of the store base has leveled off.


Over the past year, Pier 1’s management team has stated numerous times that the Company needs to reduce its store count. However, the number of stores in operation today remains virtually the same as two years ago, indicating the Company's failure to execute its plan.

Elliott believes it is absolutely clear that Pier 1 must move quickly to reduce its store count. As we stated earlier, the Company operates significantly more stores than its home furnishings retail competitors, and thus the deterioration in the metrics in the table above are probably representative of an over-saturation. We also suspect that Pier 1’s recent accelerated expansion has led to significant levels of cannibalization and a meaningful number of highly unprofitable stores. To remedy this, Elliott believes that Pier 1’s Board of Directors and management team should look to close around 250-300 underperforming stores as quickly as possible, returning Pier 1’s store count to no more than 1,000 stores.


As Pier 1’s store count has grown, so has its level of SG&A expense. Since 2002, when the Company operated 974 stores, the Company’s annual SG&A costs have grown from $448 million to $642 million for the most recent twelve month period. This represents an increase of $194 million, or 43 percent, while the Company’s top-line has only grown seven percent. Additionally, and perhaps more importantly, as the Company takes steps to quickly reduce its store count, we believe SG&A should be able to return to the level of 2002. Below is a table showing annual sales, SG&A expenses, and SG&A expenses as a percent of sales. As you can see from this data, SG&A expenses as a percent of sales have increased meaningfully over the past few years.


Indeed, on the Company’s Q3 earnings call, Marvin Girouard, the Company’s former Chairman and CEO, alluded to the fact that the Company’s current SG&A run rate has been built to accommodate a higher top-line than has actually been realized to date. Specifically, he stated, “And as you have a plan to grow from $1.7 to $2 billion, you sometimes build infrastructure that now may not be necessary to have there if you settle in with a lower number.” We would agree that the current level of SG&A expense is representative of a cost structure predicated on revenue growth assumptions that never came to fruition. However, assuming the Company moves quickly, we are confident Pier 1 can reduce expenses and “right-size” the cost structure to reflect the current realities of the industry and the smaller size of the Company.

We also believe the Company should lease out at least a third of its corporate headquarters. Over the past five years, the Company has spent approximately $100 million to construct a new corporate headquarters. This facility contains approximately 460,000 square feet. We believe that this is much bigger than the Company needs given its current revenue run rate and what we believe to be the correct number of stores the Company should operate.

We welcome the recent announcement by the Company to reduce its workforce by 175 positions and view this as a first step in the right direction. However, much more needs to be done.

Board of Directors

While we welcome the addition of Alex Smith to the Pier 1 management team, the composition of the Board of Directors has remained primarily the same for the past seven years. Elliott believes that the current Board of Directors should consider adding new independent members or replacing some existing members in order to add new talent and resources to help effectuate a turnaround.


Elliott believes that our suggested initiatives should enable Pier 1 to return to profitability rather quickly. In fact, we estimate that by shutting down underperforming stores, the Company should be able to generate sales per selling square foot of approximately $215 and gross margins of 39 percent. This compares to LTM (11/25/06) and 2002 gross margins of 31.4 percent and 42.0 percent, respectively. Pier 1 has generated gross margins north of 40 percent every year from 1996 through 2004. These sales and gross margin estimates, coupled with the SG&A cost savings, would result in a company generating more than $180 million in annual EBITDA, or north of ten percent of sales. We believe this is a sustainable EBITDA margin for a leading home furnishing retailer like Pier 1. However, the Company must move quickly. To date, Pier 1 has not committed to a detailed restructuring plan to shareholders, which strikes us as curious for a Company that is currently burning approximately $100 million of cash per year and has generated unacceptable returns on its owner’s capital for five years. This significant destruction of shareholder value, coupled with the intensifying competitive landscape, clearly indicates to Elliott that time is a luxury the Company does not enjoy. We encourage Pier 1 to present a turnaround plan to the Company’s owners as soon as possible.

In summary, Elliott agrees with Alex Smith’s statement in the Company’s press release dated March 29, 2007 that Pier 1 can return to profitability. However, we believe that the Company must expediently execute the initiatives listed above in order to stem the current cash bleed and make the time needed to return to profitability as short as possible. While we believe Pier 1 should also work on improving its merchandising and marketing, aggressive cost-cutting and restructuring initiatives must be the Company’s first priority. We have endeavored to communicate these thoughts to the Company over the past few weeks, but our calls have not been returned.

I encourage you to contact me at any time at 212-506-2999. We look forward to hearing from you.


Joshua Hertz
Portfolio Manager

Labels: , , ,


Post a Comment

<< Home