LL Flooring: Sullivan's Bid Is Worth Considering

LL Flooring (NYSE:LL) received a non-binding cash offer from founder Tom Sullivan that valued the company at $5.76 per share. This comes after disappointing Q1 2023 results that were already a bit worse than my relatively low expectations.

Given LL Flooring's challenges, I believe that Sullivan's offer is at least worth seriously considering. If LL Flooring is not acquired, it needs to turn around its business quickly and reach breakeven cash flow by early 2024 for it to preserve a sufficient amount of its value.

Challenging Q1 2023 Results

LL Flooring's results in Q1 2023 show that it is having significant challenges. I had already expected LL Flooring to produce relatively poor results in 2023, with comparable store sales declining by high-single digits to low-double digits versus 2022. That performance would be roughly 9% to 10% worse than Floor & Decor's (FND) guidance for comparable store sales in 2023.

From a sales perspective, LL Flooring's performance was moderately worse than my expectations in Q1 2023, as it reported -15.4% comparable store sales. This was 12.1% worse than Floor & Decor's comps, similar to the 12% gap in comparable store sales performance in Q4 2022.

Some of this decline was due to delays in receiving some vinyl flooring products due to U.S. Customs enforcement of the Uyghur Forced Labor Prevention Act. LL Flooring also noted that consumer spending pulled back even more in early March.

Given those issues, it may be more accurate to expect a mid-teens comparable store sales decline for 2023 now.

The large sales declines combined with cost inflation and SG&A investments resulted in LL Flooring's adjusted SG&A soaring to 41.9% of net sales in Q1 2023 compared to 35.5% in Q1 2022.

This resulted in adjusted operating margins of -4.5% for the quarter. I had modeled LL Flooring's adjusted operating margins at -3.5% for the full year, so it is doing a bit worse than expectations there too.

Bid From Founder

While LL Flooring's business results have been poor, its stock saw a boost due to the renewed interest from founder (and former CEO) Tom Sullivan in merging LL Flooring with his Cabinets To Go company.

Sullivan resigned from LL Flooring's Board of Directors at the end of 2016. He later increased his position in LL Flooring (then called Lumber Liquidators) from 1.3% to 7.7% in August 2019 (purchasing 1.35 million shares at an average price of $7.88 per share) while also discussing potentially making a bid for the company.

Sullivan then ended his efforts to acquire the company due to its share price increasing. He sold 1.25 million shares for an average price of $11.68 per share, leaving him with a 1.6% stake in the company.

This time around, Sullivan's group owns 2.71 million shares, or approximately 9.447% of the company. He has made a non-binding offer to acquiring LL Flooring's outstanding shares for $5.76 per share in cash. This bid has also gained support from other investors who want the company to at least enter into negotiations with Sullivan's group.

Valuation Notes

Sullivan's bid came after LL Flooring's share price reached an all-time low. However, the $5.76 per share price does appear reasonable at least as a starting point for negotiations.

I had previously estimated LL Flooring's value at around $5 to $6 per share if it improved its results enough to reach breakeven cash flow by early 2024. The weaker than expected results in Q1 2023 reduces my estimate to the low end of that range. As well, there is now a lower chance that LL Flooring can reach breakeven cash flow (excluding cash generated by inventory drawdown) by then.

Thus, if LL Flooring doesn't end up being acquired, it will need to improve its business results significantly within six to nine months, otherwise its cash burn will further erode its estimated intrinsic value to under $5 per share by early 2024.

Conclusion

LL Flooring's Q1 2023 results were poor, with both comparable store sales and adjusted operating margins coming in lower than my expectations (which weren't very high to begin with). A mid-teens comparable store sales decline is now my default expectation for LL Flooring in 2023, with the possibility that it could get even worse.

The poor business results will result in significant cash burn for LL Flooring, making its estimated intrinsic value around $5 per share if reaches breakeven cash flow by early 2024. Continued cash burn would reduce its value further.

This makes Tom Sullivan's $5.76 per share cash offer attractive enough to at least enter into serious discussions about selling the company. It is uncertain whether a deal will be reached given Sullivan's aborted bid in 2019 and some of his past disagreements with the company.

I am neutral on the company with its current share price roughly fair for a 60% to 65% chance of a deal being agreed upon.

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