Short thesis for Patterson Companies from Bucephalus Research

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Profile of Bucephalus Research

Bucephalus Research touts itself as "exposing creative accounting to help clients reduce risk and outperform." The firm is very active and has targeted a wide array of companies across multiple sectors, including Tesla, Renault, Thyssenkrupp, Wisetech, Cineworld, Prada, Baidu, General Electric, IBM and others. The firm also targets small-cap companies.

Michael Mauboussin’s 10 Attributes of Great Investors [Pt.1]

michael mauboussin, Credit Suisse, valuation and portfolio positioning, capital markets theory, competitive strategy analysis, decision making, skill versus luck, value investing, Legg Mason, The Success Equation, Think Twice: Harnessing the Power of Counterintuition, analysts, behavioral finance, More Than You Know: Finding Financial Wisdom in Unconventional Places, academics , valuewalkIn 2016, Michael J. Mauboussin completed his 30th year on Wall Street. The analyst, who was working at Credit Suisse at the time, decided to celebrate by reflecting on the ten attributes of great investors he had observed over the previous three decades. He published his ideas in a report in August 2016. I've summarised Read More


It utilizes its Bucephalus Idea Generator and G-A-P score. The idea generator looks at four main questions. How is the business performing? Are the returns real? Is the company fairly valued? Can you believe the accounts?

The Bucephalus Idea Generator combines their work on creative accounting screens with their work on capital expenditure and valuation cycles to see where companies are on the cycle and understand which are "an interesting investment opportunity."

The Governance, Accounting and Performance (G-A-P) score ranks companies in these three areas to quantify the risk that a company's accounts as presented by their management have "diverged from the business reality."

Thesis for Patterson Companies

One of the ideas presented on Bucephalus' website is Patterson Companies, which the firm started targeting in September. Bucephalus notes that Patterson says its revenue is recovering and that business is returning to normal.

The firm argues that this could mean a return to "front-loading profits," "manipulating" working capital, boosting CEO pay while profits fall, interest costs that are more than twice what they should be, and an increase in the likelihood that the company will file for Chapter 11 bankruptcy."

Bucephalus added that it wonders why T. Rowe Price, which has made a big deal about ESG issues, is happy to be Patterson Companies' largest shareholder. The firm also questions whether T. Rowe Price "has never properly read Patterson's SEC filings" and maybe doesn't "understand how covenants work."

"Rotting from within"

The firm describes Patterson Companies as "rotting from within" and points out that its debt to EBITDA would have been well over four times in fiscal 2020 without factoring. Bucephalus also states that there are unexplained interest costs on the company's financial statements, which suggests hidden leverage. Interest expenses are twice what they should be.

It also notes that the company books its long-term vendor financing spread as an upfront capital gain. Further, its factoring is maxed out, collateralization is up, and receivables are extending. Bucephalus also argues that the quality of Patterson's sales is declining as stagnant revenue is more and more reliant on vendor financing.

The firm also pointed out that the company's core margins are still dropping but adds that this is being obscured by financing gains. Further, Bucephalus argues that executive compensation continues to rise even though the business is deteriorating.

"Creative accounting"

The firm states that Patterson Companies is struggling as online competitors like Chewy are taking share and profit, and the company "seems unable to protect its position." It sees a growing risk that the company's suppliers will cut credit and that Patterson will collapse and default.

Bucephalus alleges that the company has been doing some financial engineering as superficially, it has stabilized its revenue and cut its debt. However, the firm adds that Patterson is "propping up sales by funding its customers and obscuring debt levels by factoring receivables." It also said that the company's short-term working capital is down while long-term receivables and payables are rising.

Although the company's animal health revenue is growing, its margins are "close to zero," the firm added. Its dental revenue is down despite vendor financing, and its real margins have fallen 39%. Patterson's software and value-added services revenue is flat, and its cash flow would have declined 53% without the accounting gains from front-loading its financing profit, according to Bucephalus.

The firm also pointed out that the company has enacted a number of poison pills and tamed its shareholders, which could be why management compensation keeps rising while their required goals for bonuses keep falling. They allege that "management is being rewarded for destroying shareholder value."

You can read Bucephalus' full report on Patterson Companies here. Bucephalus will present a new idea at our Contrarian Investor Virtual Conference. The firm will be joined by Grizzly Research, GlassHouse Research and White Diamond Research. During each of our three previous conferences, stock prices have been moved by the presentations, so you won't want to miss what our speakers have to say.

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