I’m almost embarrassed to admit to this… I feel like Mohnish Pabrai (sorry Mohnish, I liked your concentrated strategy much better). I decided to place what Pabrai calls a “basket” bet. This is when you don’t necessarily feel certain about any given investment, nor can you precisely ascertain a value for a company, but rather feel as though the odds are in your favor and therefore is worth placing 2-3% of your portfolio into. I’ve seen a few situations like this pass me by (with much success going to the shareholders after I decided to pass), and for the first time, I’ve decided to place a basket bet; this one is in Cybex Int’l.
As a quick background, Cybex is a manufacturer of weight lifting equipment and competes with Nautilus & ICON Health, among others. The industry seems to have very cyclical demand (you could even call it a “fad purchase”) for products, and purchases of exercise equipment fell off heavily in the recession 2007-today. Cybex & Nautilus have both been bleeding cash the last few years; ICON Health isn’t public but I’d assume a similar scenario. Nautilus & Cybex’s market valuations have been hammered hard and are trading much below multi-year lows (ignoring Nautilus’ recent price run up, of course).
Cybex’s market valuation has fallen even further because of a recent lawsuit that occurred. A 105-lb. woman, Natalie Barnhard, pulled a 600+ lb. leg extension machine on top of herself in a gym in 2004. She was a physical therapist at the gym and used the leg extension machine as a support while stretching her shoulders. This is clearly not the manner intended for use as a leg extension machine; it would be like pulling a washing machine on top of yourself and blaming Whirlpool. It was apparently proved in court that it took less than 40 lbs. to tip the machine. This adds much credibility to her argument, but I still feel as though this woman, who was employed by the gym, should know better when operating with heavy equipment like this.
Cybex lost this lawsuit and the accident was judged to be 75% Cybex’s fault, 20% gym’s fault, and 5% Natalie. The damages awarded were $66 million, so Cybex stands to owe $49.5 million currently. Cybex has a $4 million in insurance coverage for lawsuits of this nature, so they owe a net total of $45.5 million. As you can see by their historical financials, the company is in no shape to pay an amount even approaching $45 million. Therefore, the company will likely go bankrupt should these damages need to be paid.
As you can also see from their financials, it has been a cyclical ride the past decade. If we reasonably expect Cybex to earn $3-5 million in a year or two, this current valuation of $12 million in the market today is extremely low. The business has made $5-10 million in operating profits consistently, even if some years there was a net loss. I don’t think there’s a certain value that I can point to because their balance sheet is meaningless (lawsuit liabilities would cover their assets, and then some) and their earning power is all over the place. Knowing that $12 million is far too low of a valuation works for me; I’ll just stay diversified in this bet.
Some additional notes on this case include the fact that the piece of equipment she pulled on herself was made in 1983 and no similar accidents have occurred in the 25 years it sat in the gym, with it being used millions of times. It wasn’t bolted to the floor the way many other machines are; this probably is why the gym is 20% at fault. This lawsuit was the single largest amount in damages set in Erie County, NY and set a record (clearly an unreasonably high amount). Also, Cybex employs over 600 Americans and I’d be surprised if appeals courts allow this company to go bankrupt.
Here’s the press release from the company following the lawsuit decision. They sound very angry and still believe in their case (an appeal is highly likely here). I’ll leave the rest up to you to decide and perhaps place a small basket bet as well. I’ve seen a few similar companies (Zales, Nautilus) in the last 6 months that possessed similar qualities to Cybex and subsequently have moved up considerably in the market. I plan on holding Cybex and watching what happens.
Also, don’t bother contacting investor relations; they’ve decided to stay quiet about everything and won’t respond to questions.
As a final note, I would have bought long-term options on a situation like this where the downside is bankruptcy & the upside is 2-5X my money, but there are no options trading on Cybex currently. I plan on trying this out in the future on other similar events-based situations.