Surfstitch Ltd revenue crash: Share price under pressure

Surfstitch Ltd (ASX: SRF) has today announced that after making some adjustments to its forecasts, it now expects to report a loss of between $17.3 million and $18.3 million for the 2016 financial year (FY16).

Share trading had been halted while the online retailer worked out the issues, but it was never going to be good news as we pointed out earlier this week, and the share price could come under heavy selling pressure today.

In pre-trading, the indicative price on Commsec suggests a fall of 21% to ~40 cents a share.

The company says that it needs to adjust revenues in the second half of FY16 for a transaction that occurred in the first half. That transaction relates to the grant of a perpetual licence to a third party to use the company’s content (from Surfstitch, Garage Entertainment, Rolling Youth and MagicSeaweed).

After a review of the contracts, Surfstitch is reversing $20.3 million of revenue, which will be reflected in the full year results. Given the impact of the charge, Surfstitch now believes it will report a pro-forma earnings before interest, tax, depreciation and amortisation (EBITDA) loss of between $17.3 million and $18.3 million.

What are the implications for Surfstitch and its share price?

Surfstitch had forecast pro-forma EBITDA of between $2 and $3 million in early May, which was a downgrade and well below last year’s forecasts.

The Surfstitch share price could take a tumble today, as this news is just the latest in a series of ‘misadventures‘ by the company in the past few months. Shareholders are unlikely to be very happy with the company and management, and are likely to make their feelings known. The odds of a shareholder class action must be looming ever larger.

Where to now for Surfstitch?

The company says it expects to return to profitability and be cash-flow positive during FY2017. That at least is some good news.

Despite the company’s problems, there still might be a profitable business underneath all that. The issue investors face is how long it will take the company to turn things around, and whether there are still lingering management problems.

As one retailer has already found, it can take some years to turn a struggling business around. Pacific Brands Limited (ASX: PBG) saw its share price crash in 2007 and 2008, and it has really taken until early this year before the company was back in a solid position to grow revenues, earnings and dividends.

Foolish takeaway

Should the share price tumble again today, some brave investors might take the opportunity to pick up shares at cheap prices. But this is a highly risky proposition, and not all companies manage to turn around.

Buyer beware.

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Motley Fool writer/analyst Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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