I could raise serious concerns about the timing and synergy opportunities for Gildan/Gold Toe. But there are strategic benefits, and stocks don't go down when estimates go up. Net/net: It's a positive near-term.
Bull Case For The Deal
- Deceleration in Gildan’s top line starting in the quarter to be reported on May 11 is a near-mathematical certainty. And yes, they’ve locked in only 55% of cotton costs for 4Q – and it’s at $1.25 – with minimal hedging in 2012. There’s one easy way to get out of your way of a collapse in operating profit growth – buy something. Regardless of whether people like us frown upon this practice, the reality is that it doesn’t matter. If earnings go up, the stock isn’t going down.
- I like the diversification factor ,which should improve stability and earnings predictability, which is something I’m willing to award a higher multiple. Specific changes are as follows…
- It cuts Broder’s ‘material customer’ risk by nearly half
- Lowers exposure to Latin America from a sourcing perspective (virtually all of Gold Toe’s product is outsourced to Asia – unlike GIL, which is all vertical in Honduras and Dominican Republic).
- Trades off capital intensity for working capital intensity. The latter gives a less painful spank when revenue declines.
- The deal actually gives Gildan brands that consumers know.
- Great CEO in Steve Lineberger, but vital that he to stays on. He’s an industry veteran who was vital in several iterations of HBI’s restructurings. If he ultimately takes on a higher profile role at Gildan, it could be meaningful.
- Even though it is a tiny percent of revenue, the fact that Gold Toe makes UnderArmour’s socks is solid. All the company needs to do is put a big UA logo on its IR marketing materials and it gets instant credibility (it makes socks for New Balance too).
- At the end of the day, the 7.2x EBITDA multiple isn’t half bad. We’ve seen assets in the intimate apparel space sell routinely for 3-6x EBITDA. But if we give the company credit for synergies, we’re looking at a multiple closer to 5.5x.
Bear Case for Gold Toe
1) The timing of the deal is very suspect, as noted in point #1 above. Examples where companies succeed in buying assets to shield organic revenue from slowing are few and far between.
2) The company has been shrinking. Steve Schwarzman (Blackstone) has been trying to unload this puppy since early 2010 when it was $350mm in sales. Now it is $280mm. This revenue loss was mostly on the private label side – much of which was unprofitable. But overall, we like sales streams that are going up, not down.
3) Schwarzman didn’t want it. Other financial buyers didn’t want it. No other strategic buyers wanted it.
4) Why not pre-announce 2Q results with this deal? C’mon… the quarter ended 12 days ago and the Street’s revenue estimate is for 25% top line growth compared to guidance of 15%.
5) It was pretty clear from management’s comments on the call that Gold Toe is just as wide-open to input costs as Gildan. They are relying on pricing to stick. It might very well stick, but I don’t want to bank on it.
6) Synergies are difficult to bank on.
- First off, management’s answer to the question asking for clarification on drivers for synergies was unacceptable.
- Second, they’ve got to be on the revenue side. Why? Really…do you think that there are ANY costs left to cut after years under Blackstone’s (or any PE firm’s) ownership? No.
- With a sub-12% SG&A ratio, Gildan is, and has been, one of the leanest companies around.
- There are no tax synergies, as the tax rate is going up, not down (to a whopping high-single-digit rate).
- Netting all this out, it suggests to us that synergies need to be manufacturing-related. Yes, GIL is extremely efficient with their manufacturing ops, but even without acquisitions, it has ‘manufacturing issues’ every few quarters.
Conference Call-Outs
GIL acquiring Gold Toe for $350mm – assuming no debt.
2010 revs $280mm
EBITDA $48.6mm
Highlights from the Call:
- can leverage GT brand to the mass market via Gildan's facitilities
- Have already met with both UA and New Balance re the acquisition, both companies have already approved the continuation of licenses
- Combined entity will have sock revenues of ~$500mm
- Gold-Toe will complement Gildan's existing private label business
- Senior Mgmt of GT will stay on with GIL
- Also has long standing sourcing network
- ~80% of product sourced from Asian contractors
- $350mm purchase price equate to 7.2x EBITDA
- Gold-Toe has so far been successful in passing through price
- $10-$15mm in cost synergies:
- Expect annual amortization of intangibles of ~$10mm
- Tax rate expected to be close to 25%
- Purchase price includes more than $100mm in operating loss carry forwards
- Also unfunded pension liab's of $15mm-$20mm pretax
- Expect the deal to be immediately accretive to EPS
- Deal fulfills the 3rd leg of three-pronged retail marketing approach:
- Selectively pursue private-label brands from mass market retailers
- Develop the Gildan brand
- Look for brands or licenses in channel of distribution where GIL isn't
- Positions Gildan as the largest sock provider in the world
- Deal fills the void that Gildan had in terms of enhancing distribution = product for certain channels
- Believe they will be able to significantly expand their distribution - "there is no overlap whatsoever"
- Largest sock customer = ~60% of volume will now equal ~30% of aggregate volume of combined entity
- Gold-Toe in department stores, sporting goods, national retail chains, and wholesale clubs whereas Gildan primarily in Mass channel
- GT also adds brand design expertise
Q&A:
- SKU rationalization:
- GT has more SKUs than GIL
- Financial Accretion:
- Can assume 2010 EBITDA as a base from which to grow (even with some SKU rationalization)
- Cost Synergies:
- Primarily in manufacturing and distribution
- Shifting some manufacturing to existing facilities in Honduras
- GIL's ultimate capacity is 65mm dozen, had been producing 52mm dzn at year end - the difference will be used to accommodate GT product
- License Deals:
- Both UA and NB deals expire in 2013, but feel that they will be able to renew
- Manufacturing Strategy:
- Not intent to eventually manufacture GT product in-house
- GT mgmt strength in outsourcing
- GT's expansion into underwear - Gildan could manufacture in own plants
- GT just launched the new underwear brand so still very new in the process
- P&L:
- GMs higher, SG&A somewhat higher than GIL's
- Average ASPs for GT ~$4/dozen
- Purchase price via cash v. debt?
- Probably use about ~$200mm to finance the deal at ~1% (LIBOR + 75bps)
- Tax impact of deal on consolidated rate will be to increase it to 5-6% from 3-4% currently
- Cotton costs:
- Already have passed through price increases they expect to offset higher cost of cotton
- Have lower amount of cotton in product relative to GIL socks
- Gold-Toe owned store base plan?
- They do own roughly 29 stores - mostly in factory outlet malls
- They're profitable for GT and GIL plans to continue to operate them going forward
Will report Q2 May 11th