Conclusion: A bigger deal than VFC was initially looking to swallow, but this one makes sense on many fronts. It’s rare that we’re positive on an acquisition, but this definitely changes our longer-term outlook for VFC.
Its rare that we say this about an acquisition, but this VFC/TBL deal makes perfect sense to us.
A few considerations…
1) It gets each company what they need. In the case of TBL, it puts the company in a portfolio that allow it to regain a shred of credibility – not to mention extremely good management which will, no doubt, be leveraged across a perennially poorly managed TBL. For VFC, it takes up footwear mix from roughly 15% of sales to greater than 20% -- and broadens international exposure to 35% pro-forma vs 30% today (VFC is 30% Int’l, and TBL is pushing 60%) representing significant progress towards achieving the company’s goal of 40%.
2) The timing was ideal as well. Think about it… TBL was faced with a class action lawsuit last week for allegedly misleading investors, where TBL blew out 4Q numbers, issued very bullish forward looking statements, and then missed meaningfully one quarter later (just after management sold stock at an increasing rate). The evidence is compelling (see chart below). This deal won’t make the lawsuit go away – but for the shareholders who stuck it out over six months, it gives some relief by valuing TBL close to where it was around the bullish 4Q print.
3) This suit will be VFC’s problem to an extent – but the scope will be greatly diminished – and if anything, more focused on the individuals at TBL as opposed to the company.
4) This deal happened FAST. It was very quiet in the market without any meaningfully suspicious trading activity (while TBL mgmt continued to sell stock). What gives us comfort is that VFC had literally been doing due diligence on it for the better part of 10 years. It knows TBL better than most people at TBL do.
5) One area we caution is that TBL’s SG&A is actually down by about 8% over the past 5 years. Yes, there are some moving parts with the closure of retail stores and the shifting of the Apparel business to PVH. But we never like to see premium-branded companies that shrink SG&A, We’d far rather see the company be a better steward of capital allocatioin, and invest in its content. Hence, our lingering concern here is that TBL actually needs more capital (talent/R&D/Marketing) before sales and margins have to remain robust.
6) Chance of competing bid? Very unlikely. The 10.8x EBITDA multiple is steep – though it’s closer to 8x 2 years our if we give credit for 10% top line growth (which we’ll front them) as well as slight margin improvement, we get to a multiple closer to 8x – which is fair. In addition, Adidas and Nike are the two most likely suitors – and neither has a good track record of buying companies that need to be fixed. VFC has a better track record in doing so. Also, the fact of the matter is that the valuation on current year’s numbers is rich. If anyone were to step in with another bid, it’d need to assume an unreasonable level of synergies.
We’re making the following changes to out model:
Revenues – we’re assuming the deal closes mid-September, with Timberland adding $690mm in revs in F11 and $1.71Bn in F12 accounting for 9% growth in ’11 and 11% in ’12.
Margins – we don’t expect significant synergies to be realized in F11 given one quarter with which to work, but do expect VFC to realize substantial synergies of roughly 150bps primarily in F12. We're usually not fans of gifting high expectations for synergies either. But in the grand scheme of what VFC can add as it relates to top line, Gross Margin, and to oan extent, SG&A, we're really not talking big numbers here.
Interest Expense – with the deal financed by $500mm in cash, $700mm in commercial paper, and $800mm in term-debt, we are layering in $28mm in interested expense in F11 and $75mm in F12.
EPS – based on the our calculation, we expect $0.30 of accretion in F11 (assuming roughly $30mm in 1x charges) and approximately $0.75 in F12 assuming 150bps of margin expansion in the TBL business bringing our earnings estimates to $7.45 and $8.75 in F11 and F12 respectively. While we're above management's guidance for deal accretion, unfortunately we are still slightly behind in assumptions for its other core businesses. Net them all out and our sense is that consensus estimates will shake out ahead of ours. If not, we'll likely change our near-term tune on the stock.