LIZ: Buying The Bone


We had a theme in 2009 called ‘Bone or Bust’, which basically said to buy these single digit midgets, or short them because they’re going bankrupt. There’s no in between. Our view on LIZ has been ‘Buy The Bone’, and if the rumored sale of Mexx comes to fruition, this stock has nowhere to go but up.

Bloomberg was out Yesterday with a story that ‘sources’ indicate that LIZ is close to selling Mexx to one of several private equity firms -- Leonard Green & Partners, Sun Capital and Golden Gate.  We cannot verify or refute – other than to say that it makes sense conceptually. LIZ needed to get rid of Mexx 3 years ago, and it has turned into the mother of all distractions for a company that is otherwise inflecting in its core Liz Claiborne business at JC Penney and Home Shopping Network, as well as its direct brands – Kate Spade, Juicy Coture, and Lucky.

MEXX has lost $90mm in each of the last 2 years (about $0.60 per share, per year), and has accounted for half of LIZ’ EBIT erosion. Simply put, it has been a disaster. And due to a particularly opaque reporting structure, the Street generally cannot tell the true impact to the P&L, nor can it disaggregate the balance sheet impact of this business from the core. The latter is particularly important, because Mexx has been the biggest working capital drain in the entire company – on both inventories and payables. The other thought is that aside from a working capital drag going away, it would also give a $100mm infusion that would go a long way towards mitigating the bankruptcy concerns that are otherwise present in a $5 stock.

Speaking of sentiment, I should note that whenever Casey and I talk about LIZ, we hear crickets in response. Seriously…no one cares about it, and I’m convinced that no one will care about until it’s a $10 stock. This transaction should set it on its way.

One client asked me last night what the impact to the stock should be. In my best effort to polish up the crystal ball, I can say that $90mm loss in EBIT goes away – that’s about $0.60 per share. Cash proceeds of $100mm go directly to pay down debt. While some may want to simplistically slap a 10x multiple on $0.60 – in reality, given that it shows that 1) this Board is getting off its tail and actually doing something, 2) there’ll be more transparency  to the earnings model, 3) The biggest working capital drag is gone (it disproportionately impacted inventories – and also hit payables due to heavy Li&Fung exposure), and 4) will get a $100mm injection in cash to mitigate bankruptcy risk – I’d ask myself why we won’t see closer to $2 in upside. That’s not very scientific…but the sentiment is definitely in this thing’s favor.

One of the considerations here is whether they are going to sell Europe and Canada together. Our sense is they would, but keep in mind that they are very different from a financial perspective. Europe has lost -$97mm and -$105mm in the last two years while Canada generated $7mm and $15mm. From a revenue perspective it’s roughly a 2:1 ratio b/w Europe and Canada generating roughly $725mm in total revs.

The company has been speaking to a goal of break-even by 2012 for MEXX. It’s been a low-to-mid single-digit EBIT margin business in the past. We’ve modeled that over the next two years it will return to roughly 0%. For our SOTP we had assumed 2% margins for a value of $0.75/share.

Note that the pro-forma table below illustrates the full-year 2011 contribution we are modeling for MEXX. Given that we are already in the 2H, the 2011 impact should a transaction occur would be materially less than what we have suggested. This table is intended to reflect the annual impact of MEXX on the collective Liz Claiborne business, which would be realized in some portion over 2011-2012. In the event a transaction transpires, we will adjust the timing of our model accordingly.

LIZ: Buying The Bone - LIZ MEXX ProForma



LIZ: Buying The Bone - LIZ SOTP 7 11