LIZ: Dismantling an Empire

In 1986 Liz Claiborne became the first woman to be CEO of a Fortune 500 company. She revolutionized an industry. The current team is making a mockery of it.

I hate having to take time out of my day to react to poor earnings reports. But for LIZ, I’m making an exception. For starters, I liked this name $5 higher. Keith and I debated this one a ton. He consistently waited for a better price. I had too much blind faith in my fundamental view and did respect the math. I welcome you to YouTube my past comments on our Portal – I’m not going to hide from them. Whenever I am wrong I’ll be my own harshest critic.

Did I like the business? The strategy? Positioning? Portfolio? No, no, no and no! I liked one simple thing -- my confidence that this management team would meaningfully reign in spending, fix an egregiously bloated SG&A structure, and cut capex to a rate that more suitable for this business.

I like the capex cuts a lot – but the rate of change has not intensified since the last call – though the positioning of the business has. I wish I appreciated sooner how flat-out bad this management team is.

One of the selling points of our model is that our content is only available to our clients. I’m tempted to send this note to the Board.

I am increasingly viewing this story as binary, and I am therefore modeling as such. Here’s what I get based on my ‘incompetent management model’ and my ‘bull by the horns management team’ models…

‘Incompetent’ Scenario: Stay the current course. Consistently play defense as $1.6bn in Partner brand business bleeds by 10% annually after a 30% hit in ’08. Direct brands grow mid single digits, but not enough to leverage occupancy cost inflation. Gross margins trend down with the industry, and SG&A cuts are to the tune of 2-3% in absolute dollars. Working capital builds after a year of improvements. Capex is down, but still runs at 2.5-3% of sales in an attempt to grow Direct business. LIZ is faced with a constant overhang of a dividend cut due to the $410mm revolver that needs to be refinanced in Oct ’09. This model gets me to EPS losses through 2012, a dividend cut in ’09, and Chapter 11 could not be ruled out. All in, the company is playing defense in a game it is destined to lose.

‘Bull By The Horns’ Scenario: Cut Capex to 2% of sales – or sub $100mm. Take remaining Partner brands and go exclusive with each one to select major retailers (i.e. Macy’s, Dillard’s, Target, etc…) and major sourcing partners (Li & Fung, etc…), thereby mitigating quarter-to-quarter volatility and start working in a true partnership fashion. Get rid of Mexx. It does not work. Fess up to a bad call and fix it. Cut SG&A across the board. Employee productivity is too low, and dollars invested over the past 2 years are not paying off. It’s time to unwind. In this scenario, despite a 20% hit in CFFO, I’m getting to Free Cash Flow of $250mm, or about 35% better than ’08. This also means no dividend cut overhang, and far less refinancing risk. At that level, 3x EBITDA and 6x earnings sounds a bit more appetizing to me.

I’m sticking with the incompetent model until I gain conviction otherwise.

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