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.

S&P500 Levels Into the Close...

If you sold stocks at today's intraday low (885 SP500), that doesn't sit well with our risk management model (the tail risk now resides on the side of a massive short squeeze). The range in this market is narrowing as volume is drying up - this is not a time to dress up and play short seller.

We are buyers on red down at the 880 line in the S&P500 (see chart), and looking for this market to breakout, for a "Trade", on a close above the 945 line. Otherwise, trade the ranges.

November 15th is the final date for hedge fund redemption notices... if there is one rumor that I heard most often today (and yesterday) it's that fund XYZ is "selling" and "blowing up"... enough of the narrative fallacy already guys. Lead, follow, or get out of the way (Thomas Paine quote, not mine).

Pound/Euro: Cheap Money Getting Cheaper

We’ve been bearish on the UK and we are currently short the EWU (iShares United Kingdom) as a proxy for this thesis. The UK has one of the worst balance sheets in Europe and its economic data continues to indicate an economy that is in dire straits. Late last week we posted on British housing numbers that declined 15% y-o-y and industrial production, which contracted again in August.

In an attempt to jump start the economy, the BOE cute benchmark rates by 150 bps to take rates to the lowest level since Winston Churchill was Prime Minister. While cutting interest rates should increase money flow and hopefully revive the UK economy in time, there are, obviously, very severe implications for currency valuation.

As outlined below, the Pound as fallen to an all time low versus the Euro based on an interest rate differential that favors selling Pounds versus buying Euros. Given the extremism of the recent move by the BOE and continuing issues with the UK economy, a recovery in the Pound versus the Euro in the intermediate term seems highly unlikely and, if anything, we should expect to see continued devaluation as cheap money continues to get cheaper.

Andrew Barber

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Germany: Is the bottom in sentiment in?

The German ZEW survey shows investors are becoming less negative on the economy… Since everything that matters in our macro models occurs on the margin, this is important.

The Centre for European Economic Research (ZEW) produces its benchmark sentiment indicator by surveying 300 analysts and institutional investors to capture the sentiment of Germany’s “smart money”. After declining sharply since Q1, the latest index ZEW data suggests that sentiment troughed in October and is turning less negative as the impact of government’s bailout programs start to be felt. The index level released today for November was -53 -up 10 points from last month.

While not a good indicator of the mood of the general population, the ZEW has demonstrated value as a leading indicator over the past decade. We are long German equities via the EWG (etf) and we continue to view Germany as the strongest of the major European economies on a relative basis. We expect that if domestic investor sentiment truly has found a bottom for the near term that many other investors will start to share our view.

Andrew Barber

GS: California Conflict?

Allegedly, a Goldman report advised betting against CA’s credit…

The LA Times reported this morning on a confidential Goldman Sachs research report issued in September that advised institutional investors to hedge exposure to (or establish a short on) California debt. It is no surprise that investors would receive this advice - California has been hit hard by the current financial turmoil and Governor Schwarzenegger has issued numerous dire warnings about a potential budget crisis as the credit markets began freezing up over the summer. What IS surprising, perhaps infuriating, is the source. As an underwriter and advisor, Goldman has received millions in banking fees from California bond issues and it has significant advisory and asset management relationships with pools of public capital throughout the golden state.

This conflict will likely come as a shock to California’s lawmakers who could be forgiven for assuming that, as a reputable investment bank, Goldman’s first loyalty would be to its customers and that it would avoid conflicts of interest by helping one customer profit from another’s misfortune. In this case GS apparently event tried to broker both sides of the transaction –according to the LA Times piece Goldman “regularly urged” California to trade CDS contracts on its own credit itself.

A Goldman “spokesman” was quoted saying the firm was no longer providing that advice without elaborating…

The bankers and traders that built Goldman Sachs over the first half of the last century recognized that the trust of their customers, over the long term, was worth more than any opportunity to extract a quick profit. In those days, of course, GS was still a partnership and the long term interests of the firm and those of its customers were closely aligned.

The fact that the firm’s share price is up almost 3% today on the news that they have alienated the largest municipal borrower in the nation may be an indication that the days of that kind of long term thinking is a thing of the past.

Andrew Barber

Cozying up to TED!

We are going on 6 consecutive weeks of this spread narrowing. This is one of the major reasons why we are deploying our oversized position in US Cash into global equities. See the chart below - this is not that complicated.

When this spread was widening (August to October) we moved to 96% cash. Now it's narrowing, and we have moved to 59% cash. A narrowing TED spread is a measure of counterparty risk – it is not the only factor in our multi-factor global macro model that is signaling to buy stocks, but it is an important one.

Storytelling and narrative fallacies are currently running rampant on the Street. When we look back on this buying opportunity in 3 weeks, this is one of the many macro factors that the revisionist historians will cite. You can 'You Tube' me on that.

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