LIZ: The Question for Bill and His Board

So Bill, the question I pose to you is quite simple. Do you want equity value or not? The path you are on will erase your remaining $3 stock price faster than you can say “fashionista.” Will your options struck at $40 ever be worth anything? I doubt it. But the fact remains that you’ve got a couple of major call options that will, if exercised, 1) triple your stock price, 2) mitigate the need for a dividend cut, 3) fund your Oct ’09 debt payment, and 4) make you some friends with your company’s long-term shareholders.

It’s a simple question, no? It’s one that I thought that the Board would be asking a few hundred percent higher. I outlined two key modeling scenarios in my 11/11 note (LIZ: Dismantling An Empire) – one where management remains in denial and lets its business and balance sheet erode, and the other where it takes the bull by the horns strategically and makes the current equity valuation (or lack thereof) appear to be a gift. Here’s some added color as to why I get to LIZ being a 3-bagger if this team actually decides to embrace a proactive strategy to create value.

Assumptions in my sum-of-parts analysis.

1. Shrink. Get rid of Mexx. Aside from being an earnings drag, it is a massive working capital drain. $1bn in revenue with 75% in Europe – and the brand has not been able to make money in a weak dollar environment? Sell the leases (which you can do in most parts of Europe). See if you can get a couple of bucks for it. If not, eat crow and give it away. In the US, your leases are in good shape. Take advantage of them. Milk them. Stop trying to grow.

2. Unwind the parts of the core Liz Claiborne brand that should never have existed in the first place. This was once a $1.4bn brand. By last year it was $1bn. Take it below $700mm to a core level where it stands a chance to actually be relevant to its core customer. The asset valuation below shows that at this level, I assume margins of only 6%, and give it a 2x EBITDA multiple. Yes, I am valuing the venerable ‘Liz Claiborne’ trademark at only $125mm (or less than 0.2x sales for a non-seasonal, non-capital-intensive asset).

3. Get by on 2% of sales in corporate expenses. VFC does it. Why can’t you?

4. Juicy Coture, Lucky Brand, and Kate Spade keep mid/high-teens segment margins, and are valued at 4x EBITDA.

5. LIZ frees up $150mm in working capital from Mexx divestiture, and gets another $150mm for all asset sales remaining (including Mexx).

Keep Moving

“Move your hands, move your feet!”
-Tim Taylor
Tim Taylor was at the helm Yale Hockey for 29 years. His legendary career in American hockey has included coaching the US Olympic Team. Most importantly, he is one of the highest integrity men in the game, so it’s always easy to quote him. When I was thinking about what to do with our ‘Hedgeye Portfolio’ into Thursday and Friday’s +11% and +5% intraday squeezes, I couldn’t help but think of what my mentor would say, “Mucker, keep moving…”
If you are in cash, it better be the US denominated kind, because other than Chinese Yuan and Japanese Yen, no other currencies of consequence worked last week. In Asia, 8 out of the 10 currencies factored into my macro model closed down again last week, and currencies levered to commodity prices (Canada, Australia, Brazil, etc…) all continued to fortify their negative down “Trend.” While I had been calling for the “Beware Of The Squeeze” (, 11/12) “Trade” in Asian and US stock markets, there were two critical assumptions associated with that call: 1. Always keep a “Trade” a trade and 2. Never mistake a “Trade” opportunity in one asset class for that in another.
The negative intermediate “Trend” in both commodities and foreign currencies continues to be negative. In the end, this augurs well for trading opportunities in equity markets, particularly those that are building positive immediate term “Trade” momentum, like China. Chinese stocks couldn’t care less about whether or not Goldman’s Lloyd Blankfein pays himself this year. They got the memo on him paying himself size ($70M) at the peak of the “it’s global this time” mania, and they have no reason to trust him or his cronies at “Investment Banking Inc.” anytime soon.
China closed up another +2.2% last night, taking the Shanghai Stock Exchange Composite to 2030. Irrespective of the S&P500 losing another -6.2% of its value last week, China’s stock market has appreciated +15.4% in her last 6 trading days. China’s government is “moving her feet” by cutting taxes, spending stimulus, and playing with confidence. This is all part of “The New Reality.”
Our new Managing Director of Macro Research, Daryl Jones, is lobbying his Washington contacts hard to get “The New Reality” Investment Theme for 2009 penciled in as a capitalist version of Roosevelt’s “New Deal”,  but we aren’t making any promises! Someone sent me an angry crackberry email a while ago suggesting that I must think I could do a better job than Hank “The Market Tank” Paulson has… and upon further review… I think I could! Remember, when we consider an economic scenario within our macro models, what happens on the margin is what matters to us most. Since I don’t think anyone could have been more compromised or conflicted than the ex-CEO of Goldman Sachs was, it’s actually pretty easy to envision doing something better than horrendous. Dear President Obama, “moving Hank’s feet” out the door is at the top of my list of US market squeeze catalysts that you can inspire, immediately.
While we aren’t calling for another one today or tomorrow, there are other formidable macro squeeze catalysts to keep in the back of your head. If you watched and listened to Obama very closely last night on “60 Minutes”, you’ll have concluded that he, like Roosevelt, is going to be in it to win it for the first “100 Days” of his Presidency. Obama will have a stimulus package for homeowners of his own to slap on the tape. He will also have Osama (remember him) “smoked out of his hole.” Dear Mr. President, our only advice is to “keep moving…”
In the face of the negative “Trend” in commodities is a global deflation of the most relevant geo-macro weapon of mass destruction – the price of oil. This morning, Russia is trading off another -3.3%,. Fully loaded with Middle Eastern stock markets imploding, and Ahmadinejad’s Iranian inflation rate bloating (+30% y/y), this is all part of one big fat positive geo-macro catalyst that ObAmerica could potentially inherit. Does it mean run out and buy Russian stocks? I think the answer to that is the easiest one we can answer. The globally auto correlated stock market mania hath ended folks. Winners and losers are going to be born out of “The New Reality”. In order to proactively prepare for it, you’re going to have to trade this market and keep “moving your hands” and “moving your feet.”
The invested exposures in our ‘Hedgeye Asset Allocation’ model were reigned in on Friday. We had 12 position changes - they were all sales. The better part of our selling came in US Equities, where we took the +11% squeeze and locked in some performance. We are longer International Equities than we are US ones right here, primarily because China is the best looking liquid long player on the ice. We like winners who keep moving their feet.
Good luck out there this week,
Long ETFs
EWA –iShares Australia --Australian retail sales increased 0.1 % from Q2, which was weaker than anticipated by economists polled. The spread between Australian 3 month interbank rates and overnight indexed swap rate contracted to 32 basis points, the narrowest since Sept. 4.  Lion Nathan (EWA: 0.38%), announced a $7.5 billion AUD cash and stock bid for Coca-Cola Amatil which has been rejected by Amatil’s management. James Hardie Industries (EWA 0.26%), suspended its first- half dividend after earnings dropped 26 % for Q2.
EWG – iShares Germany --Deutsche Bank (EWG: 2.92%) won regulatory approval to acquire a 30% stake in Deutsche Postbank AG (EWG: 0.25%). On the heels of last week’s Q3 loss figures Hypo Real Estate Holding (EWG: 0.15%) guided lower for 08/09 -``We are predicting an extremely negative consolidated result'' for 2008,
FXI –iShares China --The Ministry of Finance announced tax rebate increases of up to 13% on exports of Aluminum plates and strips beginning in December (this follows the announced increased rebate for bars and rods also  scheduled to commence next month). Zhuzhou Smelter Group , the largest Chinese zinc smelter, announced an immediate  20% output reduction on low demand.
Short ETFs
UUP – U.S. Dollar Index --The FDIC is considering a revision to the $1.4 trillion debt-insurance program to address concerns that interbank overnight loans may no longer be competitive with foreign market rates.
EWW – iShares Mexico – Petroleos  Mexicanos management announced it is considering an external oil E&P contract for deepwater projects or its onshore Chicontepec development . Legislation introduced last month makes this possible for the first time, although partner firms will not own the oil or book the reserves.
EWJ – iShares Japan --Japan officially entered a recessionary period as announced GDP contracted by  0.4 % in Q3  which, following  a Q2 reduction of 3.7%.  Fitch placed Toyota Motor (EWJ 5.61%) on Negative Ratings Watch; Toyota currently holds an AAA long term rating. Honda (EWJ: 2.13%) was also downgraded by Fitch from A+ “Positive” to “stable”. 
FXY – CurrencyShares Japanese Yen Trust  --The dollar weakened to 96.43 yen as of 6:45 am.

Eye On Behavioral Finance: Groupthink

“In the fight between you and the world, back the world.”
-Franz Kafka

Franz Kafka posthumously became renowned for his writing, but while alive actually made his living, ironically, in the finance department of a large insurance company. One of Kafka’s most widely noted works is The Trial. The protagonist in The Trial, Josef K, is awakened one morning, arrested and prosecuted for an unspecified crime. The reasons for the arrest are never known. I’m sure after suffering through an almost 40% decline in the major market indices year-to-date, many investors can relate to Josef K and the idea of being punished for an unknown crime…

While the trials and tribulations of Kafka’s characters may resonate with us, it might be perceived as a stretch to think that we can learn many investment lessons from them. That’s why the aforementioned quote prompted the topic for this post, which is Groupthink. The concept of Groupthink was reportedly first coined in 1952 by William H. Whyte when he wrote in Fortune Magazine:

“We are not talking about mere instinctive conformity – it is, after all, a perennial failing of mankind. What we are talking about is a rationalized conformity – an open, articulate philosophy which holds that group values are not only expedient but right and good as well.”

In simpler terms, and paraphrased from Wikipedia, Groupthink is a method of reaching a consensus decision without critically analyzing the decision, but rather accepting the decision, or view, as correct simply because others support it. The idea of the independent view is lost out, ultimately, to the importance of group cohesiveness.

The investment world is loaded with examples of Groupthink and investment results that are subpar as a result. At Research Edge, we actually quantify Groupthink in order to augment an existing investment thesis’ and take positions that counter the prevailing view. We use various methodologies to counter Groupthink. We quantify them as factors within our multiple factor macro model. Two of the easier factors to identify are Hedge Fund Beta and Sell Side Sentiment.

We review shareholders lists to identify Hedge Fund Beta (or “hedge fund hotels”). We also review sell side opinions to identify stocks that have an overwhelming number of either positive or negative ratings.

I’m not sure “hedge fund hotel” has entered the wide investment lexicon as of yet, but the concept is simple – it is a stock that has a high percentage of hedge fund ownership. We typically consider a stock a “hedge fund hotel” when hedge funds comprise 33% of the top 1/3 of a shareholder list. For many hedge funds “trading ideas” are part of the investment process, so as these “hedgies” trade ideas, the “good” ideas tend to become over owned. In many instances, the investment rational is simply that some other “smart hedgie did the work”, so it must be a good idea and there are certain “smart hedgies” who you can’t criticize, so you just tag along and own the same stocks as them. That’s called Groupthink. We also call it Hedge Fund Beta. Being on the other side of the unwinding of a “hedge fund hotel” can be very profitable.

Sell side estimates and ratings also exemplify Groupthink characteristics that can be taken advantage of. We typical highlight as a contrarian indicator when 66% of the rankings of a stock are of one specific rating, either buy or sell. There is a wide body of evidence that supports our view that the consensus Groupthink ratings of analysts are often way off.

According to research by Robert Shiller, “analysts . . . often pay too much attention to one another instead of providing their own independent research.” The result is that both ratings and earnings estimates become redundant and are often lowly dispersed. According to Maines (1990) and Soll (1999), people often overestimate the information provided in redundant signals. As a result, we have sell side earnings estimates that are based on a foundation of conforming to consensus and an investment community that willingly accepts a lowly dispersed set of data, which inherently implies a lack of independence.

The psychological foundation behind Groupthink is based on the biological concept herding. In his book “Inside the Investor’s Brain”, Richard Petersen writes:

“Biologically speaking, herding refers to the tendency of some species of animals to seek safety in numbers. Herding occurs both when animals are threatened and when they sense that one of their numbers has found an opportunity.”

Hedge funds, and many mutual funds, are in a financial herd. Some justify their positions based on who the stock is owned by and what the well known analysts are saying. If a “smart hedgie” owns the stock and a bulge bracket investment bank has a favorable rating, a safe foundation is in place for the analyst to pitch the stock to his portfolio manager or investment committee. Conversely, these conditions also provides the portfolio manager or investment committee the “safety” to put on the position. What happens when all of these smart sell side analysts and hedgies are wrong?

In The Wisdom of Crowds, James Surowiecki provides what appears to be a juxtaposed thesis to the negative impact of Groupthink. In Surowiecki’s view, the collective knowledge of the many will lead to a better decision than a small group of intelligent experts. He provides many examples of this, such as the ability of electronic markets to predict elections better than professional pollsters, the ability of large groups to accurately predict the weight of an ox, the ability of a large group of varied professionals to find a submarine, and so on. Surowiecki, though, acknowledges early on in his book that all crowds are not created equal when he states: “Paradoxically, the best way for a group to be smart is for each person in it to think and act as independently as possible.”

There are plenty of ways to combat Groupthink. Here are a few to consider:

1. Perform research with independence at the very foundation. Start by developing your own view and then review other analysts’ expectations. When your view is most widely dispersed from the group, you are probably on to something that is worth taking a position in.

2. Foster a culture in your firm that encourages devils advocacy and taking contrary opinions, even against people in positions of power and influence. At Research Edge, we sometimes publish what call “Point and Counterpoint”, which are examples of our internal debates on different investment views that members of our firm are supporting.

At the end of the day, we call it Research Edge because most of the real edge in investment research resides on the teams asking original questions… not following everyone else’s answers to ones that have already been asked.

Daryl Jones
Managing Director
Research Edge LLC

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UA: Texas (Tech) Sized Brand Exposure

On Monday, Under Armour and Texas Tech University announced a new partnership that designates the company as the university’s exclusive performance footwear and apparel outfitter. Under the new 5-year $11M deal, UA will outfit all 17 of Texas Tech’s teams in addition to football, which it has outfitted since 2006. This announcement came at a great time.

Less than two weeks ago, the Red Raiders upset the #1 Texas Longhorns in front of a nationally televised audience vaulting the school to #2 in the BCS rankings. In the process, both Graham Harrell (QB) and Michael Crabtree (WR) solidified their respective case as legitimate Heisman candidates. If the team can complete its remaining schedule (bye week, #5 Oklahoma, and Baylor) unbeaten, the Red Raiders should be vouching for a national title bid in the BCS championship game (talk about brand exposure). Notably, the University of Utah ranked #7 at 10-0 is another UA outfitted team in the BCS mix. Would I rather this deal have been signed before the big win? Yes. It would have saved UA a buck or two. But overall, the terms seem fair.

Despite all the hype, it’s important to not lose sight of how these deals have been struck. As Brian pointed out in his 9/28 post “I’m Warming to the Armour,” the company tends to take a more conservative approach by front-end loading its endorsement deals (less than 5yrs). The same appears to be true for its sponsorship deals. In September, UA inked a 5-year, $17.5M deal with the University of Maryland following an 8-year, $4.1M deal with the University of Hawaii in February. As a point of reference, earlier this year Nike signed a 10-year, $46M exclusive sponsorship deal with UConn.

The company currently outfits five other football programs including the University of Maryland, University of Hawaii, Auburn, University of Southern Florida, and the University of South Carolina. However, with UA’s newly announced sponsorship of the NFL Combine beginning this year and the second annual high school Under Armour All-American Game in January, we expect more teams to be wearing the UA logo come next season.

I’m not going to sit here and argue which company is striking better deals at better prices. But what I can say is that UA’s terms and duration both sit well with me – especially given that its endorsements result in new exposure, whereas I can argue that Nike’s deals are largely to maintain its massive existing share of consumer voice.

Casey Flavin
The country takes notice as Michael Crabtree and Texas Tech pick off the #1 Texas Longhorns on Nov 1.


The good news: Beijing is letting significantly more tourist groups visit Macau. The bad news: they may not be gambling much.

My guys on the ground in Macau are reporting that the number of tourist groups visiting from mainland China is double what it was before the new visa restrictions were enacted. It looks like Beijing is making an effort to support the Macau economy. Unfortunately, the effort is unlikely to help the mass market casino floors much given the limited time allowed the groups in Macau.

Considering the likely demographics and economics of these visitor groups, Beijing is not exactly providing a significant shot in the arm of the casinos. If this were its intention, they would’ve just loosened the individual visa restrictions.

Beijing seems unwilling now to repair the damage created by 3 rounds of visa restrictions and is instead targeting essentially non-casino parts of the economy. Unless business levels deteriorate significantly from here, we may not see any loosening until the new Chief Executive takes over late next year.

The near term is certainly frustrating, as it is for virtually every other casino market. At least Macau still attracts excess demand. I can’t say that for any other market in the world.

The New Off-Price Retail Paradigm?

Ever have one of those situations where your logic, gut, and calculator all tell you different things? I’ve got that with TJX and off-price retailers. I think that’s the next shoe to drop in ’09.

I’ve been struggling with the analysis below for the past hour. The first chart shows the spread between the cash cycle for the apparel brands vs. the off-price retailers. As the brands profess to have found religion on inventory management, the cash conversion tightened between them and the off price retailers. Makes since due to meaningfully less inventory built up in the system. Then the second chart shows that there is a 0.57x relationship between changes in this cycle and EBIT margins for off-price retailers such as TJX and Ross Stores. The simple conclusion? That cash spreads have inflected, and as they build it is a positive for the off-price retail channel.

I don’t buy this.

I’m absolutely not being contrarian for argument’s sake. But I simply don’t think that the past seven years are an appropriate gauge of the relationship between off price retail and the rest of the supply chain. The past seven years were golden. Even the worst of the worst could make money. Strong consumer spending, $4bn+ in annual sourcing dollars injected into the industry, FX tailwind, etc… The number of apparel/footwear retail bankruptcies was less over the past seven-year period than at any other time in history. But this is a New Reality. The bankruptcy rate has started to tick up – and will do so much more meaningfully in 2009. Fans of TJX will tell me that this means better inventory for TJX. I say that this means that a new off-price retail channel will be created where one previously did not exist as legacy stores go bust. The magnitude of excess inventory will be too much for the existing off-price channel to bear.

With this channel currently running near peak margins (see Exhibit 2), there’s not a whole lot of room for error.

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