Despite my initial gut, it makes a ton of sense. If my price math is right, the big winner is ZQK as it mitigates balance sheet risk. VFC buys eps leaving Nike as the stand alone candidate for TBL.

I didn’t see this one coming… The buzz out of ASR (Action Sports Retailer trade expo) is that VF Corp is buying DC Shoes from Quiksilver. There are two things to consider. 1) Does the deal fit strategically for VFC, 2) why in the world would ZQK sell its fastest-growing business, and 3) what does this mean for the investment case for each.

1) Does The Deal Fit? At first glance, my sense would be ‘No’ given what appears to be meaningful overlap between DC Shoes and VFC’s Vans. But the reality is that distribution is radically different, with Vans geared disproportionately toward company-owned stores, National Chains, and Shoe Chains, and DC geared towards athletic specialty and department stores – and at a 30% premium to Vans. VFC gives DC a platform to grow in Europe – a region where skate is a solid market, but one where DC has largely failed to grow under Quiksilver’s leadership.

Another consideration is that with VF Corp growing Vans, Reef, and The North Face footwear, it increasingly needs scale as the Asian factories gain leverage in this new reality where factories are closing, and pushing costs to US brands and retailers that are losing leverage on the margin. This would help VFC in that regard.

Another factor to keep in mind is that VFC was one of two likely buyers for Timberland. If this deal goes through, it’s basically up to Nike to step in and buy Timberland.

2) What is ZQK Thinking? Why sell its fastest-growing division? This is a function of ‘want vs. need.’ Does the company want to divest DC? I know for certain that the answer is No. But with the stock just over a bone, and with the EBITDA multiple well above the earnings multiple – it’s clear that the balance sheet matters far more than just about anything business-related.

So what would ZQK look like ex-DC? It’s impossible to tell for sure given that lack of any price disclosure. ZQK bought DC for about $100mm in 2004 when DC was at $100mm in revs and 9x EBITDA. On one hand, multiples have been crushed – which is stating the obvious. In addition, DC has failed to realize any scale benefits, and margins are still sitting near 10%. On the flip side, ZQK has grown DC from $100mm to about $475mm. If I assume 10% EBIT margins, 3% D&A, and a 5x cash flow multiple – then it suggests about $300mm in cash to ZQK. That’s not to mention divesting ZQK’s biggest working capital drag (footwear is the biggest drag after the now-divested hardgoods business). Based on those assumptions, my math is that this divestiture would be accretive.

Backing this business out of ZQK, my math leaves me with about $0.35-$0.40 per share in earnings. Not bad for a $1.50 stock whose debt/EBITDA goes from 5x to 4.2x with such a deal (and from over 8x with hardgoods). That’s not to mention that this would leave ZQK with a core apparel business (Quik and Roxy) where it could refocus on getting margins back into the double digits – something I thing is very much within reach.

3) What Does this Mean for the Stocks?
• ZQK: If this deal happens in the ballpark of the numbers I discussed, my math suggests a value today for ZQK at least 2x where it went out on Friday. A year out (if the co can realize margin goals) then we’re talking much higher.

• VFC: This would conveniently come at a time when VFC’s base business is fizzing out, and earnings expectations are way too high for 2009. The purchase price in question will not break VFC’s bank, and will help the company grow earnings – even if not organically. Again, this is all price-dependant, but at face value this is a positive for VFC.

• TBL: Bad for TBL. There were two likely suitors. VFC and NKE. A field of one would not help TBL’s bidding dynamics.

• Other bidders? Nike would not touch DC, in my humble opinion. Not because it does not like the category. Quite the opposite, actually. Mark Parker (CEO) is very much in tune with the relevance of the skate consumer. But that is why Nike has developed its own skate brand over the past 5 years. Keep in mind that Nike bought Hurley to better understand the skate consumer. Now Nike skate (6.0, etc…) eclipses Hurley in size. Nike’s motto is ‘why buy another brand when we can beat them organically with our own?’ Regardless of whether or not they can win, as long as they believe it, then they’ll deploy the capital internally as opposed to externally – and likely get a higher ROI. I’d be surprised to see other bidders here unless the announced price is egregiously low.

LIZ: Bill… C’mon Man!

When your stock goes from $40 to $2, you just miffed the Q, and you secured credit lines by the skin of your teeth – DO NOT go public with a strategy to add high priced retail stores in a recession.
Don’t know if anyone caught this, but Reuters on Friday picked up on an interview with LIZ CEO Bill McComb. The punchline is that Mr. McComb discussed the revamped (Mizrahi) Liz Claiborne line, which will initially come out at price points about in line with current offerings. He then notes growth opportunity in Europe and Asia. I’m ok with that.

But then he went on to talk about going into higher price point products, and expanding this into more company-owned full price retail stores.

C’mon man! Why’d you have to say that? Regardless of your plans, you have not exactly earned the right to grow. You just tanked the quarter – again – and finally secured required credit lines to maintain the status quo. I’m not against thinking about growth in the long-term strat plan – just don’t articulate this to the Street!

My vote? Sell the Liz Claiborne brand to Wal*Mart/Li&Fung for 0.3-0.4x revs, and monetize Juicy/Lucky and Kate Spade. Net out the debt, blow out corporate, buy out long-term liabilities, and view monetization of any other brands as a call option. All that still gets me to a value in the high single digits.

The simple fact that the Board has not yet acted with the stock price going from $40 to $2 shows either 1) incredible vision, 2) incredible stupidity and/or 3) severe lack of acknowledging any fiduciary responsibility to shareholders.

This thing gets one more quarter of my patience.

Eye On Re-Regulation: Where There's Smoke...

We Hold These Truths

“I walk on untrodden ground. There is scarcely any part of my conduct which may not hereafter be drawn into precedent.”
- George Washington

The pageantry of the Inauguration having come and gone, the cheering millions have retired to their homes to warm themselves in the aftermath of one of the coldest Inauguration Days on record, and Barack Hussein Obama sits at his new desk in the Oval Office. He is no longer the First Black President of the United States, no longer the First African-American President of the United States, and he is not three-fifths of a President of the United States.

He is now the President of the United States. And he has work to do…

Let My Market Go
“I don’t want to get the math wrong.”
- Timothy Geithner, in confirmation hearings

We listened with a mix of disbelief and resigned disappointment to Timothy Geithner’s confirmation hearings. Mr. Geithner was asked several times whether he thought it correct that Secretary Paulson diverted the TARP money from its intended use – that of purchasing toxic assets – and instead paid it out in the biggest year-end bonus in Wall Street history. Geithner took pains to remind the hearing panel that he was not Treasury Secretary at the time. He then answered that, given the options, the money was put to the best available use. Indeed, he said, had the money not been given to the banks, the global economy would be in far worse shape today.

We did not hear anyone substantially take Mr. Geithner to task over his demur – “I only work here” – that he did not make the decisions to deploy the TARP moneys. This is a significant failing on the part of the Senate panel. We recognize that there is an Obama love-fest in the air, coupled with a manic panic over the global financial situation. This should not be a reason for dispensing with deliberation. The US tax code is so unreasonably complex that even the incoming Treasury Secretary can’t get it straight, allegedly…

But Geithner was intimately involved in pulling the TARP over our eyes; nor did he avail himself of the hearings to distance himself from Chairmen Paulson and Bernanke. Rather, he promised much more of the same. Why should large banks that have mismanaged their businesses be rewarded and urged to suck up other large banks in an environment where all large financial institutions are exposed to market instability of Miltonian scope?

Kansas Republican Senator Pat Roberts pointed out to Mr. Geithner that there are 347 healthy banks in his state. Our question is why should 347 banks in Kansas with no toxic assets festering on their balance sheets be elbowed out of their own markets as the money center giants seek to stabilize their businesses by expanding into regional banking? Because America has consistently rewarded growth for its own sake. The school of Bigger Is Better, fueled by the perceived inexhaustibleness of America’s natural wealth, values the optical result, and not the process.

For the same money – probably far less – the Feds could assign large poorly managed banks to networks of local caregiver banks. The local bank executives can create a nationwide Kiwanis program to rehabilitate the giant banks, and possibly even some of the bankers. Instead of having BofA buy Merrill Lynch, the brokerage and banking assets could be pieced out among a national network of banks with offices in cities where Merrill has brokerage operations. The notion of Economies of Scale is a canard, because oversight and management processes, support systems, infrastructure, legal and compliance are what always get cut when financial firms merge.

Professor Luigi Zingales, of the Chicago Booth School of Business, interviewed on Bloomberg radio (January 21) said that, while the real economy-shattering problems reside in a small handful of the very largest banks, many smaller ones will be gobbled up in the Great Rolling-Up the Treasury has financed. Writing on line (, January 19, “Yes We Can, Mr. Geithner”) Professor Zingales advises “it is important to keep in mind the interest of the country does not necessarily coincide with the interest of the banks.” Nobody is listening.

We agree with the Senate panel: The current deployment of TARP funds was not the program we were promised. Neel Kashkari now requires all banks in receipt of TARP funding to submit a report of their use of the assets. His timing makes it seem that someone older and more seasoned (Hank Paulson?) pulled him aside and said, “Hey, Kid! We got a new President. You better document what you’re doing.” This is routine in our industry. Firms put compliance policies in place and nobody follows up. Management issues detailed oversight program, then goes into a panic when they get an audit letter and discover there are no records, because nothing was ever implemented.

Mr. Geithner’s testimony leaves us wondering what Son of TARP will look like, and concerned that it will be launched without a transparent oversight mechanism. Worse, we fear the consequences for non-compliance will be mild to nil. Not getting the next ten billion does not look like much of a punishment. It is clear that this is going to be a very long process. As was noted by our CEO, Keith McCullough, Geithner is using the confirmation hearings to manage global expectations on both the time line and magnitude of the recovery. Looks like there will be many sequels. After “Son of TARP”, expect “Return of TARP”, “Revenge of TARP”, “Bride of TARP”, and of course, “Abbot and Costello Meet TARP”.

Mr. Geithner, you have several thousand well-managed local banks across the nation, most of which are in a position to take on a few tens or hundreds of millions of the troubled assets you seek to dump. Instead of backstopping those who got us into this mess, why not turn it over to those who have no need of our largesse and grant them not a bailout, but a safety net? The societal and market effect of this program so far has been to concentrate monopolistic power into the hands of the truly incompetent. This is crony capitalism that outdoes anything the Russian Oligarchs could come up with. This is no time to Dance With The One What Brung You.

Talk about getting the math right, Mr. Geithner, without a revolution in management and truly dire consequences for non-compliance, your plan is asymptotic: the line representing the amount of our money you throw at the problem, as it approaches infinity – and it will – will never intersect with the problem at a point of resolution. In this equation you cannot solve for N.

The More Things Stay the Same, The More They Stay The Same
“We must run as fast as we can
just to stay in the same place.”
- The Red Queen

Whither financial industry regulation, what with the massive government push on the side of the tottering giants? The Senate panel’s refusal to rake Mr. Geithner over the coals is reminiscent of the atmosphere of panic in which the USA PATRIOT Act was passed, with damned few actually reading the document.

Here is our scenario. The mismanaged banks that bought the world’s largest retail brokerages have already been given an endless stream of cash to promote this suicidal business model. The notion of Principles-Based Regulation remains an academic exercise and a topic for op-ed writers. It will be a long, hard slog to get our trillion dollars back from the likes of BofA and John Thain. Meanwhile, in the real world, there will be a crackdown on smaller and newer financial firms as examiners Get Tough On Crime. Legitimate small operators will be hampered by excessive pressure to implement meaningless regulations as examiners with no experience in the industry read down their audit checklists.

Reality check: as legitimate operators waste resources struggling to comply with regulatory requirements that do not apply to their business, criminals will simply ignore the rules and steal investor money quickly. The regulatory agencies are already so overburdened that there are firms that have not been audited in five years or more. When they finally get around to you, the time lag between a FINRA deficiency letter and an enforcement action is likely to be at least six months. If you have a good lawyer, maybe a year and a half. And ultimately, all FINRA can do is toss you out of their club, or make you pay a fine for the privilege of staying in.

The notion of a consolidation of Federal agencies in a merger of the SEC and the CFTC is possibly a very bad idea. The SEC’s embedded bureaucracy transcends the worst in Levantine obscurantism and remains in a constant state of muffled war with a changing cast of political appointees – the Commissioners. Folding another agency’s personnel, procedures and legacy record-keeping into this morass will create a quagmire that will throw the regulatory process into reverse for a long time to come.

Mary Schapiro has much to contend with in picking up the detritus left by Chairman Cox. She must balance self justification over FINRA’s failure to nail Bernie Madoff, with cracking the whip over the forward-going SEC Madoff investigation. She must deal with the present crisis in the financial markets and all its new avatars as they arise. She must use all her political wiles to cajole together some new regulatory beast, whose identity is not yet known, though the world believes its hour has come.

Who will get the assignment of designing the new approach to regulation? Why, a Rules and Principles Committee, of course. Novus ordo seclorum will have to wait until things quiet down. And when things are quiet, nothing new gets implemented, because the SEC absolutely requires panic to motivate institutional action.

The CFTC think the SEC are incompetent and rebel at the notion of being absorbed into the mega-bureaucracy. Still, we fear the SEC may carry the day. Remember that in America, Bigger Is Better – and Biggest Is Best. It will be easy to explain to the public why the SEC – household name agency – needs the additional resources and staff of the CFTC. The public has never heard of the CFTC because so few retail customers trade commodities. Even for all the embedded structural inefficiency of the SEC, it would be hard to explain why the Commission is being dismembered and handed over to people who regulate soy beans and pork bellies. The public would have a difficult time grasping it. Congress… fugeddaboudit. On such perceptions rests the fate of the world.

The Usual Suspects
“I am shocked! Shocked!”
- Claude Raines in “Casablanca”

It was obvious to all of Wall Street that Bank of America’s acquisition of Merrill Lynch was nothing short of suicidal. It was clearly obvious to John Thain – no fool he – and to Merrill’s heads of both sales and investment banking, both of whom fled within days of the merger. Was it not clear to BofA, not to the regulators and legislators who were rushing to force this deal through?

The SEC inquired specifically regarding personal enrichment of Merrill Lynch executives as a result of the transaction, only to be slapped down by the law firm of Wachtell Lipton (, January 23, “The SEC Was Asking Questions About John Thain”). In response to the SEC’s inquiry of October 15, Wachtell Lipton wrote “Bank of America has not reached agreement with Mr. Thain or any other executive officers of Merrill Lynch on compensation arrangements in connection with their continued employment following completion of the merger.” Translation: we would sooner eat dog food than tell you what’s under the hood in this deal.

What is particularly striking about this exchange is that Wachtell Lipton was BofA’s law firm, not Merrill’s. Apparently, the ghastly amounts of money being flushed away were either not known to the BofA executives and board of directors who approved this deal. More likely, BofA found out about the numbers in the midst of the transaction and realized that, if the information became public, even Hank Paulson would not be able to justify financing this deal.

Bank of America was doing the Government a favor by sucking up what would have been a very high-priced bailout. BofA, in return, stood to receive a big check once the deal closed. One suspects that BofA CEO Ken Lewis, who “forced Mr. Thain’s resignation Thursday, unhappy with the way he handled a big quarterly loss” (WSJ, January 23, page 1, “Thain Ousted In Clash At Bank Of America”) was tossing Thain under the bus. We assume NY State Attorney General Cuomo’s investigation will reveal that Lewis and the board knew of the losses and excess involved and sat on the information, rather than jeopardize their check from Washington. Watch out, Mr. Lewis, the bus is about to shift into reverse.

Everyone who understands the brokerage business recognizes that this business model is over. Indeed, no one recognizes it more than the brokers themselves. And so We The People have paid tens of billions to finance the acquisition of 36,000 stockbrokers by Morgan Stanley and BofA, including billions of bonuses. If we don’t give our brokers bonuses, the argument goes, they will leave. And if we lose our brokers, how can we give the taxpayers their money back? Alas, no one thought of not taking away the taxpayers’ money in the first place. And just for the record, the Smith Barney brokers who are taking one billion dollars in stay bonuses will be out the door the moment their contracts run out, taking the next up-front check on offer.

It comes as no surprise that Merrill Lynch paid out bonuses early, before the BofA transaction closed (Financial Times, January 22, front page, “Merrill Paid Bonuses As Losses Mounted Ahead Of Sale To BofA”). We are talking about a discrepancy of only $3bn - $4bn. As Jackie Gleason says, “A mere bag ‘o shells”. What puzzled us was the abrupt departure of two of the most significant Merrill team leaders, Bob McCann and Greg Fleming, respectively heads of Banking and Sales. How could BofA not have locked key players into long-term management contracts? Where was BofA’s management? Where their lawyers and board of directors? The exchange of letters between the SEC and Wachtell Lipton shows us exactly where they were.

So now what?

The SEC, grotesquely dysfunctional, will expend all its energy as it struggles first to survive, then in a turf war over the regulatory sector. Congress will not step in to regulate the financial industry where the rubber meets the road – at the level of investors being scammed – because they are too busy spending a trillion dollars here, a trillion there on “shoring up the financial sector”.

Look for the most seasoned and aggressive state regulators to step in where FINRA and SEC are too incompetent to tread, starting with Andrew Cuomo. Merrill and BofA shareholders voted to approve the merger on December 5th, one day before Andrew Cuomo’s 51st birthday. He could not have been given a better present.

Meanwhile, back to Mr. Geithner, we are clearly being given More Of The Same. If a global excess of liquidity led to the proliferation of bad investment paper – once all the decent investments had been bought and taken off the market – which led to discarding risk parameters, which led to the global economic crisis, does it really make sense that the cure for this malaise is to inject yet more money into the markets?

This is the “Efficient Secretary Hypothesis”: the theory that markets are incapable of taking care of themselves, and that government meddling is called for. This is based in the mistaken notion that the work of economists such as Hyman Minsky provides a prescription for dealing with crisis, whereas in reality, economists provide not prescriptions, but descriptions. We fear this may turn out to be Financial Lysenkoism.

How would it look if the government did nothing and let the markets crash, roil and rebuild on their own? Let businesses fail or prosper? Stood aside and permitted those with cash and an appetite for risk to take their chances, while permitting the faint of heart to remain on the sidelines? Permitted capitalists and risk takers to fail or succeed on their own, instead of rewarding monumental incompetence and hijacking the life savings of generations in an experiment in economic diddling?

But no one ever got elected on a platform of Doing Nothing We Can Believe In.

Moshe Silver
Director of Compliance
Research Edge LLC

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Quote Of The Week: Gina Rinehart

“I have confidence that China will get it right and it will be booming again soon. This dip that we are seeing right now is a great time to focus our thoughts on how we should be doing things better.” -Gina Rinehart

This is a simple quote that every “its global this time” asset allocator would have signed off on less than 18 months ago. Today, I am not sure who is actually allowed to be bullish on China, but the locals are enjoying a +9% year to date move in the Chinese stock market as they head into this week’s Chinese New Year (The Year of the Ox).

Gina Rinehart was quoted above by Andrew Hobbs at Bloomberg this week in an article titled “Australia’s Richest Woman Seeks Chinese Mine Partners”, and her comment was a breath of fresh Australian capitalistic air. Rinehart is only 54 years old, full of energy, and now looking to take advantage of this crisis of confidence that the manic media continues to perpetuate.

There is a big difference between the Liquidity Crisis of October 2008, and the 2009 Illiquidity Crisis that has been born out of the Crisis of Credibility. Most investors have found themselves in the newfound position of not owning the duration of their investments. This, of course, is the problem with managing other people’s money – once in a while they ask to have it back!

Have no fear however, the Darwinian rules that have been at work for hundreds of years will solve all that creatively self destructs. Those capitalists who are liquid long cash will start to rake in the prized pieces of property on the global monopoly board, one by one – everything has a price.

Keith R. McCullough
CEO / Chief Investment Officer


I kept my nose out of getting involved in Decker’s – because I simply lacked the fundamental edge on the distribution model. But as I peel back the onion, I don’t like what I smell.

Let’s look at Ugg market share for a minute. In the latest holiday season, Ugg had a 38% market share of department store shoe sales. 38%!!! I don’t EVER recall seeing a brand with share of this magnitude.

Chart 2 below is vital. It shows how Ugg went from a 2 month winter season in ’06, to 3 months in ’07, and now 5-months in ’08. It seems to be expanding its seasonal growth given inability (or lack of desire) to push above 40% share.

Now the brand is selling at a 10%+ share as early as August. To expand this footprint much further, we need to see a much bigger push into warmer-weather footwear, which usually carries a lower price point.

The emotion over this stock is massive. On one hand, short interest is 28% of the float – but that’s down from 40% in late summer, and historical peak of 70%. Also, all but one sell side analysts has a buy rating, and the average price target calls for a 110% gain from here (the only Hold rating is calling for 40% price upside). Those targets are likely to come down.

I kept my nose out of getting involved in this name – because I simply did not have the fundamental edge on the business model and distribution. But as I peel back the onion, I don’t like what I smell.

Disclaimer: I am sitting here on my couch this fine Sunday afternoon wearing a pair of Uggs. The product is so dang comfortable, but once an aging hipster like myself embraces it, I’ve gotta question how cool it is.

Chart Of The Week: 2009 Year To Date SP500 vs. Gold...

On a week over week basis, gold was +7% and the SP500 was -2.1%. For 2009 Year To Date, this puts Gold +2% vs. the SP500 at -7.9%.

In reviewing this past week of price changes across global macro, the most interesting callout here is that the US Dollar has been going up at the same time gold has. A strengthening dollar has effectively hammered equity prices everywhere but in China. Meanwhile, last week at least, the early signals of “re-flation” have manifested themselves in both 10 year yields, gold, and oil (oil had a +27% move this week, and 10 yr Treasuries sold off taking 10 yr yields 30 basis points higher week over week to 2.62%).

What does all of this mean? In the face of an improving American credit and liquidity picture (narrowing TED spread, steepening yield curve, etc…), there remains a Crisis of Credibility in Foreign Currencies, large cap US Financial Stocks, and US Treasury Bonds alike.

Keith R. McCullough
CEO / Chief Investment Officer

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