MW: Activism Brewing?

It seems to have slipped under many radars that Men's Wearhouse just added a change in control provision for its top five officers.  The language was strong enough for our affiliate Michelle Leder (footnoted.org) to flag for us, and her track record in spotting these outliers is notable. In addition, the short interest is high at 15% of the float, and the stock looks bullish from a TREND perspective on Keith's models. While we can make a pretty convincing case that the 10%+ margins of yesteryear are a pipedream for MW as unit growth, offshoring and department store destocking themes have largely played out, this is the sort of sleepy name at a trough point in the cycle where activism would not come as a surprise.

MICHELLE LEDER'S VIEW

What prompted Mens Wearhouse to suddenly add change in control agreements with its five named executive officers on May 15? The company disclosed the new agreements in both the proxy and a separate 8K filed late Wednesday.

We can think of only two likely scenarios here: another company may be looking to acquire Mens Wearhouse or a large investor - think Pershing Square's Bill Ackman and his run on Target here -- might be contemplating a challenge to the company's board. Option A seems a bit more likely, not least of all because if there is an Ackman-like person out there, they've yet to surface.

What makes the filing really stand out is that Mens Wearhouse isn't a new company and change in control agreements tend to be pretty standard things. George Zimmer, for example, started the company over 35 years ago and none of the other top executives are new hires. Given that, why would the company suddenly enter into these agreements on May 15?

After a quick skim comparing the 2008 proxy to the one filed on Wednesday and throwing the 8K also filed on Wednesday into the mix, it seems pretty clear that something is going on here that's worth paying attention to.

FUNDAMENTAL CONSIDERATIONS (ERIC LEVINE)

  • Revenue is highly tied to low-fashion "business attire", of which tailored clothing accounts for 55% of core revenues.  This is a company whose core sales have been weakened almost step for step with the overall economy. 
  • With very little fashion risk in the assortment, revenues here to do not spike in good times.  However, they do see disproportional downside when unemployment is at historical highs.  A suit is the last thing the average male "wants" to buy.
  • Historically the business was successful as they took share from traditional tailored suit distribution channels (i.e department stores exiting the low turning, service intensive business).
  • As the top-line grow, margins expanded as well.  The company benefited greatly over the past few years from greater imports and direct sourcing shifting to Asia.  Remember that the tailored business was still being done domestically, but with also a fairly large Canadian and Mexican manufacturing base.
  • Additionally, the acquisition of the free-standing tuxedo business in April 2007 has provided a positive benefit to margins.  Gross margins for the tux rental business are 82% vs. core gross margins of 55-57%.  As the tux business continues to grow (expected to be up MSD 1H09) at the faster rate than the base (which is now barely growing with store growth cut to 10 stores, from 40-50 per year), there is a positive mix benefit here.
  • Offsetting the tuxedo business is a recent decision to aggressively promote the suit business through BOGO (Buy One Get One) offers.  This is a new strategy that began in 4Q08 and is expected to continue throughout '09 at the very least.  This is a departure from the company's historical EDLP strategy, and is one that will produce gross margin pressure at the very least through 2009.  This is one of the top factors as to why it may be unrealistic to see margins expand again in the near term.  Of course they can cancel this marketing program, but we know from the shoe business how long it takes to wean the consumer off of BOGO's.
  • Also as it relates to BOGO, if you don't need a suit because you're not employed, then you certainly don't need two!
  • In looking at the CEO Zimmer's health, he did have a surgical procedure in 2005 related to an infected abdominal aortic graft.  Since then however, there have been no public announcements related to his health.
  • Bottom line, the boom growth years appear to be over from a store opening/market share perspective.  As the economy recovers, men will resume suit purchases.  However, the duration of the recovery remains to be seen and it certainly won't occur over night.