WWW: Smoke In Mirrors. Buy The Event

Takeaway: WWW will annihilate 3Q, and guide down 4Q. Not bc it has to but bc it wants to. Our thesis is on track regardless of the print. We're buyers

Conclusion: We think that two things are a near certainty when WWW reports 3Q numbers on Tuesday morning. 1) First, the company will annihilate 3Q earnings expectations. 2) Immediately following, it will guide down for 4Q. We think that it will guide as such because it wants to, not because it needs to. We’d use any weakness around a sloppy guide to add to an existing position, or better yet, use as an opportunity to build a position if you’ve otherwise been waiting on the sidelines regretting not being involved while watching it go from $40 to $58 over the past year. Our thesis hinges around WWW earning $5.65 in three years, which compares to the consensus at $4.25 (we’re 33% ahead of the Street).  All of our research suggests that this thesis is on track – regardless of what the company says tomorrow on its call. We’re buyers on the event.

A beat is already priced in. After all, WWW has beat 19 of the past 20 quarters – and the one quarter it missed was by a penny (less than 2%). But we think that we'll see both a top line and Gross Margin beat -- and upside by as much as $0.20 to the Street’s $1.01.  If we see any less, it’s likely be to be due to higher SG&A spending to facilitate growth in WWW’s PLG brands outside the US. We’re ok with that.

WWW: Smoke In Mirrors. Buy The Event - WWW chart1

Let’s bring on the accountability check.

It’s time for some basic math and an accountability check on WWW.  At the start of the year, the company said the following about the recent ‘PLG’ acquisition (Sperry, Saucony, Keds, Stride Rite) and its impact on earnings.  ‘Included in the fiscal 2013 guidance is GAAP accretion from the PLG acquisition in the range of $0.40 to $0.50 per share. Given the seasonality of the PLG brands, we expect modest accretion in the first fiscal quarter, slight dilution in the second fiscal quarter, strong accretion in the third fiscal quarter, and modest accretion in the fourth fiscal quarter.’  This means the first and second quarter roughly wash each other out and most accretion comes in 2H, which makes sense because a) the seasonality of the business lends itself to higher profitability in the second half, and b) the deals that WWW is striking with international distributors are cumulative in nature, and pick up over time as it relates to impact on the P&L.

Now, with the first half of the year already put to bed, WWW has realized $0.58 per share in accretion from the acquisition – which is huge. But the company managed to convince Wall Street that 2H would now be dilutive to earnings.  Huh?  How could that logically and mathematically be possible?

The way we look at it, this is a whole lot of smoke and mirrors.  WWW is saying that it pulled forward some demand from 3Q into 1Q, and that it pushed some costs from 2Q into 3Q – and as such, what was the most accretive period of the year becomes dilutive. It’s ironic that the company does not identify what those shipments are, or quantify how much they are impacting its financials.

This is another example of the company artfully managing the Street’s expectations. When all is said and done, we think it’s not unrealistic for WWW to print anywhere between $0.20-$0.40 per share in upside in 2H.

OUR THESIS

The Street is grossly underestimating the revenue growth opportunity as the legacy WWW scales its recently acquired brands over its global infrastructure.  We think WWW can and will add $1bn in sales to its $2.7bn base over 3-years. Under its former owner, Sperry, Keds, Saucony and Stride-Rite only generated 5% of its sales outside of the US, and most of that was in Mexico and Canada. Legacy WWW, on the other hand, is the most global footwear company in the world (yes, even more so than NKE and AdiBok), with 65% of units sold outside the US through an elaborate network of seamlessly-integrated third-party distributors. Given that the infrastructure is already in place, the incremental sales should be brought on close to a 20% incremental margin, versus 8% margin today. Similarly, minimal capital is needed on the balance sheet to grow these brands, making the growth trajectory over the next 3-5 years very ROIC accretive. As a result of the excess cash, the company will have the resources to systematically pay down the $1.2bn in debt it took on to do the PLG deal. Our math suggests an incremental 5-6% earnings growth from delivering alone. The stock might look expensive at 20x earnings and 12x cash flow, but the street’s numbers are low by an incremental 10% per year. We're at $5.65 to the Street's $4.25 three years out.  We’d buy aggressively on a pullback, but are not so sure that will happen. We think WWW is a $100+ stock over 2-years.

WWW: Smoke In Mirrors. Buy The Event - WWW chart2

WWW: Smoke In Mirrors. Buy The Event - WWW chart3