K: Repeatable Pattern

This is a classic!


If you were CEO, what would you do?


Your company is dramatically underperforming the peer group, you just reported a disaster quarter, the core business is in a secular decline and there is not a defendable strategy to fix the business.


Yes, buy another company to mask these issues!


The British press has been floating rumors around that United Biscuits intends to go public in the fall or potentially be for sale at a $2.0 billion valuation.  At the time, the potential buyers were Kraft and Campbell’s, & Turkey’s Ulker.  Today, the rumors are that Kellogg may make a $2.0 billion bid for the company.


While anything is possible, it is unlikely that the rumors are true.  However, if they were, we believe it’d make K an even better short than before.


Our summary thoughts:

  1. K has the cash to make a bid.  According to the 10Q filed on 8/4/14 – in February 2014, the company entered into an unsecured five-year credit agreement to replace its existing four-year credit agreement, which would have expired in March 2015.  The new five-year credit agreement allows the company to borrow, on a revolving credit basis, up to $2.0 billion.  This includes the ability to obtain letters of credit in an aggregate stated amount not to exceed $75 million and swingline loans in aggregate principal amount up to $200 million in U.S. dollars and $400 million in Euros.
  2. UB will not solve the company’s problems in the U.S.  The acquisition will only distract management from fixing the core business.
  3. Management’s acquisition track record has been tarnished by the Pringles acquisition.
  4. Given the multiples that food stocks are selling for, we suspect the acquisition would be massively dilutive to K.


As K moves higher on this rumor, the short becomes more appealing.


Howard Penney

Managing Director


Matt Hedrick



Fred Masotta


Nike Vs.Under Armour: Deep Dive into Endorsements

This note was originally published August 05, 2014 at 17:48 in Retail

Here’s a detailed financial look at athlete endorsement trends between Nike and Under Armour.


These are long-term trends that don’t serve as a smoking gun for a given quarter. That said, it is fascinating to see how the portfolio of sponsorship deals is both growing and maturing at an accelerating rate.


Furthermore, we can see the costs that are coming down the pike. For example, next year NKE is looking at an incremental $82mm (or $991mm in total) in endorsements. To justify that without being margin-dilutive, NKE needs to generate an extra $585mm in revenue. That’s 2.1% growth, which it can pretty much do in its sleep.


UA, on the other hand, is looking at a 39% jump in minimum sponsorship payments to $81mm, its biggest jump ever. UA can cover that with a 9% incremental sales boost, or $210mm – not a problem for UA. But keep in mind that this past year it only needed $45mm to cover a measly $5mm incremental bump in endorsements.


If there’s any real takeaway here it’s that as UA grows and succeeds in its own right, it is competing increasingly against the big boys (NKE, Adidas, Reebok, Puma) for marketable talent. It has a great advantage in that the brand is so hot, authentic and relevant. But those factors do not trump the economics associated with a higher ante-chip for sponsorship deals.


We can see what’s coming on the cost side, now we just need the revenue to follow. It’ll probably come. But anyone looking for margins to go up might be in for a surprise.


The revenue growth did not matter as much over the past year – but now it matters materially, especially with the stock trading at 70x+ earnings.



When people think of the biggest costs associated with competing in the athletic footwear and apparel business, they usually talk about raw materials, labor, distribution and physical infrastructure. All those things matter. But one of the biggest costs is athlete endorsements. This line item is so big, in fact, that the companies are required to file all minimum required payments in almost exactly the same way that retailers are obligated to outline future minimum lease payments under operating lease agreements.


We think that the comparisons are particularly interesting between NKE and UA. Obviously, there is a huge difference in aggregate sponsorship amounts, but in looking through the numbers we can pull away some interesting trends as to how each company’s portfolio is structured and evolving. Here are some key takeaways:


1. Gap is Huge, But Closing: Nike has $4.7bn in forward obligations to pay its athletes and teams, while UnderArmour is sitting at $273mm. That’s a huge difference, but keep in mind that UA was only 2% as large as Nike four years ago, and is 6% today. That far outpaced UA’s revenue growth.


Nike Vs.Under Armour: Deep Dive into Endorsements - ua chart1


2. Both Follow The Same Trend.  We’d go to the mat with anyone who claims that UA and NKE don’t compete against one another for talent (yes, many people make this case to us). The reality is that when we chart sponsorship obligations over time as a percent of sales, the trends are unmistakable for these two companies. Nike operates on a higher (more expensive) plane than UA. But in each of the past seven years, they have moved in exactly the same direction. Nike’s not worried about this. UA probably should be at some level.


 Nike Vs.Under Armour: Deep Dive into Endorsements - UA chart2


3. As a % of Demand Creation Spend, UA has become Nike. This chart is fascinating to us, as it shows how sponsorships went from 15% UA’s Demand Creation budget in its earlier years, and has more than doubled to a level that sits just higher than Nike.  This is neither good nor bad. It simply tells us that sponsorships and endorsements are a key part of the UA model.  Unfortunately, we’d point out that Nike has 4x more sponsorship obligations globally today ($4.7bn) than UnderArmour has generated in Operating Profit since the brand’s inception in 1996. UA is going to have to get more active with some bigger name athletes, and Nike won’t be too keen to lose that battle.   


Nike Vs.Under Armour: Deep Dive into Endorsements - UA chart3


4. Obligation Weighting: UnderArmour generally has an endorsement portfolio with obligations that are more near-term weighted. Today, about 65% of its obligations are due by the end of 2016. Again, that’s neither good nor bad…it’s simply UA’s strategy.  Nike is more back-end loaded with almost a third of its deals due after 5-years. This is due to Nike’s long-term deals with the leagues like the NFL and national teams like Brazil. It’s in the process of exiting its 10-year deal with Manchester United, which saves it about $38mm annually.


Nike Vs.Under Armour: Deep Dive into Endorsements - UA chart4


5. In looking at UA more closely, there’s actually been a fairly dramatic change in its sponsorship duration composition over the past two years alone. UA went from having 84% of deals due within 3-years and only 1% after 5-years, to having 19% due after year 5. This shows that UA is playing in the big leagues - competing for higher profile athletes and teams.


Nike Vs.Under Armour: Deep Dive into Endorsements - UA chart5

RL – Big Win If They Get This Right

Takeaway: The key question here is the duration of the transition and investment needed to launch the company into its next mega-growth cycle.

Not much in this RL quarter to get excited about one way or the other. The market already made that abundantly clear.  While there were a few interesting takeaways for us on the specific business units and growth levers, the big question for us is simply when the time will be right to step up and make a definitive long call on RL.  We don’t think it’s a question of If, but When.


Simply put, virtually every negative factor associated with the investment case around RL can ultimately be tied back to the company transitioning from one long-tailed cycle of repurchasing licenses/regaining control of the brand, to accelerating organic growth of its content on a global scale. Opportunities don’t come along very often where the stock of a quality company is out of favor due to the near-term financial impact of the company doing the right things to re-fuel growth. Operating profit – in absolute dollars – just hit a 4-year low with the quarter that RL reported today. The growth algorithm was horrible. Sales +3.3% (closer to flat excluding Chaps), EBIT -6.2% and EPS -7.6%. Not much to get excited about, and certainly not what one expects from a quality company like RL.  But that’s precisely why the stock is trading at 16x earnings – near the biggest discount  to Nike in the modern history of both companies. It’s also why the short interest is up 240% in six months.


We still have a lot of work to do on this one. Specifically, this ‘investing period’ everybody talks about is a lot more than that. It’s a major shift in direction for the brand(s), company, management and infrastructure. The question in our mind is whether this takes another 2-3 quarters to take hold instead of 2-3 years. If it’s the latter, then this stock is going nowhere but down.  But ultimately, if our model as outlined below is correct, then we’re going to see this company earn $10.00 per share next year, and $16.00 in year five of our model. As it exits ‘investing mode’ we’ll see organic growth accelerate to the high single digits, margins blow through prior peak to 18%, $5bn of cumulative free cash flow (which we have buying back stock), and RNOA approach 40%. Today the stock is trading at 16x next year’s earnings, and less than 10x EPS in year 5 of our model. That’s a story that not only offers considerable downside if our initial model is right, but long-term upside to $300. With a story like that, we’ll let the consensus bicker all it wants about Polo stores and Ricky bags.


RL – Big Win If They Get This Right - rl financials

RL – Big Win If They Get This Right - NKE RL PE Spread

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We Called It: A Slowdown in Mass Business in Macau

Takeaway: Our gaming, lodging and leisure team predicted the deceleration in the mass business in Macau.

The Street’s bullish thesis of Mass in overdrive has grinded to a halt with the release of the July Macau detail.  Mass revenue grew only 17% year-on-year, well below our projection of +24% and consensus of +30%. 


The disappointing Mass performance is in line with our Mass Decelerating theme for the second half of the year but the slowdown is occurring faster than even we thought.


In this video from June 13, Gaming, Lodging and Leisure Sector Head Todd Jordan and Senior Analyst David Benz discuss the likelihood for a slowdown in the mass business.



Cartoon of the Day: Small Caps, Big Problems


Cartoon of the Day: Small Caps, Big Problems - Small cap cartoon 08.06.2014


The Russell 2000 continues to struggle.