This LIZ/JC Penney deal is an absolute no-brainer. It’s also no surprise to us whatsoever. The core of our call is that LIZ has hit bottom, is taking a ‘no holds barred’ approach to its portfolio, and will realign in a way that actually makes investors remember that this company exists.
What’d we get today? The announcement that LIZ is taking virtually all Liz Claiborne brands solo into JC Penney, and is taking LCNY/Mizrahi into an exclusive with QVC is absolutely, positively, 100% the right move. It rids LIZ of nearly 75% of its exposure to Macy’s, swings to a positive profit contribution (if only due to the royalty structure of the deals), aligns with retailers that actually know what they’re doing as it relates to exclusive content, takes down LIZ corporate infrastructure and capex, and, as a kicker, meaningfully reduces working capital as LIZ leverages JCP’s superior sourcing structure.
Are there risks? Of course. Now there’s key customer risk with JC Penney. There’s also the potential for a brutally ugly transition as existing wholesale accounts blow out Liz inventory (though LIZ now has no incentive to share in markdowns). There’s also the morale issue given that the corporate structure at LIZ will take a hit – again – as resources that are no longer necessary are nixed from the equation.
But add it all together and what do you get? An $0.88 loss this year (our estimate) goes to $0.88 profit in 2010. My sense is that our number will still be meaningfully above consensus once the beans are counted. At the same time, free cash flow should go from -$30mm in ’08 to roughly $275mm in 2010. Yes, that’s almost a 10% FCF Margin.
So what happens when a highly-levered company that everyone has left for dead starts generating cash (note: 14% of the float is short, and of the 8 analysts covering there’s not a single Buy, 3 Sells, and 5 Holds)? It turns from a ‘Will this company remain viable’ call, to being a ‘let’s start to model margin improvement and financial delevering’ call.
Trust me, despite our best effort over the past six months I’ve had so few people willing to bite on this one. Now, sadly, with a 29% move on the day, people will start to pay attention. For someone willing to look at ’10 numbers, I think it makes sense. Why? A sub $7 stock with a buck in earnings power and an improving balance sheet in a rising cost of capital environment makes a heck of a lot of sense to me.