PVH: The Risk That No One Talks About
PVH has its cookie jar of special charges to make the Tommy deal fuel EPS. But does anyone care that this is the merger of the two companies in retail with the greatest and fattest-tailed off-balance sheet compensation liabilities for two individuals that have proven risqué, to say the least?
You gotta love the raging love PVH is getting in the wake of its Tommy acquisition. Several upgrades, Cramer pounding the table... and that’s AFTER a 55% move in the stock (3x retail peers) since the deal was first rumored. I guess I should probably mention that this price is roughly 2x the EV where TOM was taken out back in 2005.
The deal will be accretive immediately per management with about $1.00 in incremental EPS over the next year. But that’s if we exclude about $1.00 in special charges. Huh? In my language, that’s not immediately accretive.
I’m not here to drag this deal through the mud. In fact, it does make a fair amount of sense from PVH’s perspective, and Tommy is actually a far better brand globally than most people in the US think. But there are underlying risks to NewCo that should at least be considered, and they’re not all apparent on financial statements.
The crux of it revolves around taking brands that are based on two individuals that license their respective names to a company. It’s notable enough to have one such individual in Calvin – remember when he was ejected from a Knicks game in ’03 after interfering with a Spreewell inbound pass? But then adding Tommy to the cocktail? Remember that this is a guy that got into a fistfight with Axl Rose at a nightclub a couple years back. We can have fun with the tabloid facts and You Tube videos, but let’s simply revert to the financials. That’s where I’m most comfortable.
Consider the following…
- PVH identified about $1.55bn in forward obligations in its 10K. But this excludes another $575mm in payments required to be distributed to Mr. Klein under the original terms of the purchase agreement. The kicker is that this lasts until 2017, and is at a rate of 1.15% of worldwide net sales of products bearing the Calvin Klein name. When I add it all up, the CK payments are actually greater than the operating lease liabilities - which represent the greatest off balance sheet liability for most other companies in the retail supply chain.
- It’s tougher to get current information on Tommy. But the long-standing agreement he’s had is for a base of $900,000 each year base plus 1.5% of the net sales over $48,333,333. Keep in mind that this is a company with a revenue run-rate near $2bn. They have tweaked the agreement along the way to not include certain businesses to give his comp the appearance of being less egregious. But do the math…it’s scary.
When I net it all out, PVH/TOM has forward compensation obligations that are greater than any other off-balance sheet liability, and they are headed up over time. Liabilities should go down over time, not up. The only way PVH/TOM’s go down is if revenue goes down. That’s not a very good option either.
Expectations are high in this name, and the company has enough to snack on in its cookie jar of special charges that earnings will be fine for at least a couple of quarters. For now, I view this as a ‘do nothing’ stock.
But given the underappreciated off-balance sheet/financial risk, let’s hope that the board is keeping them away from sporting events, rock stars, and other crowded places.