Do yourself a favor and employ a process that includes something more than looking back only 3 years in analyzing Jones Apparel Group. History is repeating itself. And history pretty much stinks.
Daryl Jones – one of the senior leaders at Hedgeye – often reminds us to “never bet against a Jones.” I’ve got to take exception to that, DJ. Here’s some historical context as to why.
I’ve been covering JNY for about 13 years. How ironic that both revenue and the stock price today are at the same levels as when I first plugged the ticker onto my stock screen. What’s different? Well…management changed a little, but the culture did not. EBIT has been cut by nearly 80%, or $400mm, as the company lost its most profitable assets (a billion+ worth of 20%+ margin Ralph Lauren biz), and no longer has the macro and industry-specific tailwinds to mask its strategy to financially engineer acquisitions while starving its existing brands.
The architect of said strategy was Peter Boneparth, a banker turned CEO of an apparel company called Norton McNaughton. And yes, Boneparth ultimately became CEO of JNY. What I’ll refer to as his ‘buy and starve’ model (starve brands of capital, but buy new ones to give the illusion of growth) worked – until it didn’t. Remember when JNY blew up in 2007? Yeah… That was the end. Or so I thought.
Wes Card was elevated to the role of CEO and has done the best he could with the mess he was left. He’s cleaned up some underperforming company retail assets, and has strengthened parts of the wholesale business. Has he benefitted at 9 West from a strong boot cycle? Yes. But overall, he seemed focused on improving the core. Until now.
Enter JNY’s announcement to buy Stuart Weitzman.
I’ve got several thoughts on the deal.
1. Is it a good brand? Yes. JNY needs as much higher-end exposure as it can get.
2. Is the $180mm price tag for 55% of the company a good deal? On today’s cash flow stream, it probably is. How I’m doing the math, we’re looking at about 2-3% accretion in 2010 based on my assumption of 12% margins at SW (no disclosure there yet). I don’t dismiss the potential for mid-high teens margins. If that’s where they are, then that’s super. But then, as with all companies we analyze, we’d also need to get confidence that we did not see margins shoot up recently due to unhealthy costs cuts to dress the company for sale.
3. Now here’s the kicker…The two main sellers are Mr. Weitzman and Irving Place Capital.
a) Mr. Weitzman will stay with the company, but is in print (Friday) as saying ”This is my hobby, I love it and never want to stop.” That’s actually nice to hear how passionate he is about the business. Passion is good. But the ‘hobby’ thing kinda scared me.
b) The REAL notable point here is that Peter Boneparth joined Irving Place last year as a Senior Advisor. I repeat… Peter Boneparth joined Irving Place last year as a Senior Advisor.
So let me get this straight…If this is such a great company (I do not dispute that it is a solid brand), with margin upside and a growth trajectory that has been properly invested in over the past 2 years during the downturn, why is Irving Place selling?
Moreover, isn’t it a little ironic that it is being placed at JNY – the place where a Senior Advisor created a culture of paying top dollar at peak margins for acquisitions just to give the illusion of growth?
Maybe we give the seller the benefit of the doubt and assume that – like many of the $550bn in levered loans out there associated with deals struck over the past 7 years – Irving Place simply needs to raise the cash, and is taking advantage of a window when it can do just that.
Regardless of the seller’s motives, I want to understand the level of diligence existing JNY management did on this deal, instead of relying on their former boss as validation. The key for me will be to see how much JNY invests to grow this brand without simply robbing capital from other areas of its portfolio. Management can say whatever it wants about its intentions, but a few quarters of action will tell the story far better.
As it relates to the stock, my sense is that JNY’s strategic shift will likely result in one of two things…
1) Acceleration in both organic and acquisition-related growth while improving margins, or
2) Increasing erosion in the profitability of its current core while it chases deals, and a subsequent miss/guide down/write off as the current base – as has been the case with JNY (and coincided with Mr. Boneparth’s departure in 2007).
Until I get strong evidence otherwise, I am assuming #2 -- this company's culture of shareholder is too strong to give the benefit of the doubt for anything else. My earnings estimates for JNY are $1.30 for 2010, and $1.40 next – which are below the Street by 15% and 20%, respectively.
Let’s simply look at what a rational investor needs to believe in order to buy the stock at $20. I’ll work under the assumption that an investor at this price needs to be looking to sell at something at least $25. JNY, and others with similar models have traded between 10-14x pe over time. I’ll assume 13x. That suggests EPS just shy of $2.00. The bottom line is that we need to get to 9.5% operating margins to support these assumptions. The last time JNY had margins over 9% it was being fueled by its Ralph Lauren licenses – which simply are no longer part of the equation.
Unless they know something pretty material that they aren’t telling us, this looks to me like JNY is reverting back to its value-destroying days of old. So…with earnings compares getting tougher, high earnings expectations, and short interest near 3-year lows, can someone tell me who the incremental buyer is of JNY here?”