SKX: Deal or Not, The Damage is Done

Let me paint this little narrative for you. Imagine a company that benefits from a 4 year fashion shift, a solid consumer, extremely favorable FX, and a margin-friendly sourcing environment. Margins go from 0% to 9%. Then all at the same time the company sees fashion pull a 180, a weakening consumer, unfavorable FX, and tightening capacity in Asia putting pressure on sourcing costs. Kinda puts that peak margin into perspective, no?

We’re talking, of course, about Skechers.

I’d love to have been a fly on the wall when management collectively realized that they were nearly out of growth runway.

So what do they do?
1) Accelerate growth in its own retail stores (if retail partners don’t want our stuff, let’s try to get it consumers on our own with expensive long-lived assets).
2) Broaden distribution into marginal clearance channels (remember Goody’s?)
3) Now SKX goes ahead and bids for none other than Heelys? The brand with the distinction of having more injury-related lawsuits per-pair than just about any other street shoe brand in recent memory? The same brand that grew to $188mm from almost nothing in 2 years – but in a real market size closer to $100mm?

This is just so wrong in o many ways.

How do acquisitions create value for a company in this space? Give leverage with 1) the consumer, 2) the retailer, 3) the manufacturer in Asia making the goods, and 4) the combined cost structure. Let’s evaluate those…
1) Consumer: Will either product be any better being part of the same parent? Probably not. Skechers is all about knocking product off other brands. They don’t do any R&D. It’s all about marketing. Could HLYS use Skechers’ marketing prowess? Yes. But first it needs a better product. That’s a problem.
2) Retailer: Not meaningful overlap here with retailer customers especially with HLYS’ more technical-based retail base. It’s nice that they don’t step on each other’s toes, but this gives no added leverage whatsoever.
3) Asia: Factories are closing left and right (over 3,000 thus far in China this year alone). Capacity is tightening, and manufacturers want to be aligned with the winners. Heelys? Nah.
4) Cost structure: HLYS was already extremely lean with SG&A at 27%, which is not a ‘cut-able’ rate. EVERY acquisition I can find in this space going back 20 years where a brand with SG&A below 32% has turned out to destroy shareholder value.

Is the price right? Yes, I can see why HLYS seems cheap at $143mm in equity value and $100mm in net cash. But there’s a difference between low-priced and cheap. This thing has negative EBITDA, and not many levers to pull to get margins higher. SKX said it would consider raising the offer price after due diligence. The best margin rate I can envision is 5% -- which is 6.5% on the offer. The problem is that the market is already pricing HLYS at 8x EBITDA under the assumption that SKX’s 7% premium is not enough.

If there’s one punchline I want to make clear, it is that I could care less if this deal goes through or not. The simple fact that the offer is on the table is affirmation that the underlying strategy is misaligned with the margin challenges coming down the pike. This one remains on my ‘least favorites’ list.

Cartoon of the Day: Bulls Leading the People

Investors rejoiced as centrist Emmanuel Macron edged out far-right Marine Le Pen in France's election day voting. European equities were up as much as 4.7% on the news.

read more

McCullough: ‘This Crazy Stat Drives Stock Market Bears Nuts’

If you’re short the stock market today, and your boss asks why is the Nasdaq at an all-time high, here’s the only honest answer: So far, Nasdaq company earnings are up 46% year-over-year.

read more

Who's Right? The Stock Market or the Bond Market?

"As I see it, bonds look like they have further to fall, while stocks look tenuous at these levels," writes Peter Atwater, founder of Financial Insyghts.

read more

Poll of the Day: If You Could Have Lunch with One Fed Chair...

What do you think? Cast your vote. Let us know.

read more

Are Millennials Actually Lazy, Narcissists? An Interview with Neil Howe (Part 2)

An interview with Neil Howe on why Boomers and Xers get it all wrong.

read more

6 Charts: The French Election, Nasdaq All-Time Highs & An Earnings Scorecard

We've been telling investors for some time that global growth is picking up, get long stocks.

read more

Another French Revolution?

"Don't be complacent," writes Hedgeye Managing Director Neil Howe. "Tectonic shifts are underway in France. Is there the prospect of the new Sixth Republic? C'est vraiment possible."

read more

Cartoon of the Day: The Trend is Your Friend

"All of the key trending macro data suggests the U.S. economy is accelerating," Hedgeye CEO Keith McCullough says.

read more

A Sneak Peek At Hedgeye's 2017 GDP Estimates

Here's an inside look at our GDP estimates versus Wall Street consensus.

read more

Cartoon of the Day: Green Thumb

So far, 64 of 498 companies in the S&P 500 have reported aggregate sales and earnings growth of 6.1% and 16.8% respectively.

read more

Europe's Battles Against Apple, Google, Innovation & Jobs

"“I am very concerned the E.U. maintains a battle against the American giants while doing everything possible to sustain so-called national champions," writes economist Daniel Lacalle. "Attacking innovation doesn’t create jobs.”

read more

An Open Letter to Pandora Management...

"Please stop leaking information to the press," writes Hedgeye Internet & Media analyst Hesham Shaaban. "You are getting in your own way, and blowing up your shareholders in the process."

read more