R3: Geared Up for M&A


August 10, 2010





It’s been relatively quiet on the M&A front in retail of late, but Hanesbrands is breaking the silence this morning with the acquisition of Gear for Sports, a leading seller of licensed apparel in collegiate bookstores. While modest in size at $225mm, our view is that this is a net positive event for the company – here are a few things to consider:



  • Clean – low integration risk given existing relationship between the two companies.
  • Opportunity for scale – with only three brands in its portfolio (GEAR FOR SPORTS, Champion, and Under Armour), HBI can provide product with favorable cost dynamics.  Plus eliminating the middle man (i.e the wholesale/distributor process) margins will be inherently higher on HBI brands.
  • Higher margin –11%+ EBIT margins at Gear for Sports. HBI hasn’t posted double-digit margins since 2003 and the company is buying the company for 7.5x, a multiple below where HBI trades currently ( 8.8x EV/EBITDA).



  • Balance Sheet – leverage now moving in the opposite direction.  After increasing debt for the first time since the spinout when the company reported Q2 results in July, this deal continues the trend adding $170mm in debt ($55mm in cash).  The company still expects to end 2010 with a debt-to-EBITDA ratio of ~3.5x on a pro forma basis.
  • Low Growth Business – While an average growth rate of 2% over the last two years isn’t shabby on a relative basis, this is not likely to be a true growth business once dust settles. 
  • Opportunity Cost – hitting the bid on a ‘distribution acquisition’ likely takes HBI out of the running for the opportunity to add a better known brand to the portfolio (at least in the near term).

The company will be hosting a call on the acquisition at 9am this morning (; code: 93137436). Among the items I’m more interested in clarifying is the proposed accretion related to the deal ~$0.20 in the first 12-months. On an absolute basis ($25mm in EBIT) that may be the case, but taking into account the opportunity cost in interest expense we are coming out closer to $0.08-$0.10. Either way, we view this morning’s acquisition which is both margin and earnings accretive as a positive near-term.


Details of the deal from the press release:



(FY10 ended in June)

  • Sales ~$225mm
  • EBIT $25mm+
  • OM 11%+
    • (implied D&A of ~$5mm)


  • Expected to close in Q4 and be immediately accretive
    • ~$0.20 in 1st 12 months
    • ~$0.30 in 2nd 12 months
  • No write-offs or restructurings needed, not dilutive to 4Q or 2010 earnings guidance of $2.25-$2.35



  • Total cost of $225mm
  • $55mm in cash
  • $~$170mm in debt
  • = ~7.5x EBITDA


  • To pay for acq. Instead of debt
  • Still projects 2010 debt-to-EBITDA ratio of ~3.5x on a pro forma basis


Casey Flavin




- For those following the Jersey Shore, add Mike “The Situation” to the list of reality TV stars turned fashion mogul.  The Situation is launching a casual sportswear line in conjunction with an existing brand known as DILLIGAF (it’s acronym that requires Googling).  Retail partners have yet to be announced.


- In one of the more innovative uses of the iPhone app, The North Face launched Trailhead.  The app lists trails and maps around the US, as well as allows users to track their movements via GPS.  However, the most innovative feature comes with the weather forecasts.  The app actually suggests which North Face clothing you should wear based on expected weather conditions over the users specified route.


- Add H&M to the list of retailers finally launching e-commerce.  Similar to Zara, the retailer will launch in Europe first, on September 26.  No word on timing for the US launch.





Li & Fung Ltd. Plans to Privatize a Hong Kong-listed Transport Affiliate - Li & Fung has been acquiring rivals and entering into supply agreements to help meet a sales target of $20 bn this year. Last month Li & Fung increased its funds for acquisitions to about $1.15 bn. Privatization will help cut operational costs for Li & Fung as IDS provides logistics and distribution. <>

Hedgeye Retail’s Take:  While not an acquisition of a “brand”, Li & Fung continues to invest in the tools needed to facilitate growth.  Expect more content related deals to take place as the company diversifies its revenue and profit model away from the traditional “middle man” operation. 


UK Clothing Sales in July Led by Menswear and Womenswear - Clothing sales picked up slightly in July, helped by summer Sales and promotions but . Retail like-for-like sales across all sectors increased by just 0.5% in July as shoppers’ fear of looming public spending cuts took hold while total retail sales were up 2.6%. Menswear and womenswear clothing led the improvement in clothing sales while growth in kidswear was steady but weaker than earlier in the year. Clearance and promotions helped boost sales but often at the expense of margins, the BRC said. Dresses, tops and skirts, lightweight knits and swimwear sold well during the month. Bags, jewelery and hair accessories were popular, particularly in clearance Sales. <>

Hedgeye Retail’s Take: Kidswear/juniors apparel weakness is a common theme out of the UK and the US in July.  Interesting to note how UK retailers boosted sales through promotions at the expense of margins while many US retailers hurt top-line due to fewer days of discounting.


UK Footwear Sales in July Slowed to Record Weakness Since August 2009 - Sales of men’s and kid’s shoes were down on last year for the first time since August 2009. Women’s footwear sales also slowed but continued to show a slight gain. Footwear sales were often discount-driven, with heavy mark-downs in clearance events to attract cautious shoppers. Sales of casual shoes and sandals were boosted by the warm weather but formal styles struggled. Autumn ranges which had already been brought into store had seen good early interest in new styles. <>

Hedgeye Retail’s Take: Footwear weakness out of the UK in July marks a notable divergence from the commentary out of the US. 


Not All Back-to-School Shopping Occurs in August - A new study finds that consumer interest in computer purchases peaks in July, while interest in the office and school supplies and apparel categories remains strong well into September. Shoppers start thinking about school supplies and apparel much earlier and stay engaged with ads later than what is generally understood to be the crunch month of August. The PointRoll survey tracked interactions with online advertisements from 2006 to 2009. The study suggests marketers in the office and school supplies and apparel categories may want to rethink their practice of cutting advertising spend sharply in late August. According to PointRoll, companies currently reduce their back-to-school advertising by 75% at the end of August before Labor Day. <>

Hedgeye Retail’s Take: Retailers, for the most part, already know this.  One thing to consider is that if computers sell the best in July but were noted as a category of weakness by COST and TGT, then be weary of over exposed electronics retailers like BBY.


Innovation is the New Buzz Word in M&A - There is a rush of companies searching for businesses that have the pulse of new consumers. New players are also entering the mix, making for some pretty interesting bedfellows. Take Wal-Mart Stores Inc., which bought video download site Vudu. Denim brand J Brand sold a majority interest, said to be worth more than $50 million, to Star Avenue Capital, a partnership between talent agency Creative Artists Agency and Irving Place Capital. And the Estée Lauder Cos Inc. acquired Smashbox, picking up expertise in digital, social media and television distribution, as well as a photo studio to boot. Looking beyond the traditional boundaries of fashion can lead to a big payoff. This emerging M&A model is a distinct departure from the traditional one, where retailer A buys retailer B, reaching new customers while realizing synergies. <>

Hedgeye Retail’s Take:  Or, the glass half empty view would be that companies have run out of synergistic opportunities and are now increasing their risk tolerance in an effort to potentially acquire “the next big thing”.


Men’s Wearhouse Acquires 2 Leading Providers of Corporate Uniforms and Workwear in the UK - Dimensions Clothing Limited and certain assets of Alexandra plc, two leading providers of corporate uniforms and workwear in the United Kingdom, were acquired for $97.5 mm. The companies will be organized into a U.K.-based holding company, of which Men’s Wearhouse will control 86% and certain existing shareholders of Dimensions will control 14%. The acquisition is expected to be accretive to earnings in fiscal 2010 and projected annual sales for the business are expected to be approximately $207.8 mm, in fiscal 2011.


Hedgeye Retail’s Take:  How long before the “corporate uniforms” are replaced with suits in the UK?


Independent Retailers Feel Soft Sales and Credit Crunch - Retailers shopping the Cobb Show late last month at the Cobb Galleria here saw a slight uptick in business in the spring, but sales have been very sluggish this summer. The lack of availability of credit to small businesses is hurting retailers and vendors. Exhibitors said more manufacturers are requiring their retail customers to pay by cash on delivery, money order, company check or a credit card. Buyers were at the Cobb Show shopping for new trends for fall and looking for bargains. They wanted slimmer jeans, as well as other lifestyle looks, specifically board sports.  <>

Hedgeye Retail’s Take:  Sounds like the gradual (and profitable) shift in market share towards the better capitalized, larger chains is still underway.  Having a balance sheet has become a key asset even in an environment that is stable.


July's Import Cargo Volume Expected to Increase 15% - The large double-digit increases in June and July appear to be the result of backlogs built up due to the lack of shipping capacity earlier in the year after ship owners took vessels out of service during the recession and were slow to return them as the economy began to pick up. With many retailers appearing to bring merchandise in early to avoid any further bottlenecks, July is likely to be the peak shipping month for 2010 rather than the traditional rush of holiday season merchandise in October. There are indications that the shipping season may have peaked earlier than normal as the rush to re-stock inventories earlier in the year intersects with a combination of increased shipping capacity, consumer confidence levels not seen since August 2009 and the slowing growth of consumer spending,” Hackett Associates founder Ben Hackett said.  <>

Hedgeye Retail’s Take:  Keep an eye out for building inventories earlier than expected as this suggests holiday build is coming early.


Nike Opens New Store in Santa Monica Place, CA - The new two-story, 20,000-square-foot location unveils Nike’s newest store concept, including the introduction of Nike+ Run Club and team customization services. The store is the first multi-category concept in the U.S. since the company opened its last NIKETOWN in 1999. <>

Hedgeye Retail’s Take:  Putting the Nike store aside, this mall is supposedly one of the premier shopping venues to open in the last few years.  In fact, it may be one of the only malls to open in the last few years!


 Mizuno Corp Q1 Sales Strength Led by Europe and Americas - The Japanese athletic company cited athletic footwear as the largest contributor to growth. Revenue in Europe grew 14% and the Americas 15%, thanks to increased sales of footwear and baseball goods in those regions. <>

Hedgeye Retail’s Take:  Another sign that performance footwear remains strong.



The Macau Metro Monitor, August 10th, 2010


OVER 20 UNUSED PLOTS COULD BE TAKEN BACK Macau Daily Times, Intelligence Macau

The Land, Public Works and Transport Bureau's (DSSOPT) director Jaime Carion said, "[After a] recent and detailed analysis of over a hundred cases related to unused plots, it's a priority to find a solution for more than two dozen."  The cases include the expiration of the concession contracts, late premiums, and lack of development progress.  Carion added that authorities will also review whether or not the construction of a logistic centre at a Cotai plot granted in 2006 still “fits” the overall urban plan for the area.


According to IM, the Cotai plot that SJM is trying to obtain is going to be a third-party casino developed under the SJM license.  Despite all the hoopla lately on Cotai land parcels, IM thinks the land reshuffle has not begun yet.



In its quarterly report, Wynn Macau stated, “On August 1, 2008, subsidiaries of Wynn Resorts, Limited entered into an agreement with an unrelated third party to make a one-time payment in the amount of US$50 million in consideration of the unrelated third party’s relinquishment of certain rights in and to any future development on the 52 acres of land in the Cotai area of Macau....The payment will be made within 15 days after the government of the SAR publishes the company’s rights to the land in the government’s official gazette."  Wynn Macau is waiting for final government approval on the concession.



Chinese property prices in July rose 10.3% YoY, slower than June's 11.4% YoY growth. On a month-to-month comparison, July is flat with June.  New home prices rose 12.9% YoY in July, 1.2% points lower from June.  Prices of 2nd hand homes gained 6.7 % last month, compared with an increase of 7.7% in June.


The National Bureau of Statistics also said investment in real-estate development, one of the main forms of private investment in China, rose 37.2% to 2.39 trillion yuan (US$353 billion) in the January-July period from a year earlier, slowing from a 38.1% rise in the January-June period.



Total non-resident workers fell 701 in 2Q to 72,142. Also, 847 individuals were authorized to reside in Macau, down by 1,101 QoQ.



For money supply in June, M1 grew 2.5% compared to May and M2 grew 2.8% MoM to MOP 222 billion.  Loans to gaming and restaurants, hotels and similar establishments dropped 12.5% and 12.4%, respectively, in June relative to May.  In June, total deposits with the banking sector grew 1.7% MoM in June.  The loan-to-deposit ratio stood at 73.8%, up 0.7% points. 


The final estimate of Singapore's 2Q GDP showed 18.8% growth, slower than the initial estimate of 19.3% growth.



PAGCOR chairman Naguiat believes an 'Entertainment City' in Manila by 2014 can compete with Macau and Singapore. Naguiat said the government was looking to eventually build integrated casino and entertainment resorts in other parts of the Philippines, including picturesque Palawan island and Cebu, the nation's second biggest city.

Spinning a Yarn

“A lie has speed, but the truth has endurance.”

-Josh Billings


When someone spins you a yarn, they are trying to deceive you by lying.  While it is strong language to use, it is increasingly obvious to Americans that Washington is spinning yarns in the run up to November mid-term elections almost as frantically as the Fed is printing dollars. 


The seeds are sown by the “Fiat Fools” and other political leaders in Washington for this country to be in for some bad times ahead.  The question is when, not if.


Ben Bernanke might be able to plug a temporary hole in the dam, but he will only be making things worse for the longer term.  The definition of quantitative easing says it all: ‘A central bank does this by first crediting its own account with money it has created “ex nihilo” (out of nothing)’.  Creating something out of nothing – that’s a good policy! You can’t make this stuff up… 


As Keith said in our MACRO call for clients last week, “Pleading for another round of quantitative easing is like the Romans pleading for Caesar to go into his final Senatorial meeting.”  Needless to say that ended badly for Caesar and it’s going to end badly for the USA too.  The death of the Fiat Republic!   


Ahead of the FOMC meeting today, the VIX rose 1.8% yesterday and volume on the NYSE was anemic and declined 16.5% day-over-day.  The 0.5% move in the S&P was the sign of pleading for Chairman Bernanke to come to the rescue.   The FOMC plans to release a statement at 2:15 p.m. today and, in my view, it’s unlikely that Chairman Bernanke will be able to string together the right words to satisfy the market. 


On July 21st he said, “the central bank wasn’t ready to take any action in the near term.” Although, at the same time, his assessment that the “economic outlook remains unusually uncertain.”  The lack of conviction in this market suggests that investors are looking for more clarity from the FOMC today.  KKR backing away from its planned $500 million U.S. offering is just one example of the anxiety evident in the marketplace.


The two key areas we are focused on are housing and employment.  Neither area is showing improvement.  The politicians can spin last week’s labor market report to fit the narrative, but as suggested by the deterioration and downward revisions in the data, the recent economic “recovery” has all but evaporated.


The strategy of increasing the supply of money in an economy when short-term interest rates are near zero is not going to fix the housing or the employment picture. The only benefit from another round of quantitative easing is to provide the banks with even more excess reserves with which they can buy the treasuries that the Chinese are selling.  Coupled with the fact that the Chinese would rather buy Yen than dollars, the current situation is a real problem for the USA.


The global markets’ response to the policies of the Fiat “Wizards of Washington” is a move away from the dollar, which increases the risk for inflation (not deflation) in terms of consumer prices.  A segment on today’s “morning edition” program on NPR with the economics editor of The Wall Street Journal focused on the Fed “watching for signs of deflation”.  I bet they are looking very hard.  We’ve said it time and again: the calculation used for government data for inflation is compromised and does not give an accurate reflection of the reality consumers are facing.  Prices at the pump and at the grocery store are reflecting that.  The forty-one million Americans receiving support from the Supplemental Nutrition Assistance Program (food stamps) are aware of that reality too.


On the inflation front, the market will get a small whiff of things to come on Friday.  There is a very good chance that the July CPI could surprise to the upside versus consensus expectations.   Although gasoline prices were flat month-to-month for July (according to the Department of Energy), a swing in seasonal factors will take gasoline prices higher, which will make the CPI number look inflationary.  Complicating the storytelling on Friday is oil trading at $80 and prices at the pump approaching $3.00.  Numbers don’t lie; politicians do.   


Turning to some important global macro data, yesterday copper traded down 2.1% and could not hold the critical intermediate trade line of 3.32.  Stocks in China fell 2.9% last night; the most in six weeks after data released in China showed real estate sales falling, while prices are rising less than expected. 


Taken together with the sluggish import data, a deepening in the slowdown in China’s economy is a real possibility.  China and copper have been leading indicators for growth globally over the last 18 months and U.S. markets will feel the effects of these moves.


The immediate term TRADE lines of support and resistance for the S&P 500 are 1113 and 1138.


Function in disaster; finish in style,


Howard Penney


Spinning a Yarn - hpel

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Structural Unemployment

Conclusion: Even though Hedgeye is hiring, unemployment in the United States is becoming an increasingly structural issue as evidenced by the percent of unemployed that have been out of work for 6-months or more.


We are going to keep this note short and tight even by Hedgeye standards.  I asked my teammates Darius Dale and Matt Hedrick to look at longer term unemployment as a percentage of total employment going back as long as the data would allow us.  The output of their work is the chart below.


The chart highlights the percentage of total unemployed that have been unemployed for more than 6-months.  As can be seen in the chart below, more than 45% of unemployed have been unemployed for more than 6-months.  This is the highest level we’ve seen for long term unemployed going back to 1948.


The conclusion is simply that the unemployment in this nation is becoming structural.  While the credit boom created employment in the housing and construction sector, that entire industry has gone away and been replaced by . . . well, not much at this point.


As the non-partisan Congressional Budget Office stated in a recent paper:


“As a result, gains in employment after this recession will probably rely more than usual on the creation of new jobs, possibly in new firms that are located in different places and require workers with different skills than those needed in the jobs that have disappeared. For workers who have lost jobs to which they cannot return, acquiring new skills can take time. (In contrast, it is easier for workers who have been laid off temporarily to return to their jobs because the employers already know the workers and the workers already have the right skills and are familiar with the work.) For workers who need to move to different regions to find new jobs, the sharp declines in home prices during this recession, combined with the high loan-to-value ratios on many mortgages before the downturn, will hinder relocation. With a significant share of homeowners now owing more on their mortgages than their homes are worth, many people may not be able to sell their house for enough money to enable them to buy one in a new area.”


Further, this trend of longer unemployment comes with major issues because the longer unemployment lasts, the more likely it becomes that complacency sets in and the unemployed person becomes less willing to pursue employment in a traditional sense.


Maybe it’s just me, but I’m not sure quantitative easing is going to get us out of this one.


Daryl G. Jones

Managing Director


Structural Unemployment - Unemployed 6mo


McDonald’s sales came in very strong in July with the U.S. and APMEA showing considerable improvements in two-year average trends.


In my preview note last week I outlined some GOOD, BAD, and NEUTRAL ranges for MCD same-store sales in July.  In the U.S., July comparable sales increased 5.7%.  In my preview, I wrote that any print above 5% would be a GOOD result as it would imply an increase in two-year average top line trends.  The 5.7% number resulted in a 27.5 bp sequential increase in two-year average trends when adjusted for calendar shifts.  As outlined on the 2Q earnings call the momentum in July is due to the recently launched McCafe Real Fruit Smoothies and Frappes along with value-based drinks.  Looking forward to August, at least a 4.4% print will be required to maintain two-year average trends when calendar shifts are taken into account; same-store sales comparisons remain relatively easy in August.  


For Europe, comps came in at 5.3%, which was at the high-end of my NEUTRAL range of 3.5% to 5.5%.  Two-year average trends did increase by 42.5 bps on a sequential basis, when adjusted for calendar shifts.   Management’s commentary on the 2Q release that July global comparable sales were in-line or better than second quarter results was confirmed by a 5.3% print for Europe versus 5.2% in 2Q.  Management attributed the increase to Europe’s “unique premium menu offerings, compelling value and the ongoing modernization of Europe’s restaurants.”  Looking forward to August, a further acceleration to 6.8% comparable store sales number would hold two-year average trends level from July. 


For APMEA, comparable store sales came in at 10.1%.  This number was far in excess of the 7% level I had for a GOOD result.  On a two-year average basis, when adjusted for calendar shifts, trends improved 182.5 bps sequentially.  APMEA’s strong number benefitted from strong sales growth in Japan, Australia and China.  Looking forward to August, a 10.5% print will be needed to maintain two-year average trends on a sequential basis.  August 2009 comparable store sales increased 2.2%, versus 4.3% in July, so it should prove to be an easy compare for APMEA sales.



Howard Penney

Managing Director

Tailwind Into The Midterms

Conclusion:  It appears increasingly likely that Republicans will gain some political control in the midterms, which should put the Bush Tax cuts squarely in play for an extension.  This would be positive for equity valuations in the short term.


I’m not sure even anyone has ever said this, but I will for the first time, polls don’t lie, people do.  Now, obviously, polls can lie, but in the aggregate they should tell us the story if they are implemented in a statistically relevant manner.  For the sake of argument, we will assume that the polls in the Real Clear Politics aggregate are accurate assessments of the political situation in the United States.


As it relates to the 2010 midterms, the polls suggest that the House Democrats will win 202 seats, and Republicans will win 201 seats, and that there are currently 32 toss-up seats.  While in the Senate, the polls suggest that 49 seats will go Democrat, 43 seats will go Republican and that there are currently 8 toss ups.  Now, obviously, since the full House is up for re-election every two years, it more accurately reflects the political wind of the country.  Currently, the political wind is blowing sharply to the right.  So much so that if the election were held today, the Republicans would have a real shot at regaining the House.


It is likely that the potential for Republican share gains only accelerates into the midterms given President Obama’s approval rating.  According to the Real Clear Politics aggregate for President Obama Approval, the President negative spread, so the difference between the positive approval rating and the negative approval rating, is -4.5.  The math behind this is a 45.1 approval rating and a 49.6 disapproval rating.  This negative differential is the lowest of President Obama’s first term, and is highlighted in the chart below.


Tailwind Into The Midterms - 1


In our morning meeting, Keith posed a fair question to me, which was who is the Republican front runner for the Presidency in 2012, and the answer was, I don’t know.  While President Obama is currently struggling with his approval rating and the Republicans would win in a generic head to head to poll in 2012 by 6.0 points, there doesn’t appear to be a Republican candidate that, as of yet, has stepped into the forefront.  With heightened concern about the debt, it seems likely that a practical and fiscally tested candidate might do the trick, but as of yet we aren’t sure who that person is going to be.


Between now and the 2012 Presidential election, President Obama’s approval rating and potential loss in a generic head to head ballot is most relevant for the upcoming midterms.  Those candidates in tight races will likely not want to be seen as associating with an unpopular President, but as a result won’t have the President’s bully pulpit and funding machine to utilize either.  Regardless, one point is becoming increasingly clear, the Republicans have a tailwind heading into the midterms.


Interestingly, a key implication of the Republicans taking back a combination of either the House (likely) or Senate (less likely) is that an extension of the Bush tax cuts could be firmly in play.  In fact, Paul Krugman, even noted this today in his New York Times column when he wrote:


“But Washington is providing only a trickle of help, and even that grudgingly. We must place priority on reducing the deficit, say Republicans and “centrist” Democrats. And then, virtually in the next breath, they declare that we must preserve tax cuts for the very affluent, at a budget cost of $700 billion over the next decade?”


As it relates to our portfolios, the two key components of the Bush Tax cuts that are relevant are the capital gains tax and the tax on dividends.  In a complete roll back of the Bush tax cuts, these taxes would go from 15% to 39.6% and the capital gains tax would go from 15% to 20%.  Inherently this policy has a direct impact on stock valuations, specifically related to high dividend paying stocks.  To the extent that these tax cuts are preserved, it should be positive in the short term for equity valuations.


Of course the debate and discussion over tax policy is a long and nuanced one, which would take up more wind and paper than this simple research note has allotted to it, but we just wanted to highlight that increasingly it seems that with the Republicans likely to gain political power in the midterms there will be an impact on tax policy, which may be marginally positive for stocks in the short term.


Of course, perhaps the most compelling evidence to keeping the tax cuts in place is that former Fed Chairman Greenspan recently came out against them when he said in a New York Times phone interview on August 6th:


“I’m in favor of tax cuts, but not with borrowed money. Our choices right now are not between good and better; they’re between bad and worse. The problem we now face is the most extraordinary financial crisis that I have ever seen or read about.”


Indeed, Mr. Maestro.


Daryl Jones

Managing Director

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