BUSINESS OVERVIEW: True Religion Apparel Inc. (TRLG) operates in four primary business segments: U.S. Consumer Direct, U.S. Wholesale, International and Core Services.
The U.S. Consumer Direct segment sells directly to consumers in the United States through full-price stores, outlet stores and through its retail internet site located at truereligionbrandjeans.com. As of September 30, 2012, True Religion operated 85 full price stores and 34 outlet stores in the U.S.
Its U.S. Wholesale sales are made to leading nationwide premium department stores, specialty retailers and boutiques, and off-price retailers
Its international sales are made through a variety of channels, including subsidiaries and a joint venture that operates retail stores and sells to wholesale customers, which operate retail stores; distributors that warehouse products at their expense and then ship to, and collect payment from, their customers; and directly to wholesale customers who operate retail stores. As of September 30, 2012, its international segment operated 18 full-price stores and 10 outlet stores.
In addition, True Religion selectively licenses to third parties the right to use its various trademarks in connection with the manufacture and sale of designated products in specified geographical areas for specified periods. This licensing business is included in its Core Services segment. Corporate operations of True Religion, which include the design, production, marketing, distribution, credit, customer service, information technology, accounting, executive, legal, and human resources departments, are also included in the Core Services segment.
As the following graph shows, True Religion has been moving away from the wholesale model to a direct-to-consumer model (including the same in the international segment), which is more profitable and allows True Religion to showcase its full line of products in a setting that is controlled by True Religion. The sales in its consumer direct segment have climbed about 50% in two years, from 41% of total sales in 2009 to 60% in 2011.
(click to enlarge)
Source: Company filings
Based upon the TTM numbers, the following chart shows the segment wise breakup of the sales.
(click to enlarge)
Source: Company filings
VITAL STATISTICS
Here are some vital financial and market statistics for True Religion.
Index | - | P/E | 12.95 | EPS (TTM) | 1.86 | Insider Own | 16.33% | Shs Outstand | 25.79M | Perf Week | -8.19% |
Market Cap | 621.28M | Forward P/E | 12.11 | EPS next Y | 1.99 | Insider Trans | -1.03% | Shs Float | 24.38M | Perf Month | -8.44% |
Income | 47.00M | PEG | 0.52 | EPS next Q | 0.55 | Inst Own | 96.26% | Short Float | 6.20% | Perf Quarter | 4.97% |
Sales | 449.65M | P/S | 1.38 | EPS this Y | 2.66% | Inst Trans | -2.17% | Short Ratio | 3.11 | Perf Half Y | -17.78% |
Book/sh | 12.69 | P/B | 1.90 | EPS next Y | 8.15% | ROA | 12.96% | Target Price | 30.00 | Perf Year | -31.72% |
Cash/sh | 6.54 | P/C | 3.68 | EPS next 5Y | 25.00% | ROE | 15.40% | 52W Range | 19.89 - 36.92 | Perf YTD | -28.62% |
Dividend | 0.80 | P/FCF | 22.77 | EPS past 5Y | 14.30% | ROI | 14.61% | 52W High | -34.72% | Beta | 1.50 |
Dividend % | 3.32% | Quick Ratio | 5.43 | Sales past 5Y | 24.47% | Gross Margin | 64.03% | 52W Low | 21.19% | ATR | 0.78 |
Employees | 2623 | Current Ratio | 6.94 | Sales Q/Q | 9.40% | Oper. Margin | 17.21% | RSI (14) | 44.50 | Volatility | 3.45% 2.98% |
Optionable | Yes | Debt/Eq | 0.00 | EPS Q/Q | 0.88% | Profit Margin | 10.58% | Rel Volume | 0.49 | Prev Close | 24.09 |
Shortable | Yes | LT Debt/Eq | 0.00 | Earnings | Nov 05 BMO | Payout | 32.90% | Avg Volume | 486.47K | Price | 24.10 |
Recom | 2.30 | SMA20 | -4.73% | SMA50 | -1.79% | SMA200 | -5.17% | Volume | 130,601 | Change | 0.04% |
Source: finviz
STOCK PERFORMANCE VS. ITS PEERS
Here is the chart showing the stock price performance of True Religion and some its peers: Guess Inc. (GES), PVH Corp. (PVH), V.F. Corporation (VFC), Ralph Lauren Corporation (RL) and Buckle Inc. (BKE).
(click to enlarge)
Source: Yahoo
As you can see True Religion stock has done very well in the last eight years (except for the period in 2009 when the whole market crashed) right until it announced its FY 2011 results on February 10, 2012, after the close of the market. True Religion missed EPS estimates by 13%. The stock plunged 25% the next day. It recovered somewhat after the better Q1, 2012, results and also due to its initiation of the dividend, however the slide continued all the way to $20.
Then on October 10, 2012, True Religion announced that after receiving indications of interest from third parties regarding a potential transaction with the company, it was exploring and evaluating potential strategic alternatives available to the company, including a possible sale, in order to maximize shareholder value. The stock as a result shot up more than 20% on that day.
COMPARISON OF THE OPERATIONS VS. ITS PEERS
Here are some charts showing True Religion's growth as opposed to companies in the similar domain. We have added Deckers Outdoor Corp. (DECK) and Coach, Inc. (COH) to the list used above for price performance comparison. It's very rare for two companies to have the same exact line of products, so the exact comparison is almost impossible. Generally the companies I chose for comparison are either in the same or similar domain or are affected by the same factors or are alternatives available to an investor.
We used per diluted share numbers for the calculation of CAGR.
(click to enlarge)
(click to enlarge)
(click to enlarge)
(click to enlarge)
(click to enlarge)
(click to enlarge)
Source: morningstar and various other finance websites
TRUE RELIGION'S HIGH PRICED GROWTH
True Religion's life as a public company was achieved via a reverse merger with Gusana Explorations Inc., a mineral and valuable exploration company based in British Columbia, Canada. True Religion has witnessed phenomenal growth ever since its stock started trading first on the NASDAQ over-the-counter bulletin board and then on August 2005, on the main NASDAQ stock exchange. It has been in Fortune magazine's list of 100 fastest-growing companies twice - in 2009 and in 2010. The growth however has come at a high price.
(click to enlarge)
As you can see from the graph above, True Religion has done well in growing its revenue but the growth in the net income and free cash flow has not caught up with the revenue growth. The operating expenses have grown much faster than the revenue and predictably it has taken its toll on the bottom line and FCF.
MAJOR STRONG POINTS
BRAND POWER: True Religion is a strong brand in the aspiration product category and it's growing in stature every day. I have seen it in action in places like India. The celebrities worldwide have been spreading the "True Religion." It should continue to focus on its premium brand image and let those beautiful legs do all the talking, for free.
PRICING POWER: No company is 100% inflation proof but the high-end product brands are generally more inflation proof than others. True Religion seems to be in the latter category. It has been able to grow its revenue at a CAGR of 25% in the last five years but its cost of the revenue has grown only at a CAGR of 19%. In other words, it has been able to mark up its products faster than the rate at which the costs of producing those products rises. This is an indication of the pricing power.
TREND SETTER: True Religion has been a trend setter in high-end denim. Those big deep back pockets with a large horse-shoe logo and the thick white stitching pattern has ruled the high-end denim for the last few years. Copycat jeans from True Religion's rivals have arrived in the market and they will certainly chip away True Religion's market share in the lower end. Unfortunately what these rivals do not have is the TRBJ logo on the back pocket of their jeans. And without that logo, I don't think anyone is going to be impressed by you, in a bar.
ENORMOUS GROWTH POTENTIAL: We believe that True Religion has the kind of brand image, which if managed properly, can become a multi-billion dollar business. Its international segment is just warming up. It has yet to conquer the billion-plus upwardly mobile pairs of legs in China and India.
MAJOR PAIN POINTS: There are many issues that the company has to address at this point. Chief among them are the following (in no particular order):
EXECUTIVE COMPENSATION: Simply stated, the executive compensation has not been commensurate with the growth in the sales, income or the free cash flow.
(click to enlarge)
Source: company filings
You can read more about the executive compensation here.
EMPLOYEE HEADCOUNT AND PRODUCTIVITY: For a company growing at such a rapid pace, the increase in the employee headcount is natural, however we see two problems here:
1. Headcount: As you can see from the graph below, similar to the executive compensation, the growth in the headcount has not been commensurate with the growth in the sales, income and the free cash flow.
(click to enlarge)
Source: company filings
2. Productivity: Now let's calculate the line items per employee and use them as the proxies for employee productivity. When we look at the rates at which these items have growth as shown in the chart below, almost everything is yelling SOS.
(click to enlarge)
Source: company filings
LEASE EXPENSES: Many companies that are in the retail business use operating leases for their facilities instead of capitalizing them, which we believe they should. These operating leases do not show up in the balance sheet and are shown as off balance sheet obligations instead. In the case of True Religion, their total lease obligations have been growing at an alarming CAGR of 32%, as opposed to revenue CAGR of 25%.
(click to enlarge)
Source: company filings
The operating leases are an ever increasing drag on True Religion's operating margin. Since an upscale brand like True Religion must have its stores in a prominent, high end and desirably in a high traffic shopping district/mall (discounted outlet stores can remain in the factory outlet kind of setting though), it means the leases will continue to be expensive. You should also keep in mind the fact that the recovering economies across the world will make the real estate prices and rents even more expensive. A similar thing had happened to Starbucks once upon a time. As of now, the total lease obligations are a significant portion of True Religion's market cap and approximately 4-5 times estimated net income in 2012.
As they say, an expense will not go away or come down, unless acted upon by an external force. True Religion definitely needs to do something about its seemingly out of control expenses. Perhaps doing it all by itself does not make sense for True Religion anymore. Perhaps a better business model now is a franchise-based model. That would put a lid on the outflows associated with opening the new stores and it will definitely improve True Religion's return on capital (the real one with the leases on the balance sheet, not the one that is published now).
OTHER ISSUES: Since many of True Religion's new stores are being opened or expected to be opened overseas in places like London, Paris, Tokyo, etc, in addition to regular expenses associated with the expansion such as finding the locations, signing leases, hiring the employees and distributors, extend IT infrastructure, it also has to make additional investments in the legal and regulatory compliance areas for the new geography. This is where a strategic buyer can help True Religion because it most likely already has all this in place.
Then there have been problems such as the run up in cotton prices and fashion missteps by True Religion. Well, we are not worried about the increase in the component / commodity prices in True Religion's case since an aspirational brand such as True Religion can always pass on the cost increases to its relatively affluent customers. And the impact of the rise in the cotton prices can always be toned down by hedging if needed.
There is a belief that True Religion missed the boat for Women's business in general and skinny and colored jeans in particular. There seems to be some truth in it because True Religion's women's business never took off as well as its men's business. Some analysts believe that True Religion missed an opportunity in recognizing the trend toward the skinny and colored jeans, which it initially thought of as a fad and when it finally got into this, it was probably a little late. Whether this is a long-lasting trend or just a fad, it ain't over yet, so we shall see how it turns out in the next few quarters. Fashion missteps can happen to any apparel maker, not just True Religion. However we believe that True Religion is a strong brand to survive occasional fashion missteps.
VALUATION
We tried to value True Religion using DCF analysis, relative valuation, as a strategic acquisition candidate and as a buyout candidate. See the following sections.
DCF ANALYSIS I
We did the DCF analysis in two ways. First we did a simple DCF analysis based upon free cash flow per diluted share as following.
Discount Rate | 10% | |
FCF/share Growth Rate next 5 years (actual rate since 2008 is ~ 17%) | 11% | |
Year | FCF/share | FCF/share Present Value |
0 | $2.04 | $2.04 |
1 | $2.26 | $2.05 |
2 | $2.51 | $2.07 |
3 | $2.79 | $2.10 |
4 | $3.10 | $2.12 |
5 | $3.44 | $2.14 |
6 | $3.54 | |
6 onwards at 3% growth rate | $31.40 | |
Present value of future FCF/share | $41.88 | |
Stock Price on 12/4/2012 | $23.89 | |
Upside Potential | 75% | |
Based upon this, the intrinsic value comes to $41.89, a potential upside of 75%.
DCF ANALYSIS II
We then did a more detailed DCF analysis using much stringent criteria including the following:
Risk Free Rate: We used a 10-year treasury yield of 1.62% as the risk-free rate.
Capex Rate: We used the current sales to invested capital ratio as the proxy for determining capex requirement for the next 10 years.
Operating Margin: We used the current operating margin of 17.8% for the next 10 years.
Effective Tax Rate: We used the current effective tax rate of 38.1% for the next five years. For the subsequent five years we increased it gradually every year to reach a very conservative 40% in year 10. Remember that rarely any company pays to Uncle Sam at a rate of 40%, especially a company like true Religion that is expanding internationally, which means the effective tax rate in all likelihood will come down.
Revenue Growth Rate: We assumed that the revenue will grow at a rate of 9% annually during the next five years. During the subsequent five years - the growth will slow down linearly every year until it reaches a GDP type of growth rate of under 2% in year 10.
Operating Lease commitments as Debt: Although these are off balance sheet commitments, they still are the commitments, which have to be paid by True Religion. Remember if it does not honor the terms of the lease (most importantly the payment), the landlord will take away the facility. As a result True Religion will lose an off balance sheet asset, but an asset nonetheless. Since the operating lease commitments generally have the same characteristics as a debt, we should better treat it as the debt.
To find out the debt amount equivalent to the lease commitments, we took the estimated future lease payments for the next five years and beyond, discounted them to present value using an appropriate pre-tax cost of debt based upon True Religion's financial ratios. The debt came out to be a whooping $221 million.
Cost of Capital: To calculate the weighted average cost of capital (WACC), we used $221M as the debt, $605M as the market value of equity, 1.62% as the risk-free rate, 6% as the equity risk premium, 3.7% as the pre tax cost of debt and 40% as the effective tax rate. Using these inputs, the WACC came out to be 9.6%.
Based upon these assumptions, we created the pro forma financial statements for the next 10 years. We then calculated the present value of all the future cash flows to the equity portion and deducted the value of the stock options and RSUs, which are outstanding right now. When the resulting number was divided by the present number of outstanding shares, we came up with an intrinsic value of $38.43, which translates to an upside potential of 61%.
RELATIVE VALUATION
Here is how True Religion compares with some of its peers such as Guess, Ralph Lauren, Abercrombier & Fitch (ANF), Gap (GAP), Ann Taylor (ANN) and Fifth & Pacific (FNP) and Tiffanys (TIF) etc.
Ticker | Price | # Shares | Market Cap | Sales | Cash | Debt | EV | EBITDA | EV/TTM | Rev Growth | TTM Margin | TTM P/E | |||
EBITDA | Sales | 1Year | 3Year | EBITDA | Gross | ||||||||||
TRLG | 24 | 25.3 | 661 | 450 | 169 | 0 | 492 | 91 | 5.4 | 1.1 | 15.42% | 15.85% | 20.1% | 60.5% | 13.96 |
GES | 25.87 | 84.4 | 2184 | 2620 | 295 | 2 | 1891 | 380 | 5.0 | 0.7 | 8.07% | 8.69% | 14.5% | 44.3% | 11.37 |
ANF | 45.89 | 79.6 | 3651 | 4370 | 370 | 124 | 3406 | 511 | 6.7 | 0.8 | 19.87% | 6.07% | 11.7% | 57.7% | 35.52 |
GPS | 34.46 | 480.0 | 16541 | 15210 | 1770 | 1250 | 16021 | 2300 | 7.0 | 1.1 | -0.78% | 0.05% | 15.1% | 34.6% | 16.84 |
RL | 157.09 | 91.5 | 14371 | 6880 | 1010 | 266 | 13626 | 1290 | 10.6 | 2.0 | 21.19% | 10.98% | 18.8% | 58.1% | 22.17 |
VFC | 160.51 | 110.2 | 17682 | 10760 | 305 | 2570 | 19947 | 1600 | 12.5 | 1.9 | 22.21% | 7.37% | 14.9% | 40.2% | 17.82 |
ANN | 33.55 | 47.4 | 1591 | 2330 | 167 | 0 | 1424 | 266 | 5.4 | 0.6 | 11.73% | 0.27% | 11.4% | 51.9% | 16.21 |
FNP | 12.05 | 113.2 | 1364 | 1470 | 31 | 396 | 1728 | 30 | 57.7 | 1.2 | -6.44% | -27.50% | 2.0% | 55.0% | 14.70 |
COH | 57.84 | 283.7 | 16409 | 4870 | 761 | 23 | 15671 | 1660 | 9.4 | 3.2 | 14.54% | 13.82% | 34.1% | 34.1% | 16.19 |
TIF | 58.98 | 126.7 | 7475 | 3750 | 346 | 978 | 8107 | 898 | 9.0 | 2.2 | 18.07% | 8.54% | 23.9% | 57.3% | 18.23 |
DECK | 38.29 | 35.3 | 1350 | 1400 | 62 | 275 | 1563 | 258 | 6.1 | 1.1 | 37.59% | 25.94% | 18.4% | 48.5% | 9.42 |
PVH | 114.59 | 70.6 | 8088 | 5940 | 277 | 1870 | 9681 | 801 | 12.1 | 1.6 | 27.04% | 33.21% | 13.5% | 51.5% | 19.72 |
Sources: yahoo, Morningstar, filings etc. Market data may be old in some cases (as it's a moving target) but the goal of the analysis is to show the comparison.
As you can see only Guess has a lower EV/EBITDA and P/E multiples but then it has grown its revenue slower than True Religion, in the last three years. Deckers Outdoor looks good on both EBITDA and earnings multiple but it has already climbed up over 30% in the last three weeks.
A LOOK AT THE COMPARABLE SALES
To reward the shareholders, True Religion is looking for strategic alternatives, including a possible sale. As per the recent media reports, it has already received the first round of the bids.
Let's examine some comparable sales in the industry and the valuation they were acquired at.
Date | Target | Ticker | Seller | Buyer | Buyer Profile | EBITDA | Premium to Stock Price | |
Sep-12 | Sealy Corporation | ZZ | KKR | Tempur Pedic | Strategic Buyer | 7.6x | 3% | |
Jan-11 | Jo-Ann Stores | JAS | Jo-Ann Stores | Leonard Green & Partners | PE | 7.6x | 34% | |
Oct-10 | Gymboree | GYMB | Gymboree | Bain Capital | PE | 7.8x | 57% | |
May-11 | J Crew | JCG | J Crew | TPG Capital | PE | 8.6x | 15% | |
Oct-12 | Warnaco | WRC | Warnaco | PVH Corp | Strategic Buyer. Owns these brands: CK, Tommy Hilfiger, Izod, Van Heusen, Arrow, Bass, Chaps, Olga, Speedo | 10x | 34% | |
May-11 | Volcom Inc | VLCM | Volcom | PPR SA, France | Strategic Buyer. Owns these brands: Gucci, Puma, Volcom, Balenciaga, Alexander | 14x | 37% | |
2007 | Puma | PUM.DE | Puma | 12.2x | 19% | |||
Jun-11 | Timberland | TBL | Timberland | VF Corp | Strategic Buyer. Owns these brands: 7 For All Mankind, Nautica, Timberland, The North Face, Vans, Jansport, Wrangler, Lee | 12x | 40% | |
2007 | 7 For All Mankind | 7 For All Mankind | 9x |
Sources: Various news outlets and financial websites
Predictably the companies that were acquired by the private equity firms were paid a comparatively lower multiple than what was paid by a strategic buyer. This is because the strategic buyer being in the same industry has a war-hardened and hopefully time proven management to bring much better operational efficiencies in the combined firm. In addition, there are much better cost synergies in the operations of companies in the same or similar lines of business.
As for who may be the likely bidders for True Religion, we believe that there is a good chance of one or many of the companies listed above to be likely suitors. In addition you have the strategic player such as Moët Hennessy Louis Vuitton, Hermès and possible PE player such as Kellwood. Finally you also have a member of True Religion's board as a likely bidder as per the recent media reports. Anyway we'll see who gets the prized catch when that happens.
For now, let's see what happens if True Religion gets acquired at the multiples in the comp sales above. Note, that to compare apples to apples, I am not using operating leases as the debt in calculating the EV below, since the transaction multiples shown above for comp sales did not use that either.
TRLG | EBITDA | EBITDA | TEV | Sales | Sales Multiple | Cash | Debt | TEV Market Cap | # Shares | TEV Share Price | Premium to current Price |
7.50 | 90.5 | 678.8 | 449.7 | 1.51 | 168.7 | 0.0 | 847.5 | 25.3 | 33.47 | 39% | |
8.00 | 90.5 | 724.1 | 449.7 | 1.61 | 168.7 | 0.0 | 892.8 | 25.3 | 35.26 | 47% | |
8.50 | 90.5 | 769.3 | 449.7 | 1.71 | 168.7 | 0.0 | 938.0 | 25.3 | 37.05 | 54% | |
9.00 | 90.5 | 814.6 | 449.7 | 1.81 | 168.7 | 0.0 | 983.3 | 25.3 | 38.83 | 62% | |
10.00 | 90.5 | 905.1 | 449.7 | 2.01 | 168.7 | 0.0 | 1073.8 | 25.3 | 42.41 | 77% |
As you can see, True Religion shareholders stand to gain anywhere from 40% to 75% over the current share price if the sale happens at these multiples.
BUYOUT ANALYSIS
Here is a simple buyout analysis where an imaginary company uses the leverage to buy out True Religion. Obviously every private buyer has its own ways of doing this, including the source of funds, interest rates, the leverage used, entry, exit criteria and the time frames etc. We are doing the following exercise only as a guideline, basically to illustrate the point that True Religion is quite undervalued.
ASSUMPTIONS:
- The buyout happens at an EV/EBITDA multiple of 9x. With TTM EBITDA at ~ $90M, Transaction EV comes to $811M.
- The transaction Fee of 1.5% (typical for such transactions) is amortized over five years.
TTM EBITDA | $90,135 |
Entry EBITDA Multiple | 9x |
Entry TEV | $811,215 |
Transaction Fee @ 1.5% | $12,168 |
Total Outlay | $823,383 |
- For the sake of the simplicity, the capital structure I'm assuming comprises of 24% equity and 76% debt, i.e. no mezzanines or preferred.
- The debt comes from two sources: Roughly one-third of the debt, which is 25% of the total capital, is senior debt financed at 7%. The remaining debt, i.e. 51% of the capital is junior debt financed at 9%.
- My assumptions of 7% interest rate for the senior debt and 9% interest rate for junior debt are probably conservative as the one-year LIBOR rate is at 86 bp, the spread for the revolving credit is about 300 bp and the weighted average institutional spread is about 460 bp at this point.
Equity | 24% | $197,612 | |
Sr Debt | @ 7.0% | 25% | $208,590 |
Jr Debt | @ 9.0% | 51% | $417,181 |
Total Debt | 76% | $625,771 |
- The debt agreements provide that the excess free cash flow post-transaction is used to pay down the debt; starting with the senior debt and then the junior debt.
- For the sake of simplicity, no distribution is made to the new shareholders during the next 7 years.
- The revenue growth rates for the next five years, year six and seven are 9%, 7.5% and 6.1% respectively.
- COGS remains at 35.2% of the sales, same as FY2011.
- The total operating expenses improve by 15% in year one over the TTM number and remain at that level until the year 2018.
- DD&A, income tax rate and the Capex expenses remain at the current level of 3%, 38.1% and 4.9% of the sales. Total DD&A also includes the amortization of the transaction fee.
With that, here is the snapshot of the pro forma financial statements for the next seven years of operations post-buyout.
2010 | 2011 | TTM | 2012E | 2013E | 2014E | 2015E | 2016E | 2017E | 2018E | |
Revenue | $363,714 | $419,798 | $449,652 | $490,121 | $534,232 | $582,312 | $634,720 | $691,845 | $743,872 | $788,876 |
COGS | $133,735 | $147,969 | $161,721 | $176,276 | $192,141 | $209,433 | $228,282 | $248,828 | $267,540 | $283,726 |
Gross profit | $229,979 | $271,829 | $287,931 | $313,845 | $342,091 | $372,879 | $406,438 | $443,018 | $476,332 | $505,151 |
Total DD&A | $10,342 | $12,750 | $12,750 | $17,137 | $18,461 | $19,903 | $21,475 | $23,189 | $22,316 | $23,666 |
Total Operating Expenses | $160,057 | $197,218 | $210,546 | $195,071 | $212,627 | $231,764 | $252,622 | $275,358 | $296,065 | $313,977 |
Operating income | $69,922 | $74,611 | $77,385 | $118,774 | $129,464 | $141,115 | $153,816 | $167,659 | $180,267 | $191,173 |
EBITDA | $80,264 | $87,361 | $90,135 | $135,911 | $147,924 | $161,018 | $175,291 | $190,848 | $202,583 | $214,839 |
Interest Expense | ||||||||||
Senior Debt | $14,601 | $12,223 | $9,339 | $5,891 | $1,814 | $0 | $0 | |||
Junior Debt | $37,546 | $37,546 | $37,546 | $37,546 | $37,546 | $33,739 | $26,893 | |||
Total Interest Expense | $52,148 | $49,770 | $46,885 | $43,437 | $39,360 | $33,739 | $26,893 | |||
Pre tax Income | $70,325 | $73,974 | $76,595 | $66,626 | $79,694 | $94,230 | $110,379 | $128,299 | $146,528 | $164,280 |
Income taxes | $26,690 | $28,197 | $29,031 | $25,253 | $30,206 | $35,715 | $41,836 | $48,628 | $55,537 | $62,265 |
Net income | $43,496 | $44,967 | $47,564 | $41,374 | $49,488 | $58,515 | $68,543 | $79,671 | $90,991 | $102,015 |
Capex | $17,622 | $20,769 | $22,513 | $24,539 | $26,748 | $29,155 | $31,779 | $34,639 | $37,244 | $39,497 |
Free cash flow | $50,139 | $50,999 | $32,334 | $33,972 | $41,201 | $49,263 | $58,239 | $68,221 | $76,063 | $86,184 |
Senior Debt | @ | 7% | 7% | 7% | 7% | 7% | 7% | 7% | 7% | |
Beginning Balance | $208,590 | $174,619 | $133,417 | $84,154 | $25,915 | $0 | $0 | |||
Amortization - Txn Fee | $2,434 | $2,434 | $2,434 | $2,434 | $2,434 | $0 | $0 | |||
Sweep | $31,538 | $38,768 | $46,829 | $55,806 | $23,482 | $0 | $0 | |||
Ending Balance | $208,590 | $174,619 | $133,417 | $84,154 | $25,915 | $0 | $0 | $0 | ||
Junior Debt | @ | 9% | 9% | 9% | 9% | 9% | 9% | 9% | 9% | |
Beginning Balance | $417,181 | $417,181 | $417,181 | $417,181 | $417,181 | $374,875 | $298,812 | |||
Sweep | $0 | $0 | $0 | $0 | $42,306 | $76,063 | $86,184 | |||
Ending Balance | $417,181 | $417,181 | $417,181 | $417,181 | $417,181 | $374,875 | $298,812 | $212,628 | ||
Capital | $823,383 | $823,383 | $823,383 | $823,383 | $823,383 | $823,383 | $823,383 | $823,383 | ||
Sr Debt | $208,590 | $174,619 | $133,417 | $84,154 | $25,915 | $0 | $0 | $0 | ||
Sr Debt / Capital | 25% | 21% | 16% | 10% | 3% | 0% | 0% | 0% | ||
Jr Debt | $417,181 | $417,181 | $417,181 | $417,181 | $417,181 | $374,875 | $298,812 | $212,628 | ||
Jr Debt / Capital | 51% | 51% | 51% | 51% | 51% | 46% | 36% | 26% | ||
Equity | $197,612 | $231,584 | $272,785 | $322,048 | $380,287 | $448,508 | $524,572 | $610,756 | ||
Equity / Capital | 24% | 28% | 33% | 39% | 46% | 54% | 64% | 74% |
As you can see from the table above and the chart below; the debt and equity reverse roles in the capital structure during the seven years of operations post-buyout. The debt drops down from 76% of the capital to 26% and the equity rises from 24% of the capital to 74% of the capital.
(click to enlarge)
I guess, with 74% equity in the business after seven years, it's time for the new shareholders to hit the market again, this time as the sellers. If we assume that the private buyer exits at an EBITDA multiple of 10, here is how the return will look:
Exit Multiple | 10.0 |
EBITDA 2018E | $214,839 |
Exit TEV | $2,148,395 |
Total Return from the buyout | 987% |
CAGR Return from the buyout | 41% |
Not bad! In a world where 10-year treasury yields negative 54 bp (nominal yield of 1.62% adjusted for the current inflation at 2.16%) which essentially means that people are willing to lose their principal amount in buying 10-year treasuries, a potential return of 40% is Buffettesque.
MAJOR SHAREHOLDERS
Here is the list of the top institutions, mutual funds and hedge funds that own True Religion shares.
| |||||
Name | Reporting Date | Total Holdings | Position Value | Outstanding | |
Shares Owned | |||||
WELLINGTON MANAGEMENT COMPANY, LLP | 9/30/2012 | 2.8M | $67.7M | 10.91% | |
Allianz Asset Management AG | 9/30/2012 | 1.6M | $39.6M | 6.38% | |
VANGUARD GROUP, INC. | 9/30/2012 | 1.4M | $34.1M | 5.49% | |
OAK RIDGE INVESTMENTS, LLC | 9/30/2012 | 1.1M | $27.7M | 4.46% | |
BlackRock Fund Advisors | 9/30/2012 | 1.1M | $26.8M | 4.31% | |
Van Berkom & Associates Inc. | 9/30/2012 | 1.0M | $24.8M | 4.00% | |
PRICE (T.ROWE) ASSOCIATES INC | 9/30/2012 | 880.7K | $21.2M | 3.42% | |
ROYCE & ASSOCIATES, LLC | 9/30/2012 | 834.3K | $20.1M | 3.24% | |
BlackRock Institutional Trust Company, N.A. | 9/30/2012 | 804.0K | $19.4M | 3.12% | |
Royal Bank of Canada | 9/30/2012 | 803.8K | $19.4M | 3.12% | |
| |||||
Name | Reporting Date | Total Holdings | Position Value | Outstanding | |
Shares Owned | |||||
Allianz Fds-NFJ Small Cap Value Fd (I) | 8/31/2012 | 1.2M | $28.2M | 4.54% | |
PIONEER OAK RIDGE SMALL CAP GROWTH FUND | 4/30/2012 | 716.7K | $17.3M | 2.78% | |
PRICE (T.ROWE) SMALL-CAP VALUE FUND | 6/30/2012 | 611.5K | $14.7M | 2.37% | |
PENNSYLVANIA MUTUAL FUND INC | 6/30/2012 | 416.1K | $10.0M | 1.61% | |
ISHARES S&P SMALLCAP 600 INDEX FD | 5/31/2012 | 390.8K | $9.4M | 1.52% | |
VANGUARD SMALL-CAP INDEX FUND | 6/30/2012 | 389.9K | $9.4M | 1.51% | |
ISHARES RUSSELL 2000 INDEX FD | 5/31/2012 | 313.7K | $7.6M | 1.22% | |
VANGUARD TOTAL STOCK MARKET INDEX FUND | 6/30/2012 | 298.8K | $7.2M | 1.16% | |
VANGUARD SMALL-CAP GROWTH INDEX FUND | 6/30/2012 | 273.6K | $6.6M | 1.06% | |
ROYCE MICRO-CAP FUND | 6/30/2012 | 217.3K | $5.2M | 0.84% | |
Guru Name | Date | Current Shares | % of Shares Outstanding | % of Total Assets Managed |
| |
Richard Snow | 9/30/2012 | 22,770 | 0.09 | 0.03 | New Buy | |
Joel Greenblatt | 9/30/2012 | 88,438 | 0.34 | 0.13 | 58.09% | |
NWQ Managers | 9/30/2012 | 382,560 | 1.48 | 0.06 | -0.91% |
Sources: FMR LLC, gurufocus
Whether True Religions is acquired by a strategic buyer or a PE firm or by the management, one thing is certain - remaining public or being run by the same management or using the same business model is not optimal for the company. Many jeans makers that it competes with are either private or a division of a bigger company. If True Religion becomes part of a strategic acquirer, the brand will benefit from the economies of scale, the cost synergies, a bigger supplying power, better lease terms and better negotiating leverage.
And as you can see from the buyout analysis above, going private can significantly improve the operations. A private company does not need large accounting, legal, IR and PR departments so those are obvious low hanging fruits for the new owners. By offering a higher share of the equity to the management in the new capital structure post-buyout, the interest of the new owners and the management are better aligned. This alignment of interest revamps the entrepreneurial spirit in the company. The debt brings the tax benefits and more importantly the much-needed financial discipline. It cuts down the unnecessary or negative NPV projects. It improves the quality of R&D, working capital and brings sharp focus to most part of the organization.
CONCLUSION: There is substantial shareholder value to be unlocked in True Religion. As you can see from the list of major shareholders above in the article, there are some very bright people involved here who control a lot of shares. We do not think they will let True Religion sell itself too cheaply. In fact I would be surprised if there are no class action lawsuits flying around, if the management and the board sell the company for an EBITDA multiple lower than 7.5x (the lowest multiple in the comparable sales). And you know what even if (that's a big if) the management and the board somehow pull off a "Circular Firing Squad," the current shareholders still stand to gain 40% over the current price, as we saw above.
We are holding on to our positions dearly and in fact if Mr Market gives an opportunity to reduce our cost basis further, we might do that as well.
Disclosure: I am long TRLG.
