Joe's Jeans And Hudson Clothing Are A Perfect Match

Jul.26.13 | About: Joe's Jeans (JOEZ)

On July 15, 2013, Joe's Jeans (NASDAQ:JOEZ) -- a leading producer of denim product offerings -- not only announced its earnings but also announced the acquisition of Hudson Clothing Holdings, Inc. Shareholders showed their dissatisfaction with both items of news, sending shares down over 25% since the pair of announcements went viral.

Second-quarter earnings for Joe's Jeans were disappointing to investors as EPS and revenue both came in short of expectations. However, each miss was marginal and there were some positive signs coming out of the earnings report. Analysts were calling for Joe's Jeans to rack up $0.03 per share on revenue of $32 million. Joe's reported a profit of $0.02 per share on revenues of $30.9 million. Both figures were slightly off compared to analysts' consensus expectations, but they nonetheless sent the stock parachuting down.

The management team at Joe's provided reasons for the earnings miss and mostly attributed the lackluster earnings to tough comparables against last year's 55 colors program and the printed denim roll-out. Additionally, the cost of making this year's Vintage Reserve collection in the U.S. was more than expected and therefore had a negative effect on margins and profits. However, Joe's Jeans is confident better results and margins will be seen in the back half of the year as it will shift production of its Vintage Reserve collection to Mexico, where production will be less expensive and more cost efficient.

Heading into earnings, investors were skeptical of Joe's new and exclusive brand, Else. CEO Marc Crossman was quoted as saying:

We also continued to benefit from the addition of sales from our Macy's brand, Else. More specifically, Joe's wholesale sales grew 6%, retail sales grew 14% and Else grew 67%. ... Our Else brand continues to be a nice addition to top line sales. During the quarter, the Else brand grew 67%. Else is currently in 314 Impulse stores, which we expect to maintain through the rest of the year.

Missing earnings per share by $0.01 per share and revenue by $1.1 million is by no means an adequate reason for an otherwise healthy company to shed a quarter of its market cap value. In fact, Joe's still saw an 8% increase in net sales and had $2.1 million in operating income. Despite the positive income and clear strength of the Else brand, investors were disappointed about the earnings.

On top of investors being disgruntled about the earnings miss, investors were equally upset about Joe's Jeans decision to purchase privately held rival denim producer Hudson Clothing Holdings, Inc. The exact specifics of the deal have yet to be discussed because of the nature of the transaction. However, one thing that is known is that Joe's will pay approximately $97.6 million in cash and cash convertibles, and the deal is set to close on or before Aug. 31, 2013.

Why would a premium denim maker whose market cap the day of the acquisition was $120 million purchase a fellow competitor for nearly $100 million? Not only will the transaction immediately double the size of Joe's Jeans business, but the two businesses will work to help each other in areas where one may be weaker. Crossman stated the following during the earnings call:

Upon completion of the transaction, we will have nearly doubled the size of the company across all metrics from revenue down to EBITDA. We're purchasing 100% of the company for just under $98 million. ... We expect to drive incremental top-line growth for both companies by expanding each company's distributions. Joe's and Hudson will build upon each other's strength in the domestic, international and e-commerce businesses. It is very clear from the early stages of exploring a combination that each company has had areas in their distribution that could be filled through cross education.

It is because of the ability each company has to strengthen the other, that Joe's Jeans and Hudson Clothing are a perfect match. Certainly, the two companies will feed off of each other and will aid in each other's growth trajectories. Combining two strong companies with the ability to help each other grow while remaining distinctly separate is a brilliant move. During the earnings call Crossman was quoted as saying:

I want to be clear. Preserving the distinct and separate DNA of each brand is of paramount importance. We believe each brand, while sitting in the same department in a number of accounts, serves a different customer and or purchasing decision. [While each brand will remain distinctly separate, there will be] significant savings across all three components of making a jean -- namely, fabric, trends, and labor. Sheer size alone will provide us with significant leverage with all the vendors we use or plan to use in the future. The savings don't stop there. Equally important, utilizing just a small piece of our cross-border manufacturing can produce significant cost reduction. Garments using our cross-border manufacturing capabilities could see up to a 30% savings.

These cost saving initiatives could prove to be monumental in terms of the top and bottom lines for Joe's Jeans and its shareholders. Those who are worried about the financial standings of Hudson Clothing should rest easy. Again, according to Crossman:

I would say this, that Hudson is a very strong company that's doing very well in the marketplace. And Peter has been growing that business consistently. And we don't see any change to that trend. So this is not a case of us buying an unhealthy company, this is a case of us buying a very healthy company that the two of us can leverage off of each other.

It is almost unbelievable to think that Joe's Jeans had a market cap of $120 million, bought a very healthy and premier denim maker for $97.6 million, and now its market cap has shrunk to roughly $90 million. The math simply doesn't add up. The day following the earnings and acquisition announcements, Joe's traded at 11x average daily volume in the first 45 minutes of the trading day. This may be an indication that there have been a couple of big-time holders or hedgers who sold their positions for no other reason but panic and fear. This heavy sell-off prompted other investors to sell as well.

The combination of Joe's Jeans and Hudson Clothing will yield far better results than those shareholders who sold their shares out of panic will ever realize. Once the financials of Hudson Clothing are disclosed and after the deal is finalized, we should look for Joe's market cap to once again grow. Joe's Jeans and Hudson Clothing will be combining ideas, practices, industry secrets, and strengths to become a premium powerhouse for denim production. Almost certainly the combination will add significant scale and enhance growth potential for both companies and shareholders alike.

Disclosure: I am long JOEZ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.