You're Not Gonna Like These Earnings Numbers, I Guarantee It (But Here's Why You May Like This Merger)

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 |  About: Tailored Brands, Inc (TLRD), JOSB
by: Leigh Drogen

After bickering for months over who would annex who, The Men's Wearhouse (MW) finally announced a deal to acquire Jos. A. Bank (NASDAQ:JOSB) for $65/share on Tuesday morning. Taking over Jos. A Bank will give Men's Wearhouse control of over 1700 stores and roughly $3.5 billion in annual sales. Investors rallied behind the announcement, only to be severely disappointed by the earnings release to follow hours later.

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This quarter Men's Wearhouse announced -38c EPS and $560.60M in revenue. These are dreadful results compared to the -12c EPS and $613.36M expected by the Buy Side as represented by contributing analysts on the Estimize.com platform. The retail sector has been weak this winter and many companies have blamed frequent snowstorms and the polar vortex for the sluggish sales.

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The funny thing about this deal is that neither company seems to be doing too well at the moment. If competitors were fighting back and forth for the right to buy the other, you might expect them to be attractive companies. As it turns out, Jos. A Bank's EPS has declined on a year over basis by more than 35% in 3 of the past 4 quarters. Likewise, Men's Wearhouse has also faced declining EPS in 3 of the past 4 quarters and saw FQ4'14 earnings drop by 443% compared to FQ4 of last year.

But maybe there is method behind the madness. The merger will make The Men's Warehouse the 4th largest menswear retailer in the United States and will marry 2 of the most well known discount suit chains. Additionally, Men's Warehouse expects $100m-$150m in run rate annual synergies. What exactly does this annual synergy mean?

Well first of all, maybe Jos. A Bank can knock it off with its silly buy 1 get 7 free sales. Sure its effective marketing, we all saw what happened when J.C. Penney (NYSE:JCP) tried to switch from its coupon and sales model to an everyday low price. Revenue plummeted. And for good reason. It may sound petty but it's part of human nature to purchase things when we believe we are getting a deal, even if it's completely untrue. That's why merchants at markets and bazaars typically state a price much higher than they expect to receive for an item at sale when they begin a negotiation. This way the merchant can let you haggle them down a bit (you think you are getting a deal) and the merchant still receives more than his or her reservation rate, the minimum price they would accept to part with the item being sold.

While the example is colorful, the practical point is this. By combining 2 of the most powerful players in the discount men's wear industry, Men's Wearhouse will reduce its competition significantly. Reduced competition will allow the company to expand its margins and no longer rely on crazy sales to win business, and expanded margins means increased earnings. Although quarterly results were horrible this time around, the acquisition of Jos. A Bank may pave the road to higher profits in the future.

But this quarter things don't look so hot for MW. As confirmed by independent academic research out of Rice University, when companies miss the Estimize earnings forecast, the stock tends to drift downward over the next 3 days after the market reopens. The downward drift of a company's stock price pegged to the Estimize earnings consensus has been proven to be a better signal than traditional Wall Street forecasts. While the stock price may still gap up on news of the acquisition, more often than not you could expect share prices to decline after the open.

Disclosure: No positions