Frederick's of Hollywood Loses Its Appeal

| About: Frederick's of (FOH)

Frederick's of Hollywood (NYSEMKT:FOH) was once the gold standard in women's intimate apparel. It lost that mantle years ago and probably cannot recover. Market leader Victoria's Secret, a unit of Limited Brands (LTD), has over $5B of the intimate apparel market, while FOH has only $175mm. Catching up will prove very difficult for FOH given the following hurdles.

FOH can't rely upon its storied brand name for pricing power. Their target market is the aspirational middle class with average income of $87k, age 18-55. In a macroeconomic environment saturated with employment worries, this is not a clientele with price inelastic demand for nonessential apparel.

FOH seems to be focusing its international growth strategy on gaining a retail foothold in South Korea and Eastern Europe. The problem with this strategy is that FOH has always focused on owning and operating its own stores, seeking an A-level retail space in B-level shopping centers. Victoria's Secret has minimized such an overhead requirement in non-U.S. markets by licensing its brands through its La Senza unit to licensees in 49 countries. If FOH wants real long term growth it needs to penetrate markets where middle classes are still growing (the BRIC nations come to mind). Doing so with an ownership-only strategy for retail outlets will require knowledge of on-site retail space management practices in multiple countries that FOH simply does not possess. FOH may have come to this realization late in the game; their 10-Q for Apr. 24, 2010 mentions a global licensing agreement for a new swimwear line and discussions with potential licensees for lifestyle products in China, Brazil, and elsewhere.

Further glaring weaknesses in FOH's marketing strategy include a lack of co-branding with comparable aspirational lifestyle products and product placement in entertainment media. Frederick's needs placement in trendy movies or TV shows viewed by their target demographic. Look no further than the publicity Manolo Blahnik shoes gets from the Sex And The City entertainment franchise to see FOH's huge missed opportunity for both co-branding and placement. FOH could have minted money from a partnership with either one.

FOH is not out of options yet. Its brand has residual value; selling the company to a major apparel maker like Abercrombie & Fitch (NYSE:ANF) would add a historic intimate line to a clothier with a large retail presence.

The company's leadership is currently determined to go it alone with a turnaround strategy. FOH trades as a penny stock because its net income and retained earnings are both negative on an annual basis, having declined precipitously for three years in a row. Operating margin, ROA, and ROE are all negative as well. FOH's most recent 10-Q (dated April 24) reveals a tiny quarterly profit of $218k while total sales declined by 8.5%. That is encouraging for short-term solvency but not long-term growth. A new marketing strategy may not be sufficient to keep the company independent for long if topline growth continues to deteriorate. Fortunately for any potential acquirer, the current CEO's background as an investment banker may come in handy if a larger retailer wants a classic intimate brand.

Disclosure: No positions