Sequential Brands Emerges As Strong Licensing Company Investors Should Consider

Aug.22.14 | About: Sequential Brands (SQBG)

Summary

Acquisition of Galaxy Brands nearly doubles retail sales, puts company closer to three year goals.

Attractive business model with guaranteed royalty income and no inventory risk.

Relaunch and focus on William Rast and other brands should pay off by end of next year.

Anyone who has followed my articles here on Seeking Alpha knows that one of my favorite company's is Iconix Brand Group (NASDAQ:ICON). That company manages more than 30 brands and licenses them out to retailers and stores, generating huge streams of revenue with minimal risk due to low overhead and no physical inventory. That licensing model is alive with another publicly traded company Sequential Brands (NASDAQ:SQBG). Sequential recently acquired four brands and has several prominent brands going through transitions that should reward patient shareholders.

Sequential closed its acquisition of Galaxy Brands, a Carlyle Group (NASDAQ:CG) portfolio holding. Sequential paid $100 million in cash and 13.75 million shares. The deal will make Carlyle a significant shareholder in Sequential going forward.

The acquisition of Galaxy Brands gives Sequential Brands Avia, AND1, Nevados, and Linens 'N Things. The deal nearly doubles the annual retail sales of the portfolio holdings from $1 to $2 billion. Sequential's CEO Yehuda Shmidman said at the time:

This merger is a game changer for Sequential.

AND1 was launched in 1993 and is one of top basketball brands in the world. The brand is seen in the footwear, apparel, and accessories categories. Avia is a player in the rapidly growing activewear and running categories. Avia was founded in 1979 and is surprisingly a strong player in the technology field as well. Avia has 18 patents related to sole design and shoe technology. Sequential recently said on the second quarter earnings call:

We really believe that the brands are just at the beginning stages of their runway ahead.

This week, Sequential updated its guidance for the full year and future. Sequential now sees full year revenue in a range of $38 to $40 million. This is up from the prior range of $28 to $30 million. Adjusted EBITDA is expected to be around 60%, up from 55% in prior guidance.

After the acquisition, Sequential will now have brands that generate $2 billion in global sales for retailers. Sequential expects next year's revenue to be in a range of $56 to $60 million. Adjusted EBITDA is projected to be $36 to $40 million on a full year basis. Going forward, Sequential has three major goals for its financials:

  • Brands generate $3.5 billion in global retail sales
  • Company generates $100 million in annual revenue
  • Company generates $70 million in adjusted EBITDA

Second quarter revenue of $7 million was a large 60% increase. Adjusted EBITDA of $3.7 million was a 122% increase. Over the first six months of fiscal 2014, Sequential's revenue is up 122% to $13.3 million. This is not including any of the Galaxy acquired brands yet either. The big performers in the first half of the year were Ellen Tracy and Heelys.

From a recent investor presentation, here are the six attractive business model reasons for owning shares of Sequential:

  • Own and control intellectual property
  • Guaranteed minimum royalties
  • Diversified predictable revenue base
  • High adjusted EBITDA margins
  • Scalable business model
  • No inventory risk

Sequntial started with its William Rast and People's Liberation brands and less than five licensing deals before growing through acquisition. Today, with the close of the Galaxy Brands, here is how Sequential's portfolio looks:

  • Apparel: Ellen Tracy, William Rast, People's Liberation, Caribbean Joe
  • Athletic/Action Sports/Outdoor: AND1, Avia, Nevados, DVS, Revo, Heelys
  • Hard Goods: The Franklin Mint
  • Home: Linens 'N Things

The company now has more than 75 licensing deals with its portfolio. The company's top retailers include Nordstrom (NYSE:JWN), Lord & Taylor, Macy's (NYSE:M), Sunglass Hut, Wal-Mart (NYSE:WMT), Amazon (NASDAQ:AMZN), Foot Locker (NYSE:FL), Zumiez (NASDAQ:ZUMZ), Journey's, and Tilly's (NYSE:TLYS).

Three portfolio brands really stand out in their growth attempts from the company.

Ellen Tracy is gearing up for its 65th anniversary, which will feature a new marketing campaign from the company. Along with the anniversary, the brand will expand into new categories like intimate apparel, sleepwear, and also home goods (rugs, beding, decor).

Heely's, once known as just a shoe brand with wheels, is expanding into backpacks, phone cases, and tablet cases, to diversify its product offerings. A big back to school campaign is centered around the brand. New distribution at retailers like Nordstrom, Dick's Sporting Goods (NYSE:DKS), Sports Authority, and Modell's will help with the expansion of products. New e-commerce platform and international expansion (Spain) should also boost sales and the value of the brand, which could lead to additional branding deals.

William Rast, founded by Justin Timberlake, has several exciting expansions coming up. The brand will launch a new line of mens and womens sportswear and outerwear in Lord & Taylor stores. William Rast will also become a tailored brand in November. Women's handbags and shoes under the William Rast name will launch in 2015. William Rast will also increase its international presence with launches in Italy, Germany, Switzerland, and the United Kingdom.

Perhaps the big risk that stands out here is valuation. Sequential has a market capitalization of $330 million and generates only $60 million in 12 month revenue. This valuation depends on how investors view licensing plays. Here is a comparison of Sequential versus Iconix:

Sequential Brands

Iconix

Recent Price

$13.41

$41.14

Market Capitalization

$337 million

$2.0 billion

2014 Revenue estimate

$38 million

$458 million

2014 EPS estimate

$0.26

$2.67

2014 Price to sales

8.9x

4.4x

2014 Price to earnings

51.6x

15.4x

2015 Revenue estimate

$58 million

$486 million

2015 EPS estimate

$0.42

$2.96

2015 Price to sales

5.8x

4.1x

2015 Price to earnings

31.9x

13.9x

Click to enlarge

As you can see, Sequential trades at higher valuations than its larger rival Iconix. Sequential continues to acquire brands and push them into new categories to grow its annual revenue. Shares may be due for a pullback at any point due to 2014's sharp increase. Analysts continue to be bullish over the long term, as am I.

The other key risk is the branding power of Sequential's portfolio. Looking through the names in the portfolio won't generate as familiar of names as Iconix has. However, Sequential has $200 million in contracted guaranteed minimum royalties going forward. Prior to the closing of Galaxy Brands acquisition, Sequential added two five year renewals for Galaxy brands. Sequential also seems to do a better job of not limiting its brands to one store via exclusive deals, which is one of Iconix methods.

Take a look at some of the recent analyst upgrades:

  • 6/25: Brean Capital raises price target from $10 to $15
  • 6/26: Canaccord Genuity raises price target from $11 to $19
  • 6/26: Piper Jaffrey raises price target to $15
  • 6/27: Roth Capital raises price target from $10 to $16
  • 8/5: Wunderlich initiates with buy rating and price target of $15

Shares of Sequential are trading hands above $13, down from recent 52 week of $14.75 seen in July. Shares traded as low as $5 over the last 52 weeks. The acquisition of Galaxy Brands has sent shares significantly higher and also gotten the stock plenty of analyst coverage and recognition.

In fact, shares of Sequential are up 151% in 2014. While shares could be due for a pullback, I believe they will see a new 52 week high soon with strong analyst presence and price targets all at or above the $15 mark. A move to $15 from today's prices is still another 12% gain investors could see in the short term. Longer out, investors could be rewarded with the strength of brands and the turnaround of several portfolio holdings. Consider adding Sequential or Iconix to portfolios for strong profit generation from licensing.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.