VF Corp (VFC) is a self-described “$7 billion-plus apparel powerhouse, with an incredibly diverse, international portfolio of brands and products that reach consumers wherever they choose to shop.” While you may not have heard of VFC as a consumer, its brands are widely popular: Jansport, Lee, Majestic, Nautica, Wrangler, and The North Face. This portfolio of proven brands makes VFC the largest apparel company in the world.
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I was first introduced to VFC last summer and strongly recommended it last June when it was trading below $80. Within the last year VFC has surged 50% and has really skyrocketed in the last month since it agreed to purchase Timberland Company (TBL) for approximately $2 billion. Per its website, “Timberland is a global footwear and apparel company with expected 2011 revenues of $1.6 billion, over half of which are generated internationally.” For comparison, the S&P 500 is up slightly less than 30% over the same time period.
Whenever a company that you follow is involved in a significant M&A transaction, it is critical to evaluate the deal. I use the five-question framework presented in CFO Magazine: “What could shareholders have demanded to know? Below are five basic questions that must be posed for almost any deal. This line of questioning is derived from ‘The Value of Synergy,' a 2005 paper by Aswath Damodaran, professor of finance at New York University's Stern School of Business and author of numerous books on corporate finance and valuation.”
1. Are There Real Synergies to Be Gained?
The objective of any merger or acquisition is to create a whole that is at least equal to the sum of the parts. When all goes right you can get a transaction in which 2+2 = 5. Damodaran defines synergies as “higher cash flows from existing assets, higher expected growth rates, a longer growth period, or a lower cost of capital.” For VFC, the goal is higher growth rates as it expects to grow Timberlands by 10 percent annually.
The primary advantage of the deal is the strengthening of VFC’s outdoor segment via the addition of a world-famous brand. VFC has faced some difficulty entering the Chinese market; this is a way to get a strong foothold. This is not simply a deal for the sake of making a deal – this is a strategic fit that makes sense for VFC as it further improves its strengths.
2. Do the Savings Add Up?
VFC CEO Eric Wiseman stressed three primary ways in which Timberland can reduce costs:
- Expense management to improve SG&A ratios
- Supply chain capabilities to reduce sourcing costs
- Operating disciplines of VF’s businesses
CFO Bob Shearer elaborated on this in an investor call by stating that Timberland’s operating margin will be in line with other VFC brands (15%). In this way, Timberland is akin to a turnaround story, as there is hidden value that can be extracted by VFC’s proven management team.
3. Who Gets the Spoils?
Make no mistake about it: This deal will improve VFC’s earnings immediately. The deal “is also expected to be accretive to VF's earnings per share, by $0.25 in 2011 and by $0.75 in 2012, inclusive of deal costs and other acquisition related expenses in both periods. Excluding these expenses, EPS accretion would be approximately $0.45 in 2011 and $0.90 in 2012.” While there are elements of a turnaround story as discussed above, Timberland is a profitable company that will reward VFC shareholders this year.
4. Are the Shares Overvalued?
Companies typically use stock to pay for a deal when they believe that their stock is overvalued. VFC is using a mix of cash, commercial paper, and debt to pay for the debt; therefore, management is not sending up a red flag signaling that it believes its stock is overvalued. Paying Timberland shareholders $43 per share represents a 40 percent premium over Timberland’s market price at the time. I am always weary of paying such a significant premium for another company, but it appears as if Timberland’s share price was deflated by its first quarter 2011 earnings decline. In essence, VFC acquired Timberland in June for less than it was trading for in May.
5. Is It Really Worth It?
The VFC-Timberland deal passes my tests with flying colors. Not only is this a strong strategic fit for both companies, but VFC has the opportunity to utilize its operational excellence to improve Timberland’s profitability. The fact that VFC did not overpay is just gravy on top of a solid deal. Even if the planned cost-cutting synergies do not materialize, the acquisition will strengthen VFC’s earnings. I am looking forward to staying a VFC shareholder in 2011.
Disclosure: I am long VFC.
Additional disclosure: I hold a long position in VFC; short VFC July 110 Calls.