Liz Claiborne Cuts Its Company In Half To Pay Down Debt

| About: Kate Spade (KATE)

Liz Claiborne (LIZ), after getting crushed underneath its huge debtload, sold off most of its business throughout this year to pay off most of its debt. Did LIZ get a good deal for its businesses, or did it sell out of desperation and not get fair value? I would assume the latter.

Mr. Market liked this move, as the stock ended the day up 33% upon the news on Wednesday.

William McComb, who has served as CEO since November 2006, said that the company is not planning on any other major divestitures.

"There's really nothing available left for sale in the cupboard," he said.

LIZ sold off its International-Based segment and Partnered Brands segment. These include MEXX, Liz Claiborne brands, DKNY Jeans, Axcess and Monet Brands, and Outlet operations.

It only kept its Domestic-Based Direct Brands which are: Juicy Couture, Lucky Brand, and Kate Spade brands. These are the brands that sell higher end clothing and non-apparel (accessories, jewelry and handbags).

From the 2011 Q2 earnings report, LIZ had an operating loss on all of its segments. The Domestic-Based Direct Brands segment had an operating loss of $42.5M in the first half of 2011, compared to $23.0M in first half of 2010. In Q2 2011, the operating loss was $23.6M, compared to a $13.1M operating loss in Q2 2010. These losses may continue.

The Q3 loss will probably be worse compared to last year, as holiday sales are looking to slump. This article from the WSJ shows that port shipments are much lower this year so far.

Much of the extra expenses in the first half of 2011 was associated with streamlining initiatives like termination fees and such. However, there also was an increase in payroll expenses. Since the company is now much smaller, the officers should get paid less. Although the company is now cut in half, there has been no indication that the board of directors or executives will get a pay cut.

Interest expense decreased to $29.8M for the six months ended July 2, 2011, compared to $34.5M for the six months ended July 3, 2010. This will further be decreased in Q3 2011 as debt paydowns have been happening throughout the year. This is a good thing for LIZ.

LIZ recently sold its lower end brands, including the Liz Claiborne brand to JC Penny (NYSE:JCP), for $328M in cash. McComb said that the company expects 2011 net debt to total $270 million to $290 million after closing on its transactions. The company had just over $548 million in long-term debt at the end of its fiscal second quarter. This means that substantially all of the proceeds of the business segment sales will be used to pay off debt, and almost none of it will be used for growth of its remaining brands. I'm not sure if this is a smart move. To ensure that its Domestic-Based Direct Brands come out with stronger growth, money might need to be thrown in that direction. In business, it's important to spend money to make money.

As stated in the Q2 earnings report found here, on April 7, 2011, LIZ completed an offering of Senior Notes with an interest rate per annum of 10.5%. LIZ also has notes with an interest rate of 6%. As most of this will be paid off, we can predict LIZ will pay an average of a 7% interest rate for its remaining $270 million in debt. This comes out to $18.9M in interest expense per year. Much less than in the past, but still a noteworthy expense.

Growth Opportunities For Domestic-Based Direct Brands

The hope for LIZ longs is that Domestic-Based Direct Brands becomes a growth company that's valued at a high P/S like LULU and COH which have P/S ratios of 9.3 and 4.25, respectively.

Here are the 2010 sales figures for each segment, taken from the 2010 Annual report found here:

Juicy Couture: $566.8M a 5% increase from 2009. Lucky Brand: $386.9M a12% dec from 2009, reflecting decreases in specialty retail operations.

Kate Spade: $184.3M, a 30.5% inc from 2009.

Here are the the sales numbers for the first half of 2011 quoted from the Q2 report:

"Net sales for JUICY COUTURE were $232.5 million, a 1.7% increase compared to 2010. We ended the first half of 2011 with 79 specialty retail stores, 49 outlet stores and 5 concessions, reflecting the net addition over the last 12 months of 11 specialty retail stores, 14 outlet stores and 5 concessions.

Net sales for LUCKY BRAND were $180.6 million, a 1.4% increase compared to 2010.

We ended the first half of 2011 with 180 specialty retail stores and 40 outlet stores, reflecting the net closure over the last 12 months of 10 specialty retail stores.

Net sales for KATE SPADE were $127.4 million, a 67.4% increase compared to 2010.

We ended the first half of 2011 with 44 specialty retail stores and 29 outlet stores, reflecting the net addition over the last 12 months of 5 specialty retail stores."

"Bill saved the company," said Wall Street Strategies analyst Brian Sozzi. "Liz could have been bankrupt."

"The Lucky brand has seen a noteworthy turn in its denim business, Juicy Couture is still a viable brand and Kate Spade is a powerhouse," said Sozzi.

Although Kate Spade currently generates the lowest revenue out of the three, it's the one with the most potential. From the Q2 2011 report:

"our plans to substantially grow our business in Asia through KATE SPADE's joint venture with E-Land Fashion China Holdings, Limited and KATE SPADE's reacquisition of certain distribution rights in (i) the People's Republic of China via such joint venture and (ii) certain Southeast Asian territories" (pg 3)

"In June 2011, the Company entered into an agreement with Globalluxe Kate Spade HK Limited ("Globalluxe") to, among other things, reacquire the existing KATE SPADE businesses in Southeast Asia from Globalluxe." (pg 19)

Will LIZ become a successful growth company, or fade into oblivion? I think it is unlikely for the Kate Spade brand to grow very rapidly. Analysts go crazy because many stores have expanded in Asian countries like China and Japan, but even China is having hardships. There is a lot of excitement over the changes LIZ has made, but once that excitement wears off and reality sets in, especially after what will no doubt be a dismal Q3 2011 report coming up, the stock could easily drop back down to under $6 a share.

Disclosure: I am short LIZ.

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