Movie Star Inc.: A Pure Play on Pretty Panties

Sometimes an opportunity hits you over the head and you have to take advantage of it. That has been the case for me with Movie Star Inc (MSI), soon to be merged with Frederick’s of Hollywood.

This is an interesting investment because MSI is smaller than Frederick’s, but it was the public company and Frederick’s wanted to go public. They sensed synergies (MSI manufactures store-brand lingerie for Sears (SHLD) and Wal-Mart (WMT)) so they agreed to a merger. The combined entity will have a lot of cash on hand and will look to drastically increase the number of Frederick’s of Hollywood stores.

There are few better investments in the business world than to find a good brand and then invest money in spreading it. This is exactly what will happen with Frederick’s. The company invented the push-up bra and introduced the thong to the United States. Its water-filled bra is an excellent feat of engineering that offers lifelike feel whilst enhancing cleavage. While the company had a bit of a sleazy image in the past, it has focused for the last few years on updating its image and becoming more mainstream (think Victoria’s Secret).

As always, I encourage you to view the relevant financial data yourself, straight from EDGAR. Following is my pro-forma pro-forma [sic] analysis. I took the pro-forma financials from the proxy statement and used my own pro-forma voodoo on them.

The combined company will have book value of about $60 million (including $20 million in cash it will use to expand). It had pro-forma sales of $190 million for the year ending July 2006. After the merger, there will be $50.8 million shares outstanding. This gives the combined entity a current market cap of $130 million (using $2.55 per share current price).

I get a 2007 estimated EBITDA for the combined entity of $10.6 million. Given an implied enterprise value if the deal goes through at the current price of about $108 million, this implies an EV/EBITDA ratio of 12.3x. Frederick’s has 133 stores and looks to increase that by 50 over the next 3 years (a rate of increase of over 16% per year). 34% of Frederick’s sales (not MSI or the combined company pro-forma) are from mail order or internet. Increasing the store count significantly should thus ramp up profits (excluding organic growth) at over 5% per year.

I would also expect significant same store sales growth and online sales growth as the company increases advertising. There should also be some synergies since Frederick’s has a brand name and retail presence while MSI actually manufactures lingerie. I have not modeled those synergies. The median peer EV/EBITDA ratio is about 8.0x. I expect MSI to grow significantly faster than its peers over the next few years, so a somewhat higher EV/EBITDA ratio is warranted. At the current price, though, the company seems fairly valued.

While I am not excited at the company’s current price, if it should fall, I will gladly increase my stake. An opportunity to buy a brand like Fredericks for cheap does not come around often.

Disclosure: I own shares of MSI

MSI 1-yr chart