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