G-III Apparel: Double-Digit Growth Trajectory? Yes, It Karan

| About: G-III Apparel (GIII)

Summary

G-III Apparel's share price has fallen 40% since its Donna Karan acquisition announcement, second quarter results release and full-year guidance update.

G-III intends to double revenue to $5 billion believing it already has three $1B brands. Klein should break $1B this fiscal year. Karan is expected to be the fourth.

G-III expects double-digit sales growth for the next several years and it is very likely Karan was part of that plan long before the acquisition was announced.

G-III Apparel Karan Acquisition Source

G-III Apparel (NASDAQ:GIII) is in the designer clothing business. It licenses or owns multiple well-known brands - Calvin Klein, Tommy Hilfiger, Karl Lagerfeld, Wilson's, G.H. Bass. The company's founder, Aron Goldfarb, established an outerwear company in 1956. In the past decade, the company seriously diversified beyond cold weather goods. The majority of G-III sales are now from product lines in ready-to-wear dresses, accessories and handbags, footwear and team sports.

Early in its history, G-III found consumers tend to be loyal to brands. This purchasing behavior led to several operational decisions:

  • offer a wide array of brands to appeal to more consumers,

  • offer a variety of price points, and

  • offer different tiers of retail distribution but limit the number of retailers in each tier.

Retailers, in turn, responded to the behavior. Retailers want to differentiate themselves by offering exclusive product lines, whether they be branded or private-label. By focusing on branded products exclusive to its stores, a retailer can limit the number of vendors with which it must do business. Further, even more operational efficiency is achieved when the vendor can provide the retailer with both branded product lines and private-label product lines.

G-III distinguishes itself by how well it tends and grows a brand.

"We consider efficient and effective integration of acquired businesses to be a core organizational capability."

In the past decade, G-III Apparel executed eight acquisitions - Marvin Richards, Winlet, Jessica Howard, Eliza J, Andrew Marc, Wilson Leather, Vilebrequin and G.H. Bass. In June, 2015, G-III Apparel announced a joint venture with icon Karl Lagerfeld for the North American market. Initial licenses were for women's apparel, handbags and men's outerwear. A few months later, the breadth had exploded to outerwear, sportswear, dresses and footwear.

The company had been on an acquisition hunt for some time. In the fiscal 2016 first quarter earnings call, Mr. Goldfarb shared the next acquisition may have already been on G-III's radar.

"So it can be pretty much any classification of apparel we feel comfortable with, if it adds the right metrics that fit the profile of what we're looking at, and that it can be a standalone brand that we can build from inception. So there's several different areas that we can look at and we are looking at... We have opportunities that we're looking at now. And it just takes time to find the right deal and to close on it."

Finally, in July 2016, G-III Apparel announced it would purchase the Donna Karan brand from LVMH Moët Hennessy Louis Vuitton (OTCPK:LVMUY). While the Lagerfeld JV was a noteworthy accomplishment for G-III, there are hints Karan may have been in its sights all along.

Donna Karan is best regarded for her influence in the 80s on the way women dress. Her "Seven Easy Pieces" concept is said to have revolutionized women's fashion. Karan started her own business, Donna Karan International (DKI) in the mid-80s. DKI went public in 1996. In 2001, LVMH Moët Hennessy Louis Vuitton purchased the outstanding shares of Donna Karan International and the Donna Karan trademarks. In July 2015, Donna Karan and brand owner, LVMH, announced she would "step down" as head designer of her brands. In an interview with WWD, Karan shared she was ready for the move in mid-2014. Newer passions needed her attention.

"From my point of view, it could have been last fall. I didn't expect to be here for this fall."

However, the industry was surprised when LVMH decided to suspend her designer collection alongside her departure.

"It's an emotional moment for our company... It felt like the right thing for the moment we're at. For this particular founder and this particular company. Maybe, it's not the moment to turn it around this second. Maybe, it's the moment to live with it, to respect it and to honor it."

Many considered the move "a slap in the face" to Karan.

LVMH moved forward. It named new designers to head the DKNY brand. According to a Page Six report, the moves disappointed.

"Donna Karan and DKNY was a mega brand in the U.S., but all the things [LVMH] has done to change it and take it forward just haven't worked," said an insider.

The "insider" sharing with Page Six also shared a key titbit.

"The word is that they have a buyer in mind and have approached a U.S. company to buy the brand."

LVMH confirmed it was "targeting a single, specific American buyer, rather than putting it out to multiple bidders". LVMH group managing director, Mr. Antonio Belloni, mentioned his company had not been looking to sell until it was contacted by G-III. What he does not mention is when G-III first contacted LVMH.

It must be noted LVMH does not gratuitously divest its fashion brands. The Karan sale is only the second in three decades. The last was in 2005 when it sold Christian Lacroix to the Falic Group.

LVMH had to be confident in its decision to withhold the brand from multiple bidders. Such confidence implies ongoing and intense interaction with a potential buyer. The CEO of LVMH Fashion Group, Pierre-Yves Roussel, even noted G-III's fervor.

"G-III are super-passionate about the brand."

Such observation would not typically be made if the interaction were infrequent or casual.

In an investor presentation discussing the transaction, G-III emphasized it had "conducted significant due diligence" for over four months. Working backward, it's quite practical to believe the interaction began in 2015. It's just as plausible it could have started earlier. The true time frame may well have slipped from G-III's CEO, Morris Goldfarb, in the second quarter earnings call.

"We've been after this brand for years."

Donna Karan's 2014 fall show was considered a "huge success". It was the 30th anniversary of her brand. That alone would have been reason enough to warrant surprise when LVMH decided to suspend the brand the next summer.

But, there were already rumors circulating about Karan's retirement. According to a New York Times interview, Karan's relationship with her brand owner was strained by the summer of 2014.

"Vuitton runs their businesses separately. I would love to work more with them, but Vuitton has given me the cold shoulder."

Perhaps knowing there was a willing and interested buyer fueled the dismay in the summer of 2015 when the brand was sidelined.

Such speculation is pertinent when considering Karan's next step. Her latest pursuit is Urban Zen. According to Karan, it's been on her idea board for over 15 years.

"I have arrived at a point in my life where I need to spend more time to pursue my Urban Zen commitment to its fullest potential and follow my vision of philanthropy and commerce with a focus on health care, education and preservation of cultures."

The Urban Zen Foundation was founded in 2007 and is philanthropic in nature. Urban Zen markets products from artisans around the world as well as designs by Karan inspired by her travels. It is purported Karan had hoped LVMH would help finance Urban Zen. It is also purported Karan would be responsive to investors interested in the brand.

This type of speculation is also pertinent when considering LVMH's next decision. Marc Jacobs is the sole U.S. fashion brand left under the LVMH umbrella. Prior to the Karan divestiture, LVMH had both U.S. brands, Donna Karan and Marc Jacobs, in the status of being "repositioned". LVMH has assured it is "fully committed" to Marc Jacobs. When the proposition of additional sales, specifically Jacobs, was floated by CEO Roussel, he did state Karan and Jacobs were "completely different models". Curiously, in the summer of 2015, the company assured it was "fully committed" to Donna Karan.

Regardless of speculations, G-III will have the Donna Karan and DKNY brands closed in early 2017. The purchase is valued at $650 million. When LVMH purchased DKI in 2001, it paid $243 million for the outstanding shares and $400 million for the Donna Karan trademarks.

G-III believes the DKNY business alone has the potential to achieve $1 billion in sales. It also expects the DKI brand to generate the highest operating margin of all its brands. Some have argued the company is overestimating the potential and overpaid for the brand. G-III Apparel engaged three advisors, including Barclays who also provided an opinion on the fairness of the transaction price.

In 2016, DKNY sales are projected to reach just $300 million and, as already discussed, the DKI brand was suspended. However, the chaos created by LVMH decisions cannot be ignored. In 2015, sales for the DKNY brand reached $500 million.

G-III does credit LVMH with making hard decisions in the past year that should ultimately benefit the brand. It reduced overhead costs, closed unprofitable stores and decreased sales to off-price distribution channels. But, G-III also believes there are significant opportunities to grow the brands.

  • Collections will be relaunched.

  • Product categories will be expanded.

  • Websites will be enhanced.

  • Retail stores will be tended.

  • Donna Karan brands will capitalize on G-III's sourcing, manufacturing and distribution channels.

In the past five years, G-III has increased its revenue by over $1 billion. Its target now is to churn out another $2.5 billion from its brands. As G-III projects billion-dollar brands, it is of significance the company is now projecting its first brand will hit the mark. In 2005, the Calvin Klein business produced $35 million in sales. G-III expects Klein to hit $1 billion in fiscal 2017 (ending January 31st, 2017).

Brand

Potential

Calvin Klein

$1,500 million

Tommy Hilfiger

+$1,000 million

Karl Lagerfeld

$500 million

DKNY

$1,000 million

Vilebrequin

$250 million

G.H. Bass

$1,000 million

Ivanka Trump

$100 million

Despite G-III Apparel's track record and aspirations, the Karan transaction did not generate market confidence. The traditionally debt-free company will now carry $575 million in debt relative to the Karan acquisition. It will also issue $75 million in additional shares to LVMH as part of the purchase price. The share price dropped just over 20% on heavy volume following the news release.

A month later, G-III Apparel's second quarter results disappointed. In addition, the company lowered its full-year guidance. Overall, sales are expected to increase year over year from $2.34 billion in fiscal 2016 to $2.48 billion. But, non-GAAP net income and earnings per share are expected to decline from $2.44 per share to a range of $2.20 to $2.30 per share. This non-GAAP guidance does not include the one-time costs related to the Karan acquisition nor does it include the issuance of additional shares for LVMH. The share price fell another 25% on heavy volume over the next five days.

G-III shares are trading at their lowest mark in the past 12 months. At the midpoint of G-III's EPS range, the current year P/E ratio has lowered to well below 15.

G-III is scheduled to report its third quarter results in late November/early December. The third quarter historically produces the heaviest wholesale outerwear shipments as retailers prepare for cold weather. In the fiscal 2017 third quarter, G-III is forecasting a double-digit percentage decrease in outerwear products. In contrast, it expects non-outerwear sales to increase by approximately 20%. G-III projects the net effect will be an additional $30 million increase compared to the fiscal 2016 third quarter production of $910 million.

Outerwear sales in the fiscal 2016 fourth quarter were slowed by the mild winter and tallied $527.4 million. Based on its third quarter and full-year guidance for fiscal 2017, fourth quarter sales are projected at approximately $640 million. G-III expects an increase in outerwear sales and improved retail sales for Bass and Wilson's will contribute the difference.

Though full-year revenue is expected to grow just 6% year over year, G-III Apparel should return to the double-digit trajectory in fiscal 2018 it projected last December.

"Yes, we believe that it (the business) can generate double-digit growth for the next few years. We don't see an issue with it."

Of course, G-III Apparel saw more on the horizon than it was able to share at the time.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in GIII over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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