True Religion: Waiting For Mr. Right

by Will Ashworth | December 7, 2012 9:10 am

At the start of November, PVH Corp. (NYSE:PVH[1]) announced it was acquiring Warnaco (NYSE:WRC[2]) for $2.9 billion. And at the time, I speculated that M&A activity in the apparel industry was heating up[3].

One reason: True Religion Brand Jeans (NASDAQ:TRLG[4]) put itself up for sale two weeks prior, fielding potential offers from both strategic buyers and private equity firms.

But now, it’s been eight weeks since the denim-maker’s formal announcement and there’s been some speculation in The New York Post[5] … and not much else.

So, is a deal going to happen?

As an interested bystander* with with little more information than what I see in the press, I am intrigued by some more recent news in the retail space: In late November, news broke that Japan’s Fast Retailing (PINK:FRCOY[6]) — parent of Uniglo — is buying just over 80% of J Brand Jeans for $290 million — and paying slightly less than three times 2011 revenue of $124 million to do so. The acquisition gives the Japanese retailing sensation further credibility here in the U.S.

Who cares? Well, as I mentioned, J Brand was sold for 3x last year’s sales. True Religion’s trailing twelve-month revenue is $450 million. At the same multiple of sales, True Religion would fetch $1.35 billion or almost $47 a share.

And that’s simply not happening.

The main reason is that the two businesses are at entirely different stages in their development. J Brand is said to have grown its 2011 revenue by 38%, while True Religion’s 2012 sales are expected to grow by only 9% to $458 million.

In addition, J Brand’s net income in 2011 was $17.8 million with a 14.3% net margin, while True Religion’s 2012 profit is expected to be $45.5 million with a 10% net margin.

You simply can’t compare the two businesses, although it does give a rough idea of what the market is willing to bear.

The PVH/Warnaco deal is another possible barometer for a deal. PVH is paying 1.2 times sales for Warnaco, which would value True Religion at $550 million or $21.72 per share. Given True Religion is still growing, has excellent international expansion prospects (not to mention almost $7 in cash per share), an offer this low would be dismissed without serious consideration.

Also, the fact that PVH is buying its licensee means that it already held some of the cards in any negotiations with Warnaco — something a completely independent buyer won’t have.

At the end of the day, even though True Religion’s operating margins have been declining in recent years, they are still double Warnaco’s. Plus, any buyer would undoubtedly want to get them closer to Lululemon (NASDAQ:LULU[7]) or Michael Kors (NYSE:KORS[8]) — somewhere in the mid-20s.

The New York Post article names four private equity firms as possible bidders: Advent International, Carlyle Group, Apax Partners and Leonard Green & Partners. Advent, to start, has the closest ties to True Religion, with board member Marcello Bottoli leading the bid.

Advent will be familiar to those of you who’ve invested in Lululemon in the past, too. The private equity firm was the big money behind Lulu’s expansion into the U.S. It put $74.4 million into the company in December of 2005 and got that back (and then some) in August 2007 when the maker of yoga apparel went public.

Director Bottoli’s experience running Louis Vuitton (PINK:LVMUY[9]) and turning around Samsonite (PINK:SMSOF[10]) would come in handy as True Religion tries to restart the growth engine.

Of the other three prospective buyers, Leonard Green & Partners makes the most sense. It’s based in Los Angeles, for one, which is where True Religion’s head office is. Plus, Leonard Green and TPG Capital acquired J. Crew for $2.9 billion in March 2011. Both are committed to investing in retail businesses — always important when looking for a suitable buyer.

While numbers (anywhere from $26 to $37 per share) have been tossed around a lot since True Religion announced it was fielding offers, the big hangup for investors might actually be a little different, though: whether anyone is willing to take a chance on high-end denim.

Personally, I see a brand that is well-known and has a loyal following. If it can do for women’s wear what it’s done for  men — which I believe it can — global revenues of $1 billion within five to seven years isn’t out of the question. Plus, the company already has a pristine balance sheet.

On top of that, Fast Retailing’s acquisition of J Brand demonstrates that investors — whether strategic or financial — still see denim as an attractive category. Whether True Religion gets a deal done really depends on potential buyers being willing to open up their wallets.

Any offer for less than $35 a share (slightly below two times sales) should be rejected. Despite True Religion’s problems (what company doesn’t have them?), it still generates a reasonable amount of free cash flow. In fact, the reality is that True Religion doesn’t even need to sell. Its cash on hand combined with its free cash flow generation is sufficient to keep the lights on for many years.

But if the right suitor came calling with more than just money (like Advent), I’m pretty sure the special committee won’t have a problem recommending a sale.

Now, all we can do is sit back and wait.

*Full disclosure: My wife is a District Manager for True Religion in Canada. We don’t own any shares and have no plans of buying any in the foreseeable future.

Source URL: https://investorplace.com/2012/12/true-religion-waiting-for-mr-right/

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