On its face, Naked Brand (NASDAQ:NAKD) stock seems like an intriguing retail play. The company has put together a stable of intimate brands, including owned brands Bendon and Naked, along with licenses to Frederick’s of Hollywood and products sold under the banner of supermodel Heidi Klum.
It’s a business model along the lines of Iconix Brand Group (NASDAQ:ICON), albeit in a smaller, more focused way. And it’s a model that had some success. Notably, the acquisition of the Frederick’s license led to a sharp increase in profit in fiscal 2017, according to the company’s U.S. Securities and Exchange Commission Form 20-F.
The problem at the moment, however, is that the model hasn’t worked. EBITDA (earnings before interest, taxes, depreciation and amortization) has turned sharply negative in recent years. That in turn has put significant pressure on the balance sheet. Naked Brand is running out of cash, and executing increasingly desperate financing transactions to keep itself alive.
With NAKD’s market capitalization now at roughly $4.8 million, investors have made clear their thoughts on the company’s viability. They’re not wrong: NAKD stock has a high probability of hitting zero.
The Financial Problem
The problem for NAKD stock right now is simple. Cash is running low, and the business is operating at a loss.
The exact cash position at the moment isn’t clear. As of July 2019, the company had approximately $1 million in cash. It raised another $14 million in the ensuing months.
But it’s likely that at least some of that cash was used to fund operating losses and restructuring costs. Meanwhile, debt remains a concern.
Borrowings were 26 million NZD as of July 31. According to the recent prospectus, the figure dropped to 17.4 million NZD ($12 million) on a pro forma basis, thanks to a series of transactions in which Naked issued shares in exchange for existing debt.
That doesn’t mean, however, that debt at the moment is just $12 million. Naked likely ran at a loss in the second half. EBITDA, including adjustments, was a loss of nearly 10 million NZD in the first half, even with help from cost cuts. It’s unlikely the company improved operations enough in the second half to reverse a similar loss in the second half of fiscal 2019.
The problem at this point is that the operating business needs to get back to profitability in a hurry. Recent promissory notes have been issued at a staggering 20% interest rate, compounded daily. As noted, Naked has issued shares to repay those loans. But with NAKD stock continuing to plunge, creditors aren’t going to be interested in stock going forward.
It’s a classic vicious cycle. It’s tough to see how Naked Brand gets out of it.
The Path Out
Indeed, management’s own plan looks dicey at the moment. In an amended 20-F filing this month, the company unsurprisingly disclosed a so-called “going concern” warning. That’s the same warning that hit shares of Chesapeake Energy (NYSE:CHK) in November.
Management’s plan requires more capital raises before Feb. 28, with the plan to raise an additional $15 million. Without selling something like two-thirds of the company, that level of financing seems close to impossible.
Naked announced on Tuesday that it is selling the trademarks to the Naked brand, but terms are undisclosed. If the deal is materially changing the company’s financial position, one assumes the company would disclose that fact. The lack of such disclosure, and the company’s own admission of thin U.S. revenue, suggests the cash coming in simply doesn’t change the story here all that much.
From an operating standpoint, Naked intends to get back to positive cash flow and improve gross margins. Both are at least possible. Management has said that the recent cash crunch has caused sales decreases, as the company couldn’t properly fund inventory. With that problem resolved, perhaps the operating business can get back in the green, raising enough confidence that the company can raise capital in the debt market.
The Bottom Line on NAKD Stock
That’s an awfully thin path, however. Performance needs to improve — and needs to improve almost immediately. If there was evidence of such improvement, it’s unlikely that Naked would be executing repeated, small, high-interest debt raises and then quickly funding them with equity sales.
The other roadblock is that the diversified brand model really hasn’t worked out that well anywhere. ICON stock is down over 99% in the past five years. Shares of Sequential Brands (NASDAQ:SQBG) too have collapsed. Centric Brands (NASDAQ:CTRC) soared on a seemingly transformative deal in 2018 — and has continued to fade ever since.
Even ignoring the financial difficulties, Naked doesn’t look like an exception to the performance in the sector. Add in those difficulties, and NAKD stock quite clearly is one to avoid.
As of this writing, Vince Martin has no positions in any securities mentioned.