Designer
IPO's
by Dale Wettlaufer
(TMF Ralegh)
ALEXANDRIA, VA (June 12, 1997) /FOOLWIRE/ -- To expand upon what Tom
said, Polo Ralph Lauren is a mature brand name and has run a stable business
over the years. While DONNA KARAN <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: DK)") else Response.Write("(NYSE: DK)") end if %> has not been run to generate
cash, Ralph Lauren generated gross cash flow of $134 million and free cash
flow of $99.3 million in the year ended March 31, 1997. Other money managers
have compared the offering to TOMMY HILFIGER <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: TOM)") else Response.Write("(NYSE: TOM)") end if %>, a hot designer
of the last few years, saying Polo was looking too rich in comparison. Through
nine months, Hilfiger is running better margins and is generating a good
deal of gross cash, but it's not generating the free cash flow that Polo
is. We'll also look at fiscal 1996 multiples for Donna Karan.
Annualized free cash flow (FCF) at Hilfiger was $54.9 million and gross cash
flow (GCF) was $105.4 million. Multiples on the two measures of cash flow
are as follows:
GCF FCF
Donna Karan 6.84 11.9
Polo Ralph Lauren 23.0 31.2
Tommy Hilfiger 15.8 30.3
*Hilfiger numbers annualized off nine-month financials. DK = FY1996
Based on the stronger measure by which one should value a company, the amount
of cash that can be pulled out of the business given neutrality in working
capital and financing, Polo and Tommy Hilfiger are similarly valued. However,
Polo grew revenues 15.7% last year while Hilfiger came close to tripling
that rate, having grown the topline just under 40%, through nine months of
1996. In its most recent quarter, revenue growth slowed slightly, to about
35%. Why, then, should Polo attract the same valuation when Hilfiger is growing
much faster?
Number one, besides the lesser capital expenditure needs of Polo, Hilfiger's
asset management needs are much different than Polo's. Year over year, Polo's
inventory investment was neutral, meaning that its net inventory did not
change, even though sales grew 15%. A company that can support greater sales
on the same amount of inventory is doing something right. However, to support
its rapid growth, Hilfiger had to increase inventories by 52%. That's cash
that could otherwise be going to marketing, other brand-enhancing measures,
or shareholders' benefit. The divergence between the two is not all that
encouraging, even given that one should understand that growing businesses
need to support sales growth with greater inventories. If you don't have
the items on the shelf, you're not going to make that sale. One wants to
see tight control of working capital as the quarters go by, though, especially
in apparel.
Secondly, mature, proven companies attract greater valuations because they
have shown ability to generate earnings and cash flow year after year. Every
wonder why price/earnings multiples on Russian equities are so low? A main
reason is that investors aren't totally confident that those companies will
be able to generate those earnings repeatedly. Same thing with Hilfiger --
not everyone is confident that fickle young consumers will be wearing Hilfiger
next year. Polo has proven itself to be an evergreen type of company, able
to generate growth over a long period of time.
Finally, Polo is able to spend much, much more on its marketing, even though
it might choose to slack off in that area, having built a good deal of brand
equity. In recent years, the company's sales, general, and administrative
(SG&A) expenses have fallen between 33% and 35% of sales, possibly a
touch more than the usual consumer branded business prototype of 25%. Hilfiger
has been devoting about 27% to 28% of revenues to SG&A expenses, about
what you'd like to see. That investment has been paying off, too, in the
company's growth rate. Nevertheless, Polo has a big advantage when it can
steer, say, half of its SG&A budget, amounting to $187 million, into
marketing and advertising versus Hilfiger's financial resources. With less
of a corporate infrastructure, say Hilfiger can spend 60% of its SG&A
on marketing and advertising. That amounts to $113, or 40% less than Polo.
Not only is the spending smaller in absolute dollars, but Polo is spending
to build upon already-strong brand equity while Hilfiger is still trying
to create brand awareness. Polo's advertising and marketing dollars are worth
more, then.
In all, Polo is going to attract the large-cap sort of valuations that other
proven consumer entities such as PROCTER & GAMBLE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PG)") else Response.Write("(NYSE: PG)") end if %> or
even something like KELLOGG CO. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: K)") else Response.Write("(NYSE: K)") end if %> garner. That's because there's
less risk in the proven brands and the proven financial performers. Considering
the greater safety, investors are willing to pay up for companies like Polo.
At the same multiple to free cash flow, Hilfiger might offer more growth,
but it also represents a higher risk. A company like Donna Karan, that has
proven lately only how good at losing money it is, and at how erratic their
earnings are, just isn't going to attract the multiples of these companies
until it can get things under control. At that point, the loosely efficient
market will do its thing.
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