This extensive portfolio makes Iconix one of the largest pure brand-management firms in existence. This is a compelling business model. Iconix's operations consist of acquiring brands, signing licensees that want to use the brands, coordinating and ensuring a brand image, and handling marketing for the brands. There are no manufacturing operations — manufacturing is done by licensees. This means Iconix has no inventory, extremely low capital requirements, and very little employee overhead. This leads to extreme profitability — the firm's five-year average operating margin is a lofty 67%, one of the highest I've ever seen! Also, most licensee agreements include minimum royalty stipulations, giving Iconix a near-certain baseline of revenue to plan around.
Consumer brands are durable, versatile assets. Most of them have indefinite useful lives. London Fog has been around over 80 years, Cannon for 113 years, and Danskin is over 126 years old! For many, the brand can be extended to multiple merchandise categories. Candie's, for example, is slapped onto shoes, jeans, purses, and even perfumes. Peanuts has over 1,100 licensees, ranging from the MetLife blimp to filmed entertainment to amusement park rides to clothing.
Iconix's primary external growth driver is going to be acquisition of additional brands. Most of the firm's portfolio has been acquired since 2004. Recently, the company expanded its ownership of Ed Hardy to 100%, from a previous 50% stake. Management has been very clear that the firm will continue to be acquisitive and is always on the lookout for new brands to acquire.
The other growth opportunity is international. The company has established operations in China, Latin America and Europe, where the primary focus is to take equity stakes in manufacturers in exchange for brand rights.
Iconix has been a successful growth company. Revenues have increased 400% since 2006 — a 35% compound annual growth rate. Operating profits have followed a similar growth track. Recent growth has also been strong, around 20% year-over-year growth in both revenues and profits. The question we have to look at going forward, however, is simple: Can these solid financial results continue, and will they translate into higher stock prices?
There are two primary risks here. The first is expiration of large licensee agreements. Three deals with Walmart (WMT) (Danskin, OP, and Starter) account for 21% of sales. The Ocean Pacific deal expired in June, and so far there has been no news of a renewal on it. Both Danskin (2012) and Starter (2013) have relatively near-term expiration dates. A similar situation exists with Target (TGT), which is about 7-10% of sales. The Waverly deal expired early this year with no renewal, and Mossimo's expiration is next year. Without licensees, Iconix' brands don't really have much value.
The second risk is the firm's capital structure. Buying brands requires financing, and Iconix carries over $640 million in debt. Even more concerning is that $287 million in convertible notes comes due next June. Since these notes have a conversion price of about $27.50 a share, and Iconix has a share price under $20, this could set up a big cash payment requirement that will stress the firm's cash reserves. I don't see it as a terminal event by any means, but it is an overhang that will handcuff management in seeking new brand purchases and could lead to increased debt or even equity dilution.
Speaking of dilution, that is another issue I have with this stock. The share count has increased a rapid 10.8% compound annually since 2006, eating about one-third of common shareholder's piece of the profit pie over those five years.
Finally, it should be pointed out that Magic Formula Investing (MFI) does not properly penalize firms that grow by expensive acquisitions. Iconix has about $1.6 billion in intangible assets on the balance sheet — that's about 84% of their entire asset base that is thrown out by the MFI method. As a result, Magic Formula return on capital looks good at nearly 60%. However, over the past five years, real post-tax returns on invested capital have been been just 7% — not much better than a high-yield bond. The stock also trades lower than it did five years ago.
In all, Iconix does look undervalued — the share price has certainly trailed growth in profits and cash flows. I believe a reasonable fair value on the stock is around $25. This leads me to put a "positive" rating on the stock, but it is not "top buy" material.
Steve owns no position in any stocks discussed in this article.