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ICON Is a Growth Story at a Steep Discount to Fair Value

April 26, 2012 | About:

Chandan Dubey

91 followers
1 The Company

Iconix (ICON) is a simple business. It manages brands. It licenses them to manufacturers and retailers primarily in the apparel and footwear industry. Its brands can be found in JCPenney, KMart, Kohl’s, Sears, Target, etc. A brief history of the company put together with the help of Wikipedia.

No of shares: 75 million

Share price: $14.65 (April 26, 2012)

Market cap: $1.1 billion

Net debt: $433 million

EV: $1.5 billion

FCF: $176 million

EPS: $1.72 (for year 2011)

Ticker: ICON (ICON)

1.1 History

1993 The company began as Candie’s Inc., whose brand it purchased in 1993.

1998 Bongo brand was purchased.

2004 Purchased Badgley Mischka.

2005 Purchased Joe Boxer and Rampage.

2006 Purchased Mudd, London Fog, Mossimo, Ocean Pacific.

2007 Purchased Danskin, Rocawear and Starter from Nike.

2009 Acquired 50% of Marc Ecko Enterprise.

1.2 The Brands

The only brand of the company I know of is Peanuts (the comic strip) which it acquired in partnership with Charles Schulz Associates. Iconix holds 80% of this brand and Schulz owns 20%. Now to think of it, I have also heard of the brand Mossimo, but have never bought anything. In the defense of the company though, it sells mostly in the U.S. and I am in Europe. I will be happy to hear comments from people in the U.S. if they have heard of the brands and how famous they are.



1.3 Business Model

Iconix manages a diversified portfolio of brands with annual global sales of over $12 billion. In a traditional company like say Gap, the company itself designs, manufactures, distributes, retails, advertises, and decides which way the brand will go. Iconix splits these jobs into two parts. It is responsible for advertising, marketing and deciding the trend direction for the brand. It makes money by licensing the brands to companies that do all the legwork, like designing, manufacturing, distributing, warehousing, retailing etc.

This cuts out a lot of risk from the business. The company has no inventory, no operational risk, minimal working capital, and small capital expenditure. Most of the cash that the company generates by licensing deals goes to the free cash flow. The company as you will see spews copious amounts of cash and has a very asset light model. This is one of the best businesses I have seen in a while.

2 Management

The CEO Neil Cole has been on the job since 1993. This was the same year when the company had its IPO. Neil Cole has been instrumental in transforming the company from a manufacturing company to a brand management company. The CEO also owns nearly 4% of the stock.

2.1 Compensation

In 2010, each non-employee member of the board received a cash payment of $50,000 and RSUs of common stocks with fair market value of $100,000. In my opinion the board of directors is not overpaid.

The management generally is another story. But with Iconix, the compensation is not too outrageous. The fact I like is that the management is paid in common stocks and RSUs and not options. This is a good thing in my book as the management gets to have the same performance as the shareholders on the stocks he gets.



2.2 Insider ownership

As I said earlier, 4% of the company is owned by the CEO Neil Cole. The rest of the management owns 1% more.

There is also not so significant institutional holding.Baron Capital owns 5.2%, Black Rock wowns 7.5%, Luxor Capital owns 8.5% and Dimensional Funds holds another 5.2% of the shares.

The figures for the stock ownership have been taken from the annual report of 2011.

3 Operating summary

The company has performed phenomenally. The asset light model and the copious cash it produces has resulted in an enviable performance.







The company follows a growth by acquisition strategy and it is paramount to determine if the are overpaying for the brands they acquire. For this we will look at the RoIC.

Item20042005200620072008200920102011
RoIC0.5212.957.856.865.595.276.197.32


The RoIC is not great. On an average the company has managed to eke out a 6% return on the invested capital. This means it might be overpaying for the brands it acquires.

A closer look of the acquisition history gives a better clue. Since 2005, the company has put in $1.5b in new brands and have so far recouped only $1.2b on them. This is an average performance and not great.



The company as expected from the business model has a very high net margin. The company has also been able to retain a significant amount of earnings and reinvest in the growth. The result can be seen. The income has grown at a very satisfying pace and he revenue growth too has not disappointed.

in $m200320042005200620072008200920102011
Net Income-3.95-1115.9432.563.77075.1198.85126.11
Revenue157131.3830.1680.7160216.76232332.56369.85
Net Margin-2.52%-8.63%52.87%40.28%39.85%32.36%32.37%29.72%34.10%
Retained earnings-40-51.5-35.2-2.8161131195294420
RE Growth %-11-28.231.43922265115495042.8


4 Financial Summary

4.1 Current situation

Let us as a warm up look at the current figures from the annual report of 2011. It is hard to gauge what the trademarks are worth. The company also has $311m in debt and is quite manageable. With nearly $182m in cash, I am not too worried about it.

Items in $kDec 31, 2011Dec 31, 2010
Cash181,788121,935
Current assets284,505225,866
Trademarks and Intang.1,550,9961,400,550
Goodwill223,269192,780
Total assets2,161,3031,951,470
Current liability362,78399,960
Income tax liab174,238138,577
LT debt310,966548,007
Total liability867,727812,556
Equity1,293,5761,138,914


The FCF of the company is bordering on nearly $200m and the net income is around $126m. With $50.7m in interest expense, the interest coverage ratio is around 2.5 and is not very comfortable. I would have liked to see something in the range of 4 or 5.

Item ($k)Dec 31, 2011Dec 31, 2010
Interest expense50,75443,155


4.2 Historical developments

The company has been able to increase its cash on hand, year after year. The book value has also increased at a satisfying rate. This although is not very informative as most of the book value is in intangibles.

Items in $m200320042005200620072008200920102011
Cash1.92.812785367202122182
Current Assets51.8262210096130281226285
Total Assets103752177011,3401,4201,8001,9502,161
Current Liabilities4631273676103133100363
Total Liabilities7456116236808807893915972
Stockholder' Equity29191014655286149091,0401,190
Current Ratio1.130.830.842.801.251.262.122.260.78
TL-to-TA0.720.750.540.340.600.570.500.470.45


The net debt has come down with respect to the earning of the company, which is good news. The management clearly is on the right track and sees the need to reduce the debt load of the company. Given the copious FCF, the company will be able to easily pay-off the debt.



5 Shares

The share count of the company has crept up quite a bit since 2002. But the book value per share has also gone up from $1.23 per share in 2003 to $15.25 in 2011.

2002200320042005200620072008200920102011
Shares (in M)19.6523.6825.1834.7745.2761.4361.2568.3374.7175.50


The company is now trying to reduce the share count by share repurchases. It has authorised $200 million for share repurchases on Oct. 27, 2011. As of Feb. 2012, $29 million worth of stock (1.7m at average price of $16.86) has been purchased. Given that I am quite bullish on the stock, the share repurchase at the moment is going to give the shareholders a tremendous value. The company is cheap and now is the best time to buy shares.

6 Risks

Major risks with the business model are but a few, given that the company has no operations. The two risks I see are as follows.

The company does not design or manufacture the clothes/apparel for its brands. They do not do the quality checking and hence errors from the manufacturers can result in loss of goodwill for brands.

The brands are but a fickle business. Missteps can be very dear indeed. Given that I am not aware of many of the brands, I can not put a price on them. But significant competitions from other brands can lead to loss in sales and impairment of goodwill.

7 Valuation

The company is quite cheap. The company is selling for EV/FCF of around 9 and P/FCF of around 7. With stable cash flow I think the DCF model is the best here and currently the market has a messed up expectation with the stock. The current price means that the market is expecting shrinking FCF. This clearly is a mistake from the information we have so far.

8 Additional disclosure

I am waiting for the market to drag the price of the stock by 10% more. In the first quarter report the company made a weak forecast and the shares dived yesterday by nearly 14%. I feel that the in the near term the company may be dragged down a bit more and I should wait for the pullback to start a position. The company is cheap and it is possible that I may buy around these prices if the situation stabilizes.

About the author:

Chandan Dubey
I invest because I want to be free by the time I reach 40 years of age i.e., 2025. My investment style is to find a small number of bets with large margins of safety. I pay a lot of attention to management and their incentive. Ideally, I like to buy owner operator businesses. I am fortunate to have a strong inclination towards studying. I aid my financial understanding by extensive reading in psychology, economic, social sciences etc.

Rating: 4.0/5 (35 votes)

Comments

pravchaw
Pravchaw premium member - 1 year ago
Great article Chandan. Apart from return on equity which is a lower than what I like this is a good price for the stock. But acquring the company at a discount to book value should resolve that issue.

However, one thing which worries me is that the value of the brands will erode over time. Is the company investing in the brands to enhance its value? What is to prevent the licensee to put brands on low quality products?

Another issue is that company issues a lot of equity (probably to fund acquisition). The number of shares have tripled from 2002 to 2012.
cdubey
Cdubey premium member - 1 year ago
Both are valid points, and something I looked into. The dilution is a bit of a worry but given that the management is not using it to fund their compensation (the compensation practice I like), the money is going into increasing the value of the company. The management has also started buying back shares and if they are running it now, they are getting a good deal for the money.

The company does invest in its brands. There is a great presentation on their website about it. I have to look how the company does the quality check on the stuff the licensees put the brands on. I will get back to you about it.

The shares are creeping up, which is a bit sad for me. I want it to get a bit cheaper to build a good stake.
Dr. Paul Price
Dr. Paul Price premium member - 1 year ago


Chandan,

Your error was in not taking at least a partial position in shares you determined were already cheap. Buy some immediately and more later if the downtrend continued.

Wanting something to go lower doesn't mean it will happen.

See my earlier article on ICON from when it was in the $12's.

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