Aeropostale: Dark Matter in the Teenage Retail Space?

Company

Aeropostale (ARO, Financial) is a teen retailer. From its latest 10-Q: “As of November 2, 2013, [the company] operated 976 Aéropostale stores, consisting of 897 stores in [USA], 79 stores in Canada, as well as 148 ‘P.S. from Aéropostale’ stores in [USA]. In addition, our licensees operated 88 Aéropostale locations and one Aéropostale and P.S. from Aéropostale combination location in the Middle East, Asia, Europe and Latin America.”

Thesis

ARO has had multiple missteps in recent years —Â most notably declining sales, poor merchandising and overexpansion. The brand image has suffered from heavy discounting and I believe both investor and consumer sentiment have bottomed. Recent events suggest that ARO has finally launched an effective marketing campaign and is connecting with its target demographic.

Meet Bethany Mota, the Millennial Martha Stewart?

On Dec. 8, 2013, ARO launched the Bethany Mota winter collection. Who is Bethany Mota? OMG, she’s the teenage sensation YouTuber with 5.4 million besties (subscribers) — duh!Â

To give some background, five years ago, Bethany, now 18, uploaded her first YouTube video. She was an everyday teenager who was depressed from being bullied and made a video to escape her worries. She reviewed cosmetics in that first video. Since then, she has created hundreds of videos and amassed a loyal following. Her viewers idolize her and parents will have no problem supporting their enthusiasm. Her personality is humble, sincere, genuine, and warm. She is the anti-Miley Cyrus. The videos are light-hearted and range from DIY projects like how to make a Starbucks’ cotton candy frappuccino or a McDonald’s shamrock shake or how to make homemade Halloween costumes. But her bread and butter is fashion. She goes on “shopping hauls” and then reviews all of the “cute” stuff purchased from the mall. As you might guess, her core fan base consists of girls from 10 to 17.

Recently, ARO launched her spring collection on Feb. 2, 2014, and Bethany went on the “Motavatour” bus tour that visited nine cities in 14 days. I’ve been tracking social media closely since that time and her reception is mind-boggling. ARO announced the tour stops with only two days' notice for each stop and yet YouTube videos show packed malls in the nine cities where people wait  to 6 hours to see her. There’s evidence that some people waited for 12 hours. In one YouTube video, a group of girls drives four hours to wait five hours, and that doesn’t seem to be atypical. If you want to see firsthand, go to YouTube, search “meeting Bethany Mota,” and filter on date within "last month." Not only will you see the lines but you’ll see how much her fans idolize her.

CAUTION: You may lose your sanity from listening to obsessed teenagers and gratuitous high pitched squealing. But if you’re a glutton for punishment, I’ll give you a pretty mellow example.

Â

A safer research method is to search Twitter, but Twitter doesn’t put the crowd sizes or fervor in perspective. Another worthwhile search is to search YouTube for “Bethany Mota Collection Haul.” You’ll get numerous videos of fans who have purchased multiple items from Bethany’s clothing line which is money in ARO’s cash registers that hasn’t been reported on yet. At last count, there were over 200 videos of girls who had gone on a “Bethany Mota Collection Haul.”

Update Feb. 16: As luck would have it, the Motavator tour’s last stop was today in my hometown of San Jose, Calif., and I was able to see for myself — w00t!! w00t! Oh yeah! That’s right. I got to breathe the same Cinnabon-scented, mall air as Bethany Freakin’ Mota.

My firsthand experience today re-confirms the accounts on YouTube, Twitter, Pinterest, etc. Bethany’s meetup was from 10 a.m. to 12 p.m. I showed up at 9 a.m. guessing that peak lines would be around this time. When I arrived, the line started from ARO which was in the middle of the mall and extended outside to fill a third of a parking structure level. Bethany draws thousands of fans per appearance. I filmed the line by placing my cellphone to my ear. I pretended to be on the phone so I didn’t look like a creepy old guy filming a bunch of pre-teenage girls. It took me about six minutes to film the beginning of the line to the end and I think it kept growing after I left. That’s about a fifth of a mile!

The Bethany Mota madness is real. As I exited to the parking lot, I was almost trampled by a pack of Mota-vated midgets who mistakenly thought Bethany was still in the bus. Girls dashed in front of moving cars with total disregard. One jokester dad screamed, “Look, there she is!” and preadolescents momentarily squealed and circled frantically like confused chickens.

Although this video is a little dated, it’s the best example of the hysteria.

Â

Bethany is a game changer. She has that “it” factor. From a corporate endorsement perspective, there’s much less risk than with athletes, actors or musicians. Athletes have injury and performance risk and eventually retire. Actors/musicians fall out of favor. Bethany can age with her fans like Oprah and Martha Stewart. I have to think she’s down-to-earth and intelligent enough to avoid insider trading too.

Her besties relate to her because she is one of them and they live vicariously through her. To promote her Motavator tour, she’s been on the Today Show, The View, Entertainment Tonight and Ryan Seacrest, and her fame is bound to grow. Her reach is international. A review of Google trends reveals that Singapore googled her the most, followed by Canada, U.S., Philippines, Australia, UK, and the Netherlands. You can search YouTube for “Bethany Mota Hong Kong Meetup” to see an example. Amazingly, teenage shrieking sounds identical in Cantonese as it does in English and Spanish. At minimum, Bethany represents the future of corporate social media interaction.

ARO won’t disclose the terms of Bethany’s deal but one would have to assume her contract is much less expensive than teaming with someone like Beyonce or Katy Perry or ... Miley Cyrus. Management should get a smiley face for developing a cost-effective and creative marketing campaign.

Another item to note. On the latest conference call, management revealed that the Bethany winter collection took three months to develop from concept to store release. It shows their ability to react quickly to developing trends.

ARO’s Other Marketing Moves

ARO’s second initiative has been the Pretty Little Liars collection based on the ABC family TV show. It’s the first series in TV history to amass over 1 million total airtime tweets. The PLL collection launched on Jan. 6, 2014. My Twitter searches have also shown positive feedback although I get much less quantifiable data than from the Bethany Mota material.

For its PS stores aimed at the four to 10 crowd, ARO has launched the “Epic Kids” campaign where kids like Kaelyn Whalen, a precocious martial artist, and Autumn de Forest, a prodigy artist, are featured. Kaelyn is incredible with her swordplay and karate chopping. Autumn has already sold a painting worth $250,000. Her painting “New Dripping Life” is amazing. You can see it here.

On the PS website, there’s a Twitter feed where parents submit pictures of their “Epic Kids” wearing PS clothes. The campaign is brilliant because every parent thinks their kid is epic. These latest promotions demonstrate that ARO is a company getting its act together. It’s connecting with its customers emotionally and an optimist might say it’s developing something extremely difficult in the youth fashion industry —Â stickiness.

Can We Quantify ARO’s Latest Marketing Campaigns?

• ARO is a more than $2.2 billion (TTM) a year company that’s been trending the wrong way. Will its most recent marketing campaigns move the needle? Given that total net sales declined 15% year over year for the last quarter, I’m optimistic that the newest initiatives will start the mending.
• Even if Bethany visits nine states and draws 1,000 people per stop, it’s not going to move the dial much. What makes me optimistic is that her fans are only getting about two days' notice on where she’ll show up. This is because ARO tweets hints and her fans guess the next city. ARO’s website, Twitter, and word of mouth are the only forms of advertisement. That speaks to her drawing power. The people who show up are going to tell their friends or tweet about it. People who don’t know her but happen to be at the mall when she arrives will inquire. Local news stations are running stories. The fans that can’t make it will visit ARO’s website.

Let’s try a thought experiment:

• I checked one of Bethany’s non-Aeropostale YouTube videos from three days ago and it has approximately 1.5 million views. You can do the same exercise with Pretty Little Liars which I’m guessing gets approximately 2 million viewers per show based on Nielsen ratings. That’s without Hulu views.
• So let’s SWAG incremental sales for first quarter 2014.
• Scenarios below:

• Timing is very important. ARO’s fourth quarter 2013 ends on Feb. 2, 2014, the same day that the Bethany Mota Spring Collection launched. So the above numbers won’t be reflected in the fourth quarter but rather first quarter 2014.
• On Feb. 13, 2014, BMO Capital Markets downgraded ARO citing expectation of weak fourth quarter 2013. The stock dropped approximately 4% to $6.16 per share which is just about the 52-week low. Current book value is $4.43.
• The street is expecting a loss of 30 cents per share and ARO has forecast a loss of 24 cents per share for fourth quarter 2013. I don’t have a good feel for if the Bethany Winter Collection and the PLL collection were able to move the dial for fourth quarter 2013. I didn’t start seriously paying attention to this stock until Feb. 4.
• Average analyst estimates for first quarter 2014 is a loss of 17 cents per share.
• The most likely scenarios for the fourth quarter 2013 earnings release on March 13, 2014 are:

1. Management misses targets and decides to dump all of the bad news into fourth quarter 2013 so they can have a blowout first quarter 2014. Depending on the magnitude of the miss, most likely result may be further decline in the stock or price stays steady given that it’s already at 52-week lows. Note there’s a 39% short interest on this stock which may help provide a floor.
2. It reports in line with expectations and gives strong guidance for first quarter 2014. The stock would then have a rally depending on the strength of the guidance.
3. Fourth quarter 2013 exceeds expectations and it gives strong guidance. In this case, the stock should pop significantly given the 39% short interest.

• My scenarios assume that it doesn’t lose customers from last year and the table above is incremental. I didn’t SWAG incremental revenue from any other form of advertising (radio, Internet banner ads, Epic Kids, etc.).
• All of my scenarios represent a vast improvement over last quarter’s -15% decline in net sales.
• At minimum, ARO’s image is getting a badly needed boost laying the groundwork for future sales. Or as one teenage tweeter puts it:
  • kitten ” Feb 8 [2014] -Ugh I hate myself for saying this but Aeropostale is making a comeback with the Pretty Little Liars line and Bethany Mota's line.

Management

The bad news. There’s a reason ARO has tanked in recent years and unfortunately management has a lot to do with it. Former CEO Julian Geiger stepped down in early 2010 and the results since haven’t been pretty. Immediately after Geiger’s retirement, a co-CEO situation was in place until December 2010 before current CEO Thomas Johnson assumed full control. If you look at the GuruFocus “10-Y Financials” tab for ARO, you will see that metrics such as EPS, ROE %, GM%, etc. all slump markedly after fiscal year 2010.

However, this is the teen fashion industry and merchandising must me be spot-on for retailers to be successful. During the early Johnson tenure, it appears that they went back to their “roots” and carried a lot of logoed inventory which did not resonate well with their customers. This caused the company to discount heavily to clear excess inventory. I’m hopeful that they’ve finally gotten the message and have shifted gears to carry less logoed attire and to focus more on fashion items.

Risks

• Gross margin for fourth quarter 2012 was 19.8%. The last two quarters GM was at 18% and 17%. Weak fourth quarter 2013 margins given the tough Christmas environment and continued asset impairment charges.
• About $200,000 per store of asset impairment charges for YTD fiscal year 2013. ARO expects to close approximately 175 stores in the next few years, so gross margins will be impacted throughout the store closings.
• Cold weather (polar vortex) may actually have had an effect on sales and it would be a legitimate reason for fourth quarter 2013 and first quarter 2014
• ARO’s brand takes longer to heal than anticipated because the teen fashion industry has the most fickle consumers.
• The Bethany Mota phenomenon is a done and done deal.
• Reading through the recent SEC filings shows management has made some shareholder unfriendly moves like a poison pill. There are PIPE rumors too so possible share dilution.

Bull, Base, Bear Valuations

• Diluted EPS from fiscal year 2004 to fiscal year 2012 has ranged from $0.42 to $2.49.
• Average analyst estimates project losses for fiscal year 2013 at $1.10.
• Tangible book is currently approximately $4.
• Since the bleeding in earnings hasn’t stopped yet let’s look at how ARO stacks up to its peers via P/TB. From GuruFocus:

• Bull – In the late '90’s, I owned Fila Holdings, a Nike competitor, which was a 6 bagger because it endorsed Grant Hill. Unfortunately, he got injured and that stock dropped. I think Bethany has a chance to be like Grant and become the face of a company badly in need of an image makeover. I’m not implying ARO will be a 6 bagger but it shows that one endorser can change the fortunes of an entire company. If we average out the diluted EPS of the last 10 years plus the anticipated loss of $1.10 for fiscal year 2013 then I get an 11-year historical average of $0.93 diluted EPS. Assuming ARO can bring earnings back in line with history in fiscal year 2015 and we use a 15 multiple, we would get a share price of $13.88.
• Base – If we average out the diluted EPS of the last 10 years plus the anticipated loss of $1.10 for fiscal year 13 and a fiscal year 2014 loss of 65 cents for next year then I get a 12-year historical average of $0.79 diluted EPS. Assuming ARO brings earnings back to historical norms in fiscal 2015 and we use a 15 multiple we would get $11.91.
• Bear – ARO isn’t able to bring earnings back to historical profitability, dilution occurs, and 30 cent EPS becomes the new normal. A multiple of 15 would give a $4.50 share price.

Catalysts

• Positive revenue/earnings surprises in the next two quarters and beyond
• Easy comparisons to last year. Bar is set extremely low right now.
• Short squeeze (39% of shares are short).
• Activist investors and a management with a sense of urgency to show results.
• New strategic initiatives gain traction.
• $104.4 million remaining for authorized stock re-purchase plan.
• Appealing risk/reward ratio given low P/B ratio and no debt.

Conclusion

If we use numbers and attempt to rationalize the fourth quarter 2013 and first quarter 2014 scenarios conservatively, one may derive some pedestrian results, but this is one of those situations where the upside from the “We don’t know what we don’t know” factor could be huge.

The hysteria surrounding Bethany is not rational and the contrarian play would be to hypothesize that in the years to come, there’s an invisible dark matter in the teenage universe that compels countless preadolescents to annoy the crap out of their parents until they get ARO attire. Thousands of parents from nine states in the last 14 days can testify. If that’s the case, then ARO may exceed my most bullish estimates.

Disclosure: Long ARO