*Disclosure: No position in ARO. I’m not interested in buying at current levels. This post may be a waste of your time.
After Julian Geiger left Aeropostale, his successor (Thomas Johnson) has managed to run the retailer into the ground. On August 18, Aeropostale announced that Geiger is returning. During Geiger’s previous reign, Aeropostale’s revenues went from $123.8M in 1997 to $1,886M in 2009.
Suppose that Geiger returns Aeropostale to its former glory several years from now. Geiger’s last full fiscal year at the company was 2009 (Geiger officially left in Jan 2010). In that fiscal year, Aeropostale posted GAAP net income for $149M. Suppose that Aeropostale makes $149M, achieves a P/E multiple of 15, and has 82M shares outstanding. The share price would be $27, roughly seven times the current share price of $3.87. Of course, there are risks and other possible outcomes. It is likely that Aeropostale will face the same secular headwinds affecting its peers ANF and AEO. The profitability of all three ‘teen titans’ may be significantly lower several years from now.
Turnarounds can fail
Geiger left Aeropostale to become the CEO of Crumbs. At the time, Crumbs was an unprofitable chain of cupcake stores. Currently, Crumbs is a bankrupt chain of cupcake stores. Given that Geiger failed at turning around Crumbs, it’s possible that he will also fail at Aeropostale.
Apparel retailers are facing headwinds
Aeropostale’s direct competitors ANF and AEO are also publicly traded. Both of these peers have been facing major headwinds in their business. Abercrombie’s CEO (the colorful Michael S. Jeffries) has been in place since Feb 1992. Abercrombie’s woes cannot be blamed on a CEO transition. There is some type of macroeconomic headwind going on.
There are different explanations for the headwinds:
- Teen retail is shifting towards the “fast fashion” concept.
- Highly promotional environment.
- Apparel retail is shifting towards online purchasing. (I’m not sure how this will play out.) For example, Abercrombie has seen its bricks and mortar sales drop while its online sales have increased. The net effect has decreased their profits, so this long-term trend is not good for them.
Both Abercrombie and Aeropostale have more or less saturated the US market. Historically, apparel retailers no longer experience wonderful economics once they saturate their domestic market. New concepts and international expansions often fail.
I’m not smart enough to figure out how much these headwinds will hurt Aeropostale. I think the end game is a shift to a mix of offline and online shopping. I think that online distribution will enable an explosion of competing brands that will dilute the market share of the titans of teen apparel (AEO, ANF, ARO). These titans will see some market share decline due to the shift towards online shopping. Eventually the industry will stabilize at some level of online and offline shopping. I could be wrong about all of this.
The cash burn at Aeropostale is significant. In the trailing twelve months ended April 2014, ARO burned through $128M in cash. The cash burn may increase a little if management aggressively closes stores. (I believe this would be the right thing to do.) Aeropostale will have to spend cash on exiting leases and on severance payments for ex-employees. I also believe that Aeropostale has bloated overhead. It will incur more costs from firing employees and cutting down on office space.
Because management has been very slow in closing down PS from Aeropostale stores (its money-losing concept for kids’ clothing), the full impact of one-time costs will be coming. Johnson has stated that Aeropostale will close 125 of its existing 150 PS from Aeropostale stores. In the past, it was unclear whether or not this concept was profitable because management never disclosed its profitability (or that of JimmyZ, another concept Aeropostale was developing). I suspect that PS from Aeropostale was never profitable and that eventually all of the PS from Aeropostale stores will be closed. What happened to JimmyZ will happen to PS. I expect to see many one-time “restructuring” costs at Aeropostale.
Sycamore will backstop Aeropostale
Aeropostale has a $230M credit facility. It is in the process of closing a deal with the private equity firm Sycamore Partners for an additional $150M in liquidity (the deal was originally made in March of this year).
The terms of the various credit facilities matter because it affects how much of these credit facilities can be drawn. I haven’t done that much research into the details. However, I think that Sycamore understands Aeropostale’s precarious financial position and is there to backstop the company. The financing has a high cost:
- High interest rates
- Aeropostale has to direct business to a company owned by Sycamore
- Effectively Sycamore will own warrants on 5% of ARO shares.
I believe that the $150M from Sycamore comes with few restrictions; the $230M bank facility should be more restrictive. All in all I believe that Aeropostale will have enough liquidity to orchestrate a turnaround.
Is there value in Aeropostale?
Aeropostale currently has a highly profitable licensing business. In YE2013, the licensing segment generated $21.472M in revenue and $20.035M in operating income (90%+ margins). At YE2013 there were 96 stores licensed internationally, so the average revenue per store is around $224 thousand. I haven’t figured out how the licensees make money given that the licensing fees are rather high and Aeropostale’s expenses so low. Aeropostale’s own stores generate around $2M/year in revenue. If licensed stores have similar revenues, then the licensing fees account for more than a tenth of their revenue. It may be difficult to make money given such a high expense. Despite this, licensing has been growing rapidly and continues to grow. On the latest earnings call, management stated that they expect to open 50 more licensed stores by the year’s end.
The licensing business suggests that there is a lot of value in Aeropostale’s brand (and other intellectual property) given what other people are willing to pay in licensing fees.
On a standalone basis, the licensing business itself could be worth a lot. Multplying $20M in operating income by 10 gives a value of $200M. Aeropostale has a book value of around $200M without licensing assets and a market cap of around $304M. (But… the numbers don’t make sense to me. How are their licensees able to make money???)
I find this stock incredibly difficult to value. The major factors are:
- What the macro environment will be for these retailers, which I’m not smart enough to figure out.
- What earnings will be several years from now.
- The chance that Geiger succeeds in turning the company around.
Suppose that Aeropostale is potentially a $15 stock in 5 years, there is a 50% chance of the stock going to 0, and that an appropriate discount rate is 15%. The present value would be roughly $3.75, which is below the current trading price of $3.91. Using less conservative assumptions, the present value would be much higher. Lowering the chance of bankruptcy to 30% raises the present value to $5.25.
Because this is too hard for me to value, I’ll probably stay away from this stock. But there is a degenerate part of me that might buy some stock near the 52-week lows (slightly above $3.10).
EDIT (10/8/2014): Bought a small position slightly below $3.
EDIT (12/3/2014): I sold my ARO a while back. I don’t think that Aeropostale is on track for a turnaround. The company continues to discount heavily in the clearance section on its website. For example, there is a logoless T-Shirt marked down from $19.50 to $2.99. This is rather extreme. It seems that the cost structure remains too high as the company continues to use real estate consultants, which suggests other excess at the company.
Retail and reversion to the mean – In this old blog post, I briefly mentioned that ARO was a stock that I thought about shorting. When I wrote the post on May 25, 2013, ARO was trading around $14.76 versus the current price of $3.91. Unfortunately I did not short ARO. I put in a limit order at an extreme price; it never filled.
My theory about the CEO being the important factor in retail has mostly worked out. I was wrong about CROX (long and short). I was right about going long TJX, ROST and right about shorting PSUN, JCP, and COH. I shorted BBY (profitably), TTS (profitably), RH (unprofitably), and GME (unprofitably) for non-management reasons.