Wednesday, October 07, 2009

Can Gisele Bundchen's 'Rampage' Save Iconix Brand Group?

Long known as the unlucky kid brother of fashion designer Kenneth Cole, critics have long alleged that Neil Cole, chief executive of Iconix Brand Group (ICON-$12.34), has a history of overpaying for acquisitions -- in his eagerness to add breadth to Iconix's portfolio of apparel, footwear, and household related-accessories. As the recession stumbles along, if licensees of Iconix's clothing and footwear brands, such as iconic names Joe Boxer, London Fog, and Candies, fail to deliver on mandated royalty streams, what will this mean to the company's financial health and growth prospects going forward?

Cole has built Iconix on a novel, licensing-only business model with guaranteed royalty streams from 15 direct-to-retailer distribution partnerships, with such well-known stores as Wal-Mart, Target, Sears, K-Mart, Kohl's, and Lowes. The attractiveness of this business model, says management, is that it shifts all the cost-risks of inventory, manufacturing, and distributing goods to the licensing partners, which pay Iconix guaranteed royalties of up to 10 percent.

To date, Neil Cole has proven his detractors wrong, as sales increased from $80.7 million in 2006 to $216.8 million in 2008, largely resulting from acquisitions and licensing deals. Nonetheless, this growth has not come cheaply. Cole has spent more than $800 million in the last three years acquiring trademarks of long-lived brands that had fallen on tough times -- with the goal of resuscitating their growth prospects through licensing arrangements and marketing campaigns with leading global retailers. Nonetheless, concerns still linger that Neil's entrepreneurial reach might exceed his managerial grasp.

Iconix's revenues are primarily dependent on the recurring royalty streams from its licensing agreements -- which in most cases provide for guaranteed, minimum payments from its retailing partners (up to $500 million under existing contracts). However, a substantial portion of revenue is concentrated with a limited number of retailers: Target, Wal-Mart, Kohl's, and K-Mart represent approximately 17 percent, 15 percent, seven percent, and five percent, respectively, of total revenue.

Not to rain on the company's successful picnic, but could nimbostratus storm clouds be forming on the horizon? Target's U.S. licenses for Mossimo, Fieldcrest, and Waverly Home-branded products expire in January 2012, July 2010, and January 2011, respectfully; license agreements with discount, retailing powerhouse Wal-Mart for Ocean Pacific and Danskin expire in June 2011 and December 2010; and, Candies and Joe Boxer-branded product categories trademark agreements with Kohl's expire in January 2011 and December 2010, according to a recent common stock prospectus. If these retailers fail to re-up, or negotiate new agreements at less-than favorable terms to Iconix, future revenue and cash flows could be adversely affected.

The real scorcher to Iconix's financial health, however, could be the material impact changes in the amount of goodwill and other intangible assets, including trademarks, would have on the company's growth prospects. Goodwill represents almost $152 million, or 11 percent of total assets, and trademarks and other intangibles account for approximately $1.06 billion, or about 76 percent of total assets! The 10Q Detective finds it troubling that despite uneven comparable store sales at the company's key customers in the last three years -- e.g. Joe Boxer-branded sales at K-Mart dropped sequentially from $19.4 million in 2006 to $10.8 million in 2008 -- the company did not believe any impairment write-downs of its brand names were warranted.
Could the fact that asset impairments often signal a weakening undertone of fundamentals -- and reinforce industry watchers possible uneasiness with baby brother Neil Cole's continued ability to lead -- explain the reluctance to move forward with this financial litmus test? That said, asset write-downs could decrease shareholder equity, increasing financial leverage, and borrowing costs of future debt.

A read of the company's regulatory filings with the SEC shows that debtors of $328.9 million in asset-backed loans hold liens on trademarks acquired in connection with the debt borrowings. Ergo, violations of debt covenants or debt default would enable the lenders to foreclose on valuable assets such as Mossimo, Candies, Bongo, Joe Boxer, Mudd, and London Fog. Luckily, this debt, however, does not come due until 2012.

Iconix anticipates five percent organic growth for fiscal 2009, although it said in a recent press release that underlying operations will not be strong enough to offset dilution from a recent $153 million stock offering and changes to licensing terms of its Rocawear women's lines. The industry trade group, National Retail Federation, is predicting the all-important holiday retail sales season will record its second consecutive decline this November - December, too, which suggests apparel and retail clients of Iconix are not out of the winter's woods just yet.

Editor David J Phillips does not hold a financial interest in any stocks mentioned n this article. The 10Q Detective has a Full Disclosure Policy.


Andre said...

Dear Mr. Phillips,

You are absolutely right with one exception, the business model is not that new. For example, Perry Ellis operates on licensing-only for years.

What makes Iconix even more vulnerable is direct-to-retail licensing. If Walmart drops Danskin, who would pick up the license?
Other retailers are not likely to license what is then a "Walmart Brand" or to even stock the goods for resale. And - without a chance to built retail distribution - no manufacturer will take the license either.

Direct-to-retail licensing means to put all eggs (manufacturing AND distribution) into one basket. If that basket is dropped, your brands are dead. And consequently have almost no value.

Rick said...

It is a chicken and egg scenario, you can't build a brand without distribution, you can't get distribution without a tested brand.

While the risks of DTR are clear, it is a far easier and on the whole less risky strategy in my opinion given the fact that inventory, and production risks are held on the side of the retailer.

However, the re-newal issue is a real concern but no doubt can be overcome with some strategic thinking.