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Over the past decade, PVH Corp. has completed a series of acquisitions that has transformed the previously staid supplier of Van Heusen dress shirts and Izod sportswear into one of the largest and most dynamic apparel marketers on the global stage. It purchased Calvin Klein in 2003, the neckwear manufacturer Superba in 2006 and Tommy Hilfiger in 2010. Three months ago, PVH made waves again when it revealed its purchase of Warnaco Group Inc. for $2.9 billion.
The quartet of acquisitions over the past decade has swelled PVH’s top-line revenue from $1.55 billion in 2003 to about $6 billion in 2012, a 16 percent compound annual growth rate, or CAGR. Earnings per share in the 10-year period have grown from 98 cents to $6.38 (a 23 percent CAGR), while the stock price is up from about $12 a decade ago to $117.83 on Tuesday.
While PVH may have made its aggressive acquisition strategy look like a surefire winner in hindsight, Wall Street often took a pessimistic view on the deals — until PVH proved the naysayers wrong.
“M&A is very hard. There’s a reason that 60 to 70 percent of deals do not deliver what the expectations are. Acquisitions, even small acquisitions, create tremendous disruptions and uncertainty in the entire company,” said Emanuel Chirico, chairman and chief executive officer of PVH, in a presentation outlining the potential upsides and pitfalls of acquisitions. “If you don’t manage that uncertainty and if you don’t manage that disruption, you really have issues.”
Studies from consulting firms like McKinsey & Co., Bain & Co. and Boston Consulting Group have proven the majority of mergers and acquisitions fail to boost shareholder value. Yet, due to the growth demands of investors and markets, companies are persistently faced with the imperative to buy and sell brands and companies.
“No matter how strong a brand is, one day sooner or later a brand is going to face sustainable growth issues. Trees don’t grow to the sky and there is a limit to how big a brand can become,” said Chirico of the need to find avenues of nonorganic growth. “At some point, if you are just driving for growth, you do something to damage the brand.”
It’s no surprise then that leading apparel makers including VF Corp., The Jones Group Inc., Oxford Industries Inc. and G-III Apparel Group Ltd. have sought growth through acquisitions in recent years — even though Chirico pointed out that monobrand firms tend to garner higher valuations than portfolio companies, due to the latter’s greater complexities to investors.
PVH’s Warnaco deal was the only acquisition applauded by investors right off the bat, with PVH stock soaring $20 on the day the deal was unveiled last fall. The deal was a major positive to Wall Street because it solidified PVH’s control of the Calvin Klein brand, bringing into its fold Warnaco’s owned Calvin Klein underwear business and its licensed Calvin Klein jeans businesses.
Once the transaction is finalized next month, the combined companies will have more than $8 billion in pro forma sales and more than $1 billion in pro forma earnings before interest and taxes. The new company is among the largest apparel companies in the world and the second largest in the U.S., putting it behind VF Corp.’s $10.96 billion in 2012 revenue and $1.5 billion in EBIT.
The deal also adds Warnaco’s robust operating platforms in Asia and Latin America to PVH’s regions of strength in North America and Europe. Following the deal, PVH’s Asia and Latin America revenues will increase from 7 percent of total company revenue to 15 percent, while EBIT from those markets will increase from 13 percent to 21 percent. “It’s a compelling story and makes a whole lot of sense,” said Chirico.
In fact, investors have been rooting for the Warnaco deal for years — and were surprised when PVH decided to acquire Tommy Hilfiger in 2010, rather than Warnaco. “No one really understood in the market the strength of the Tommy international business, from a brand or business point of view,” said Chirico. “Our investor base tends to be North American-centric.”
The $3.1 billion Tommy Hilfiger purchase from private equity firm Apax Partners was highly leveraged, with PVH taking on $2 billion in new debt. At the time, Hilfiger had total revenues of $2.5 billion and operating income of $280 million.
Crucially, PVH persuaded Tommy Hilfiger’s senior management to stay on with the company and retain a big percentage of their proceeds from the sale of the company within PVH stock. “As with many private equity transactions, they owned a chunk of the equity of the company. They were all going to be walking away with a couple hundred million dollars, so you instantly made the guys who delivered the business wealthy,” explained Chirico. “But we were able to convince them that there was a next upside to this transaction, so they took back 40 percent of their proceeds in stock and agreed to hold it for a three-year period. It helped us sell the transaction to Wall Street at the time.”
The financial fruits of the Hilfiger deal have been sweet for PVH, with sales and earnings outpacing projections. The brand’s 2012 revenues hit $3.1 billion and operating income was about $400 million, with EPS growing 31 percent between 2009 and 2012. PVH has been able to de-lever its debt position, paying off $1 billion over the past three years.
Chirico dubbed PVH’s acquisition of Superba neckwear for $105 million as a bolt-on acquisition, noting that the neckwear business was a symbiotic fit with its heritage dress shirt business — which includes the owned Van Heusen and Arrow brands along with a slew of licensed brands like John Varvatos, Nautica, Michael Michael Kors, Kenneth Cole New York, Joe Joseph Abboud, Geoffrey Beene and Sean John.
“This business was so synergistic to the dress shirt business we operate, they sit so nicely next to each other,” said Chirico. Still, the market reaction to the deal was almost nil as it shrugged it off for a category seen in decline. “It wasn’t even negative. It was a nonevent.”
PVH ended up delivering revenue synergies of over $100 million by moving its own brands onto the Superba neckwear platform and recruiting brands from Superba’s stable of licenses to sign onto its own dress shirt platform. The deal significantly exceeded financial targets and the PVH neckwear unit now generates sales of $200 million with operating income of $30 million and has been “exceedingly” accretive to earnings.
In reference to the Superba deal, Chirico made note of earn-out clauses that are common in purchases of private companies. “Dealing with management earn-outs, there are always issues. It’s a great incentive, but at the same token you get into discussions about, ‘Well, you’re spending another $4 million in marketing and we would never have done that,’” he noted. To avoid those types of conflicts, Chirico recommended tying the compensation to publicly reported earnings as opposed to internal measures.
The Calvin Klein acquisition 10 years ago was a transformational transaction for PVH, setting it on the course the company is on today — but analysts were initially bearish on the deal. “We were a $1.5 billion company, doing less than a dollar EPS and our market cap was about $300 million,” recalled Chirico of the company in 2003, when he was chief financial officer. “We recognized we had some solid national brands that really didn’t have international appeal. Our growth was limited based on those brands, but we were generating a ton of cash.”
Following a heated auction that went down to the wire, PVH won Calvin Klein for $430 million in cash and $400 million in deferred payments — more than double PVH’s entire market cap.
At the time, Calvin Klein was ringing up about $2.5 billion in global retail sales via a $100 million licensing business. The image-building Collection business was posting significant losses and the company’s total operating income was just $15 million a year.
Moreover, the PVH management team had limited knowledge of the designer business and the purchase price was highly leveraged, using funds from private equity firm Apax Partners. PVH shares sank by 20 percent immediately following the deal, to about $10.
“There was a real feeling that we way overpaid for the brand given the pro forma earnings and what it looked like. There was a sense that we had bet the ranch on the transaction. They just didn’t believe the growth story or that we could execute that growth story,” remembered Chirico.
Since then, PVH has grown Calvin Klein retail sales to $7.6 billion. The company paid off its Calvin Klein debt and took out its private equity financing in less than three years, while its stock price tripled in the three years following the deal. Calvin Klein EBIT grew to $278 million in 2011.
“The strength of the Calvin Klein brand exceeded all our expectations,” said Chirico.
Core to PVH’s post-acquisition strategy was to allow Calvin Klein to operate independently, without diluting its corporate culture. PVH convinced senior management to stay on board, including current Calvin Klein president Tom Murry.
An early decision to outsource its money-losing Collection business was reversed after a few years once its importance to the company and brand became apparent. “We learned that outsourcing the Collection was a tremendous failure,” said Chirico. “It was the life blood of the brand and organization.”
Chirico made light of PVH’s ability to prove the markets wrong when it came to most of its acquisitions. “What the f–k does the market know!!” read several slides in his PowerPoint presentation, which drew laughter from the audience. (“We had this whole debate in the company whether I was going to drop the F-bomb this morning,” said Chirico. “I went home last night and asked my wife. She said, ‘Just because you dress like you are in “Goodfellas” doesn’t mean you have to speak like a Goodfella.’”)
Adjusting a company’s corporate culture post-acquisition is central to the success of absorbing another brand or company, emphasized Chirico. “I think you have to view every acquisition you do not as an acquisition but as a merger,” he noted. “You have to level the playing field inside the company. The acquired company has to feel that you’re making decisions in the best interest of the new combined entity. If you don’t change who you are for the better, that acquisition won’t be successful.”
Looking down the road, digesting Warnaco and shedding debt will occupy PVH for the next three years and take it out of the M&A arena, said Chirico. “But the reality is that if, three years from now, things work the way they should, we will have paid down our debt again and we’ll be in a position where the capital will be available and we’ll have to make a decision on how to invest that capital. If past is prologue, then I would think three years from now we’ll be looking to do something else that could enhance growth for shareholders,” he added. “As a public company, you either grow or you die — so you have to drive the wagon.”