IS WALL STREET BAD FOR FASHION?
ONLY A FEW MILES APART ON THE MAP, THE GAP DIVIDING SEVENTH AVENUE AND WALL STREET CAN APPEAR CONTINENTAL IN SCALE.
Byline: Vicki M. Young
The dynamics of Wall Street and fashion are like denim and cashmere – sometimes they work great together and sometimes they don’t.
Wall Street’s expectations are that industry executives have a vision that they can execute consistently quarter-in, quarter-out. Industry veterans, on the other hand, complain that Wall Street never seems to give them any breaks – even when they do well in a difficult retail climate.
“By and large, most fashion-related firms really don’t appear to have any recognized legitimacy,” Emanuel Weintraub, a management consultant at the firm that bears his name, says. “They’ve never gotten the multiples that they should have, and you rarely hear any cheering from Wall Street.
“The apparel sector, and retail to a lesser degree, have over many years not enjoyed any kind of popularity among Wall Street professionals. They like Liz Claiborne and Jones Apparel Group and they used to like Kenneth Cole Productions. VF Corp. is a favorite among institutional investors. If the same firms were in fiber optics or technology, it might have been very different. Take Liz or Jones and well-managed retailers such as Federated Department Stores or Wal-Mart. They are accepted companies but there’s not real excitement surrounding them and they were never the darlings of Wall Street.”
To be sure, the stock prices of publicly held apparel makers and retailers tend to suffer in both bad and good markets, either because of lackluster sales or because margins aren’t as strong as in other industries. But there’s more here than meets the eye. While the impression is that the multiples in other sectors don’t rise and fall as quickly as hemlines, there’s also a fashion dichotomy in which a small group of luxury firms appear to be made of heartier stock. Is Wall Street applying a different standard for luxe firms?
According to Gilbert Harrison, chairman of private investment bank Financo Inc., “Yes, traditionally there is a different yardstick for luxe firms because the sector, before the recession and the terrorist attacks of Sept. 11, has been a high-margin, faster-growth industry. The expectations for continued growth are extremely high.”
Due to the negative wealth effect produced by the recession and dropoff in stock prices recently, he notes, the middle sector of the market is getting squeezed as consumers are either migrating down to the discount channel or moving in the direction toward the luxe market. This has left the department stores out in the cold.
Of course, the grousing done by some apparel and retail observers reflects an industry that believes investors don’t fully understand the sacrifices needed to build a brand or gain market share on a long-term basis, even if it means bottom-line results take a short-term hit. They also gripe that the Street focuses too heavily on the uncertainties that invariably come with new style trends and shorter fashion cycles (conveniently forgetting that they can do that themselves).
So what? After all, can there be anything more fickle than the vagaries of a consumer’s response to ever-changing fashion trends?
Maybe. Try Wall Street.
According to David Lamer, analyst at Ferris, Baker Watts, “If you think the fashion industry is fickle, you haven’t seen anything until you look at how Wall Street operates. Wall Street has a lot of components, including, ‘What is the soup du jour?’ The big focus after the Enron debacle broke involved accounting issues, and any public company that might have an unusual accounting standard saw a pullback on its stock because of that concern.”
Lamer says that part of the reason Wall Street always sticks its nose in issues affecting earnings is because of the possibility of restatements. “Companies forget that Wall Street doesn’t like surprises,” he points out.
Because of different constituency groups, Wall Street’s focus must shift as quickly as the speed of light. After all, it is an industry that’s focused on other people’s money, always looking for ways to make more greenbacks in a short amount of time even if it means focusing on higher risk sectors such as technology. The search for that quick buck paves the way for both a short-term memory and an unforgiving investment environment when companies don’t meet expectations.
STOCK PRICE IPO: $31.50
AS OF APRIL 2002: $30.35
Seasonal retail and market cycles aside, there are other factors such as different investment groups that can affect which public companies get on the radar screens of some investment firms and not others. While these factors affect other industries as well, analysts say that the constant business pressures encountered by many fashion executives in just getting through the current season don’t give them much wiggle room or spare time to talk with members of the investment community.
The stock prices too can fluctuate in odd ways, sometimes going unexpectedly down even when the news is good. Of those investor constituents, Lamer explains, “There are different investors buying shares for various reasons. A large institutional investor wants to buy a good company because fundamentals are strong and there is a three-to-five years growth pattern. A hedge fund will buy and sell for a quick pop before dumping the shares. Value investors will look for stocks with a low multiple, and they would consider Tommy Hilfiger a good value company to buy into. On the other hand, you have momentum investors who see movement in the trading of a stock, so maybe they’ll buy but it won’t have anything to do with company fundamentals.”
Wall Street isn’t totally at fault for the pervasive belief of many retail and apparel firms that they rarely catch any so-called breaks from the investment community. Some analysts note that industry executives need to share in the blame because they just don’t understand what it means to be a public company or their responsibility when it comes to interacting with the investment community.
“Let’s face it,” notes one apparel executive. “It’s hard to find major apparel executives who have it all and aren’t either glorified merchants or glorified sales managers.”
Joseph Teklits, apparel and retail analyst at Wachovia Securities, says, “Balancing what is best for the company with Wall Street’s expectations is any chief executive officer’s primary challenge, but most do not make enough of an attempt to understand how the Street thinks. Consistency and predictability are at the top of a list of criteria investors look for, they span all industries and maybe even rank higher than growth in the long run. “Planning as best as possible for steady growth, not spectacular growth one year with nothing left the next year, combined with proper communication can go a long way toward smoothing out the relationship between apparel companies and Wall Street.”
Jennifer Black of Wells Fargo Securities says that the first requirement for analysts is that they know their customers. A 25-year veteran in the investment sector, she was a money manager for individuals before changing gears and turning her focus on the needs of institutional investors.
“The criteria are different for each investor group. You have to know who they are and what they are looking for. In the case of apparel and retail, the main way we do our work is by going into the stores and making judgments on customer service, merchandising and the product. A company can do everything right, but if it doesn’t have the right product, forget it.”
Black says that lack of candid, full disclosure by public companies is a problem too. While the apparel and retail sector is an easier industry to cover than others because of the ability to “go and see and feel the product,” there is nevertheless a lack of information flowing from company executives to the investing public. The paucity of details from some companies on certain operations can affect the stock’s rating and lead to guesswork in earnings projections.
To be sure, certain branded firms seem to have a leg up on the competition because of the nature of the business, leaving others behind at the outset.
Wall Street tends to favor and give higher earnings multiples to companies with loftier gross margin levels. Status brands, with a 42 to 48 percent gross margin, fall into this category and usually have greater ability to cut selling, general and administrative costs.
Coach, which went public on Oct. 5, 2000, closed on the first day of trading on the Big Board at $19.63. The stock closed recently at $55.80. According to analysts, Coach’s gross margin is around a high of 65 percent.
Lamer says the stock gets a higher multiple because of management’s ability to create new product categories and styles sought after by both loyal customers and new customers. Retail analyst Walter Loeb of Loeb Associates observes that Coach does well because of its high brand visibility in the U.S. and its affordable price points.
Gary Wassner, president of Hilldun Corp., a factor, says it is much easier to work with companies that have higher margins. “The making and selling of luxe goods is really a different business from the rest of the industry. A high-end designer client can sell a dress wholesale at $1,000, but it only cost $500 to make. That’s a very high margin, and multiplied by the number of units sold gives the company and my firm a greater comfort level in terms of room for error. The better-price stores don’t negotiate up front for price, so it’s just markdown money to be concerned about later on instead of a hit on the front end and then later again at the back end.
“A luxury firm that has its own stores sells product to its retail business at cost. Even when it has to discount at the end of the season, the company makes a very high profit on the goods. While those stores have high overhead, that’s really built into their advertising budget because of brand imaging. Wall Street analysts understand this, and that’s why luxury firms get the high multiples that they do.”
Many firms, however, don’t start out with high gross margins and a few apparel companies, depending on the distribution channel they target, barely eke a profit margin-wise.
So while Wall Street may be assailed for having a short-term memory, the fashion industry is also challenged by what is seen as a typical three-year growth cycle, five being exceptional. The two public apparel firms that have bucked the trend are Tommy Hilfiger, which went public in September 1992, and Gucci Group NV, public since October 1995, analysts said.
Tommy had consistently strong earnings growth until fiscal 2000 when it faltered, mostly due to challenges in the men’s wear market. Sometimes portrayed by analysts as the poster child of successful public apparel firms, Tommy posted a consistent and minimum 22 percent earnings-per-share growth from the time it went public through 1999, and, according to Lamer, even 30 percent EPS growth until March 2000. Following the enormous run from 1992 through 2000, EPS growth was just 9 percent in 2000.
STOCK PRICE IPO: $24.00
AS OF APRIL 2002: $94.72
STOCK PRICE IPO: $28.00
AS OF APRIL 2002: SOLD
Perhaps unfairly — but owing to the strength of the brand and a pattern of consistent high growth — one analyst notes that Wall Street had come to expect Tommy to keep on posting high double-digit growth in EPS. Shares of Tommy were beaten down when those expectations hit the proverbial brick wall.
In contrast is Polo Ralph Lauren Corp., whose share prices have been somewhat disappointing since it went public in June 1997, even though it has realized steady growth.
Although Polo was the most anticipated fashion IPO in the Class of 1997, even its chairman and chief executive has since admitted disappointment in the stock’s anemic performance. Opening at $32.13 on June 12, 1997, the stock’s 52-week low was in the $17 range, and recently has climbed back up to the $30 range.
Ralph Lauren told shareholders at the company’s August 2000 annual meeting, when the stock price was around $19, “You may be happy, but I’m not happy. I’m the largest shareholder in this company and I have stayed that way because I believe in this company.”
He also told them that a public company needs to be able to do at least two things in order to succeed: “You have to prove longevity and that you can deal with Wall Street.” He concluded that the company, now celebrating its 35th anniversary, has done both.
Still, some public companies have left investors largely disappointed by, or even burnt from, past experiences. Gucci gets the credit for being the IPO that started the craze for luxe IPOs after its October 1995 offering. Estee Lauder Cos. in November 1995 is considered another winner in the IPO stakes. However, most design houses have not fared as well.
The Donna Karan International Inc. IPO in June 1996 probably did much to hurt the perception of the apparel business among investors, analysts note. Now part of LVMH Moet Hennessy Louis Vuitton, Donna Karan faltered early on as a public company as its issues declined sharply one quarter after the firm’s much publicized IPO. Lately, there’s little of the hunger investors had in 1996 when Donna Karan, Revlon Inc. and Saks Fifth Avenue Inc. (since acquired by the department store group previously known as Proffitt’s) all rushed to market. The investment community, while still receptive to fashion IPOs — including upcoming offerings from Aeropostale and, presumably, Burberry — isn’t clamoring for them.
To be sure, there are some inherent negatives to being public, such as having to live corporate life in the proverbial fishbowl where every operation and financial component of a business comes under the scrutiny of analysts and shareholders.
Why would any company want to be public?
It’s certainly not a matter of visibility. As Robert Passikoff, president of Brand Keys, which just completed its biannual customer loyalty index survey of leading brands, observes, “Consumers don’t care whether a branded company is private or public.”
Arnold Zetcher, chairman, president and chief executive officer of specialty retailer Talbots Inc., sees it differently: “While there are obvious pressures in being a public company, we feel it’s a positive for our company and our associates. As a public company, we have access to capital markets, and our associates have a greater ownership over the company and its performance.
“Whether we were public or private, we would essentially manage our business the same way. From the day we went public, we felt it was important to continue to be upfront, to take responsibility for our performance, to maintain a clear vision, and to manage our business with discipline and resolve for the long-term.”
Margaret Cannella, managing director of North American credit research at J.P. Morgan Securities Inc., says, “Public companies have the added advantage of access to public debt and equity markets. Being public also provides an added level of motivating owners and managers to move more quickly in reacting to changes in the marketplace. Private companies can set their own pace, but the public ones are often tied to Street expectations, which can often be a great motivator. It is not necessarily better to be public than private, but with the degree of volatility that occurs in fashion and the need sometimes to remain small to be distinctive, there is an argument that [certain] apparel companies stay private.”
Oftentimes a company will go public so its owners can cash in on their hard work. That was the case with Donna Karan, although one investment banker who requested anonymity says that the company, “because of its licensing agreement with Gabrielle Studios, took advantage of its public shareholders. At the end of the day, the amount of money that Donna walked away with is something for the history books.” (When LVMH bought Donna Karan International, it paid Karan $400 million for Gabrielle Studios alone.)
In the case of Gucci, being public has certainly helped management become wealthy. Financo’s Harrison observes, “People should be compensated for the work that they do. The brilliance that (chairman and chief executive officer) Domenico de Sole and (designer) Tom Ford brought to the revitalization of Gucci parallels the amount of money shareholders made in the appreciation of the stock. Their pay is justified because everybody was working on the same plane.”
Frank Badillo, senior retail economist at Retail Forward, observes that a common criticism is that public companies are more short-term oriented when they should be focused on the long term. “Public companies are more pressured to cut back on investments such as research and development in the short run to meet the financial targets of Wall Street.”
He explains that fashion houses are less likely to cut back on those investments and other staffing requirements because they fuel creativity, the backbone of any successful fashion enterprise. “What you have is Wall Street looking quite negatively on these companies for not retrenching enough,” he concludes.
Loeb said another negative to being public is that management has to devote a considerable amount of time on financial relations. While the chief financial officer spends time with senior investors, it is the chief executive that is charged with explaining the vision of the company. At many fashion firms, the designer is the ceo. Ironically, he points out, fashion designers aren’t always the best ones to be front and center when it comes to explaining the vision of a company.
“Designers often aren’t good spokesmen for their companies. They’re at their best when charged with the responsibility of customer preferences and with keeping tabs on the changes in the marketplace. Because designers are viewed more favorably for their creativity than their business acumen, credibility is sometimes an issue.”
According to Ferris Baker’s Lamer, “Retailers, with their higher overhead expenses, often fare better as public companies. They tend to benefit from the greater access to the public markets because of the capital outlay required to roll out stores. Vertical chains such as Abercrombie & Fitch and American Eagle Outfitters can get good multiples, and store rollouts is an avenue of growth.”
For Teklits, some apparel companies can benefit from public offerings. “There have not been a lot of apparel wholesaler initial public offerings over the past five years, and because most of the handful that did go public have underperformed the overall market, the industry gets a bad rap.
“Look at an example like Skechers though — it is the public equity capital that is helping to create one of the largest footwear companies in the world. And for the most part, investors have been rewarded. The same can be said for other footwear and apparel companies. Apparel retailers tend to have more control over their year-to-year growth and in my opinion have proven to be relatively successful stocks,” he says.
But can the interests of fashion ever be reconciled with Wall Street’s priorities? Perhaps. And with a few more decades of corporate persuasion, the view of the Street (Wall) on the Avenue (Seventh) might finally begin to change.
STOCK PRICE IPO: $5.00
AS OF APRIL 2002: $16.01