WACHNER’S CHALLENGE: WIN BACK THE STREET
Byline: Karyn Monget / Thomas J. Ryan / with contributions from Lisa Lockwood
NEW YORK — Has Linda lost her luster?
Linda J. Wachner, chairman, chief executive officer and president of Warnaco Inc., was riding high in the mid-Nineties, highlighted by the 1994 purchase of Calvin Klein’s underwear business and a series of other acquisitions that made her the queen of innerwear and a dominant player in jeans.
Now, two straight years of earnings disappointments have caused Warnaco’s shares to collapse about 76 percent off its June 1998 high to where it is now trading slightly above the price it fetched in its 1991 initial public offering.
And that notorious Wachner touch — endless work days and a raw-nerved personal style that plows through executives — has always been forgiven by investors who made plenty of money as the company grew under her direction.
But the pressure is no doubt mounting: Warnaco’s market capitalization — total outstanding shares times the stock price — now sits at around $630 million, dramatically down from its high of $2.8 billion in June 1998, and is trailing many of its apparel peers, driving some speculation that the firm could be vulnerable to a takeover. In comparison, Jones Apparel Group has a market capitalization of around $3.3 billion; Liz Claiborne, $2.7 billion; VF Corp., $2.8 billion; Polo Ralph Lauren, $1.84 billion; Tommy Hilfiger Corp., $1.3 billion, and Kellwood, $490 million.
Analysts said they don’t expect any takeover attempts for two main reasons: Warnaco is so highly leveraged and there is a lack of potential interested buyers. Total debt at yearend increased to $1.32 billion from $550 million in 1998. One of the reasons for the high debt was last December’s acquisition of Authentic Fitness. Warnaco expects to reduce debt levels by $200 million in 2000 as a result of improved earnings and reduced working capital due to lower inventories and better inventory turns.
There’s another potential source of major debt looming, however: Wachner is said to be hot for the Calvin Klein business. She already controls Klein’s jeans and underwear brands and was an early, unsuccessful bidder for Calvin Klein Inc.
Despite the bloated debt such an acquisition would bring, sources say the $2.5 billion Klein business could be a strategic growth vehicle for Warnaco, which may reemerge now that the early front-runners, Tommy Hilfiger Corp. and HdP, have dropped out of the bidding. However, the relationship between Wachner and Calvin Klein executives is said to be so strained that Klein and Schwartz would not likely sell to her, unless they plan to remove themselves from the day-to-day operation of the business.
Wachner has all along insisted her relationship with Klein is fine.
“I love Calvin,” she said, pointing out that she made a fair bid for his business and even hired an investment bank and did due diligence to make a serious offer. It just wasn’t good enough initially. And Hilfiger’s top bid — believed to be in the neighborhood of $850 million — fell short of Klein’s minimum asking price of $1 billion. Whether Wachner will up the ante remains to be seen, but any offer she makes would have to be considerably north of $850 million, according to sources.
As for Warnaco’s woeful stock price, some analysts said that a large part of its weakness can be traced to investors’ current chill toward the apparel sector. But Warnaco is being punished even more than most of its peers for recent earnings disappointments and problems Wachner has in delivering bad news.
“The biggest negative I get from investors is the credibility issue,” said Josie Esquivel of Morgan Stanley Dean Witter, a long-time supporter of Warnaco.
She echoed the sentiments of several other analysts when she said: “The question is whether she [Wachner] can revive growth again and make Wall Street believe it.”
Essentially, some analysts believe that Wachner — the longtime darling of the investment community for turning acquisitions into gold mines while pruning underperformers with the efficiency and style of Patton parading through North Africa — is now being scrutinized by money managers over whether she can continue to deliver on her promises.
One of Wachner’s problems on Wall Street is the way she communicates with analysts.
“Clearly, Warnaco is a good company with a viable business,” said Leslie McCall, an analyst at Brown Bros. Harriman. “I think if they can communicate to investors in a systematic way and perhaps more frequently, that might close the gap between what I see as the quality of the company operationally and in merchandising and its stock price.”
Warnaco is apparently looking to hire an experienced investors relations person as a result of complaints.
Moreover, some analysts said Wachner rubs some in the investment community the wrong way by relentlessly pushing the stock and then not coming through. One analyst described Wachner as a “great task master,” but said she was “too promotional about the firm’s prospects and not realistic enough.”
For instance, they complained that Wachner on conference calls had previously touted the now defunct Marilyn Monroe by Warner’s and the licensed Fruit of the Loom bra brands as major growth vehicles, only to rarely mention the brands once they showed some slippage. Another noted that Wachner raves about the enormous potential of the Weight Watchers shapewear, yet the business will do only about $15 million this year, nary a speck for a $2.1 billion firm.
A lack in management depth and extremely high turnover has been a longer concern of analysts. Besides Wachner, the only long-term senior management comprises William S. Finkelstein, chief financial officer and senior vice president of Warnaco for 14 years, and Stanley P. Silverstein, Warnaco’s vice president, general counsel and secretary since 1987. James Mogan, president of Warnaco’s intimate apparel division, has been with the firm four years.
One analyst suggested that while Wachner is a “very talented merchant,” she could use a “deeper bench of management.”
But for Wachner, the golden rule is making the figures, and over the past 1 1/2 years, she said she has pruned senior management ranks for “not making the grade,” including Stephen Ruzow, president of Calvin Klein Intimates Worldwide; J. Thomson Wyatt, president of Warnaco Intimate Apparel; Alex Cannon, president of men’s wear and CK Jeans, and Maurice Reznik and Jay Greenblatt, each of whom held the post of president of the Warner’s division.
Asked about the company’s revolving door, Wachner replied: “There is no room for nonperformance. We don’t have any trouble holding on to people who do their jobs. There are a lot of people who have been here a long time.”
When questioned whether Wall Street had lost faith in her personally, Wachner bristled, “Au contraire,” contending that Wall Street has lost faith in all apparel stocks — not just Warnaco.
“Just look at Tommy,” she said. “His stock recently took a big hit and others [public apparel firms] aren’t performing that great either.”
As reported, shares at Tommy Hilfiger Corp. nosedived 17.9 percent on Jan. 13 after the company reported weak sales trends would cause it to drop well short of Wall Street estimates, and is now trading down 66 percent from its August 1999 high.
While Wall Street has feasted on luxury stocks such as LVMH and Gucci as the demand for high-ticket apparel and accessories continues to build, other venerable brands, including Polo Ralph Lauren Corp., Jones Apparel Group and VF Corp., endured a roller-coaster ride throughout 1999. Some retail stocks have bounced back in early 2000, but the apparel sector, with few exceptions such as Guess, Liz Claiborne, and Kenneth Cole Productions, has remained in a slump. VF Corp. is down about 56 percent from its 1999 high; Kellwood, 39 percent, and Nike, 42 percent.
Polo and Jones have both recovered somewhat this year, although both are still down from their 1999 highs by 22 percent and 18 percent, respectively.
Whether Warnaco has been tarred with a broad brush or not, some analysts are questioning if the company can continue to grow, particularly with apparel, in a department store channel that has consistently lost market share to mass merchants in recent years. But Wachner told WWD she foresees considerable growth ahead.
For starters, Wachner — whose newly merged company [Warnaco and Authentic Fitness] posted combined wholesale volume of $2.1 billion in 1999 — projects the firm will generate sales of approximately $3.7 billion by 2004. That “Street” estimate excludes additional acquisitions, she said.
Wachner said she has proved her ability to successfully increase sales, considering that Warnaco only had sales of $425 million in 1986, when she acquired the firm in a leveraged buyout.
The growth will be driven by Warnaco’s diverse brands, including Olga, Warners and Chaps by Ralph Lauren, which have been around since the Eighties, as well as many names that were acquired, she said. Over the past six years, Wachner has been on the hunt for premium brands and companies that some in the apparel industry compare to the quest for the Holy Grail. Since 1994, Warnaco has made one strategic acquisition after another, including:
Calvin Klein’s men’s accessories and underwear, and Calvin Klein innerwear for women that year.
GJM, a Hong Kong-based maker of silk sleepwear; Bodyslimmers, a shapewear specialist; and Lejaby, an upscale French bra label, all in 1996.
ABS by Allen B. Schwartz, a contemporary dress and sportswear brand; Penhaligon, a luxury bath and toiletries brand from England, and Izka, a small emerging French manufacturer of overall seamless undergarments — all in 1999.
She took another big bite of the Calvin Klein money machine in late 1998, when Warnaco acquired the license in North America and Mexico for Calvin Klein Jeans. The license is active for another 44 years. In December, Warnaco acquired Authentic Fitness, a swimwear firm also headed by Wachner.
Wall Street has, over the years, applauded Warnaco’s acquisition prowess, even Authentic. In particular, in the past they’ve applauded her ability to make acquisitions quickly become accretive to earnings and revive sales.
For instance, combined sales of Calvin Klein underwear for men and women reached $350 million in 1999, compared to $309 million in 1998. Wachner noted that in 1994, when Warnaco acquired Klein’s underwear businesses, the women’s line generated wholesale volume of $5 million, and the men’s did $50 million.
Wachner is also well respected for quickly eliminating underperformers before they become a huge drag on earnings. Even with Warnaco’s rapid growth, the firm has eliminated Hathaway, Golden Bear by Jack Nicklaus and Puritan in its men’s wear business and Marilyn Monroe and Valentino Intimo on the intimate apparel side.
But investors seem to be tiring of waiting for Warnaco’s earnings to rebound. Its stock closed at 11 13/16, up 1/2 on the New York Stock Exchange on Friday, but had sunk to 9 1/8 in December, well below its 52-week high of 30 5/8 in May, as well as its all-time high of 44 7/16 reached in June 1998. Warnaco went public in October 1991 at $10, adjusted for a 2-for-1 stock split.
Analysts said Warnaco’s first crucial misstep came in October 1998 when the company tempered its growth plans internationally because of weaker economies in the Far East and Russia. International sales were expected to provide a large chunk of Warnaco’s growth. The shortfall prompted analysts at that time to trim their estimates by about 5 cents in 1998 and about 30 cents in 1999.
Warnaco sent up a red flag again in October 1999, when the firm warned that earnings for the year again might be less than expected, largely due to a loss of sales to several customers that either declared bankruptcy, liquidated or were sold. These included Upton’s and T. Eaton’s, which both liquidated last summer; Mercantile Stores, which was sold to Dillard’s in August 1998, and Filene’s Basement and Loehmann’s, each of which filed for bankruptcy last year.
The firm also said that it was hurt by several other factors: markdowns in its Calvin Klein junior jeans business, which has been underperforming; extra start-up costs associated with the opening of a new manufacturing facility in Mexico, and a general softness at department stores. Analysts slashed their estimates by an average of 52 cents for 1999 and about 36 cents for 2000.
For the year, Wachner missed the numbers she had initially projected, reporting on March 5 that earnings before charges grew 29.3 percent to $1.91. This was in line with revised expectations, however. Net earnings came to $97.8 million, or $1.75 a share, against a $32.2 million loss a year ago. Sales advanced 8.4 percent to $605.7 million.
Wall Street now expects earnings to reach $2.37 this year and $2.63 in 2001.
Asked to elaborate on the Wall Street credibility issue, Wachner chuckled as she hunkered down on a cream-colored sofa next to the ever-present Finkelstein.
She dismissed the question with a wave of her hand and said, “It’s really all so simple. I majored in economics. I don’t think we have any credibility problem, because what the people [shareholders] will vote for at the end of the day is cash flow. We have built cash flow from $25 million to over $400 million. Cash flow is going to be king.”
By generating that kind of cash flow and building market share, Wachner contended that she’s done right by her shareholders. She also argued that once investor sentiment shifts back to cash flow, Warnaco’s shares — along with all apparel stocks — will recover.
“If you want to know what it’s really all about, it’s about the multiples of earnings that have crashed in the apparel industry,” Wachner said. “The industry has degrown. Our stock is down for only one reason — the multiples have gone down in the apparel industry.”
In fact, the entire apparel group has underperformed for the past 1 1/2 years as investors have focused largely on technology issues and blue-chip firms. Price/earnings ratios — Wall Street’s omnipresent tool for stock valuation that measures the stock price compared with earnings — seem particularly depressed for the group. Warnaco’s stock is trading lower than most of the competition at 4.5 times Wall Street’s expected earnings for 2000. Both Tommy Hilfiger and Kellwood have forward P/E ratios of 6.5, and VF is at 7.9. Relatively higher P/E ratios are being garnered by Liz Claiborne, 13.1; Polo Ralph Lauren, 13.7, and Jones Apparel Group, 12; but the whole pack is still trailing well below the S&P 500 stock index, which carries a P/E ratio of about 30.
“Unfortunately,” continued Wachner, “we have to wait and see when the public decides to beef up the multiples of apparel stock. I think people simply decided they wanted to put their money in things other than apparel.”
Wachner asserts that Warnaco’s stock, as well as all apparel issues, will bounce back once investors move to from buying stocks on a “growth” basis, as evidenced by the dot-com craze — last week experiencing the start of what many believe is an overdue correction on the Nasdaq market — to a “value” basis.
“At some point, people are going to ask ‘Where’s the beef?’ and see that Warnaco has the cash flow,” she said.
Wachner predicted a second or third quarter upswing in the apparel sector. But she noted that the current weak multiples extend to department stores, Warnaco’s primary customer, which have seen their stock valuations become particularly depressed compared with those of discounters and the top specialty stores. A promotional climate and sluggish sales have caused investors to worry about department stores, as well as their suppliers, while discounters and specialty stores have recently been thriving.
“Wal-Mart has exhibited tremendous growth. So what is the market betting on? Stores like Gap and Wal-Mart are the winners, while apparel growth is not going to be as fast,” Wachner said.
Commenting on all department store vendors, Wachner said, “We have to justify our performance to shareholders on cash flow, maintaining revenues and profits, and paying down debt.”
The jury is still out on Wachner’s gamble to sell Calvin Klein underwear at J.C. Penney, which enraged executives at traditional department stores, and some analysts envisioned it causing the same problem the Vanity Fair Intimates division of VF had with its traditional department store base, when it began selling Vanity Fair bras to Sears in 1998.
Department store executives and industry analysts said the Penney’s move was a big risk, which could only pay off if sales continue to be strong at the better-store level. If department store sales drop, the move to sell to Penney’s would be blamed. Dillard’s has since dropped the line and the move has negatively impacted other Calvin Klein licenses at Dillard’s. And May Department Stores has cut back a significant chunk of Klein’s underwear business. Some supporters contend that the Calvin Klein brand is strong enough to carry both distribution channels, and noted that many department store brands already were in Penney’s.
Klein officials have not commented on the Penney’s move, but it came at a very sensitive time for the brand — shortly after Klein and Schwartz put the business up for sale.
Asked about the Penney’s deal, Wachner said, “We consider Penney’s a department store in the lingerie segment. I am not going to further discuss J.C. Penney. We’ve only sold 300 of Penney’s 900 doors. We think it will keep with the department store image that the Olga, Warner’s and Bodyslimmers brands enjoy.”
She also said Warnaco will continue to concentrate on shipping department stores despite growth concerns, noting that the firm has been able to add square footage while the channel underwent severe consolidation throughout the Nineties.
“There are 1,200 fewer department store doors [overall] to ship to now than in 1986, all due to mergers,” Wachner said. “However, we have no plans to leave department stores, because they are the bulk of our business.”
Wachner said Warnaco’s prior earnings shortfalls primarily stemmed from extraordinary events such as liquidations and bankruptcies of retailers as well as unforeseen economic implosions in Asia, and reiterated the argument that the stock weakness primarily relates to investors shunning the apparel sector.
Notwithstanding all of its challenges, many analysts are recommending the stock, partly because the price is so low. Of the 12 analysts that follow it, three have “strong buy” ratings, six “buy” and three “hold.”
The stock in the near term is expected to be held back pending the elimination of excess inventory and improvement in sales at department stores, which many saw as excessively promotional this past holiday. Warnaco has vowed to cut $60 million in inventory this year and also improve its fill rate at its intimate apparel plants to more than 90 percent from 70 percent in 1999.
On the positive side, analysts noted that the company has continually generated cash flow and its stable of brands — including Calvin Klein Underwear, Calvin Klein Jeans, Warner’s, Olga, Chaps by Ralph Lauren and Van Raalte, which is distributed exclusively to Sears — rank among the best in the industry.
In buying Authentic Fitness in December, Warnaco grabbed Speedo and several swimwear licenses from the designer arena — Oscar de la Renta, Ralph Lauren and Polo Sport, and Anne Klein. Additionally, the company plans a fourth-quarter launch of the licensed Weight Watchers swimwear to mass channels.
“Through its licenses, Warnaco has aligned itself with some of the best-known and sought- after brands in the world,” said Noelle Grainger, analyst at J.P. Morgan, in a report.
Warnaco’s recent acquisition of Authentic is expected to be accretive to earnings this year by about 20 cents as Warnaco management said it has located about $15 million in operating expenses that can be cut from Authentic.
Wachner, perennially one of the highest-paid executives in the country, noted that she “gave up” her salary as chairman and ceo of Authentic Fitness, as well as bonuses and stock options, and her pay package at Warnaco will not be restructured. Her compensation at Authentic Fitness’s year ended June 1999 was $1.06 million, slightly ahead of the $1.4 million she earned the prior year.
At Warnaco, Wachner earned $15.6 million for 1998, including a $6 million bonus and $6.5 million from exercising stock options. For 1997, she earned $11.5 million, including bonuses and stock options. Her 1999 pay has not yet been disclosed.
For 2000, Warnaco told analysts in late December that it expects earnings to rise about 25 percent to $2.40 a share. Sales are expected to jump between 25 and 30 percent to about $2.7 billion, largely due to the addition of Authentic. Excluding Authentic, sales of the core Warnaco business are expected to grow between 7 and 10 percent.
Breaking down 2000 sales forecasts in Warnaco’s three divisions, analysts project the following:
Intimate apparel sales should rise between 4 and 5 percent to about $1 billion.
Sportswear sales are expected to surge about 47 percent to $1.5 billion, with about $360 million stemming from the acquisition of Authentic. Excluding Authentic, sportswear, which includes CK jeans, Chaps and ABS, is expected to rise about 8 percent to about $1.1 billion.
Retail sales are expected to reach about $200 million, up from $140 million, with about $50 million coming from Authentic Fitness retail stores.
Backing its forecasts, Warnaco pointed to gains in market share in intimate apparel, as well as strong backlogs in CK jeans, up 21 percent, and Chaps sportswear, up 8.3 percent. Chaps should benefit from its expansion into Germany and England in the fourth quarter. Despite general softness in intimate apparel sales, Warnaco increased its market share in department stores last year in bras to 39 percent from 37.5 percent; in panties to 27.3 percent from 24.8 percent, and in shapewear, to 24.5 percent from 21 percent.
Warnaco officials said about $90 million in sales from those lost customers that liquidated or went bankrupt are expected to be made up by the new Warner’s product introductions in the first half, expansion of Weight Watchers, new Olga’s seamless bras and higher order- completion rates due to new logistical systems. The move to bring CK underwear to 300 Penney doors is expected to increase CK underwear sales by between 5 and 7 percent.
Also possibly boosting sales are the success of six freestanding CK underwear stores in Asia, which boast sales-per-square foot of between $700 and $800. Another CK underwear shop was opened on Prince’s Street in Glasgow in January. Two more stores will open in London, with possibly more in Japan.
Overall intimate apparel backlogs were flat for spring, but April-to-June backlogs were up 15 percent, led by a strong response to new Warner products.
A Penhaligon store that recently opened on Madison Avenue in Manhattan is performing well, with a store in Scotland just opened and an additional store in England; and the addition of robes and sleepwear is expected to drive total sales to between $10 million and $12 million this year.
Izka stores are set to open in London and Hong Kong in the first quarter, and a search is under way for a site in Manhattan. The Izka brand will be tested in Hong Kong. ABS by Allen Schwartz is slated to hit between $50 million and $60 million in 2000, up from between $30 million and $35 million in 1999.
Management also noted that CK junior jeans is starting to show some improvement. In Calvin Klein men’s and women’s jeans, tops are still a big opportunity, accounting for only 22 percent of the business, with new knit sweaters recently performing well. Warnaco also said its “dirty” denim promotion was successful and will be followed by a “green” denim promotion.
At Authentic Fitness, Speedo brand backlogs were up 14 percent, and designer swimwear, excluding Polo, were ahead 12 percent. The firm also told analysts that recently introduced separates lines in both RL Sport and Anne Cole have been well received.
International, which accounted for about 17 percent of revenues in 1998, also remains an untapped area.
Another growth vehicle may develop from Warnaco’s recent acquisition of the domain name to underwear.com. Warnaco’s company Web site is still under construction.
Cash flow is expected to exceed $300 million in fiscal 2000, with about $60 million coming from inventory reductions and about $50 million from the planned sale of 800,000 shares of Interworld InterWorld Corp., a New York-based Internet commerce software and services company.
InterWorld has worked with Warnaco and Authentic on their Web sites, as well as American Eagle Outfitters, Brooks Brothers, Guess and Boo.com.
But Warnaco has to deliver. Warnaco will have to fight against low-single-digit overall growth in intimate apparel and possibly some maturity in sportswear, given the glut of megabrands that has entered the market, analysts said.
J.P. Morgan’s Grainger also said 2000 earnings “could prove vulnerable if excess inventories drag well into 2000 and if plants in Mexico experience further delays.”
Besides coming through this year on growth projections, Warnaco’s stock would benefit from aggressive buybacks by the company and Wachner herself.
Some financial gurus are perplexed over Wachner’s sale in January of 7.5 percent of the firm, although most agreed it made sense to sell shares to offset capital tax gain resulting from the acquisition of Authentic Fitness in November. As part of the merger, shareholders tendered 97 percent of Authentic’s stock in response to Warnaco’s $20.80-per-share bid. The deal values Authentic at $540 million, including debt.
None of the analysts queried was exuberant about Wachner’s sale of Warnaco stock, which represented about one million shares, bringing in about $36 million in personal tax relief for Wachner because the bulk sales put downward pressure on the stock price. One analyst described the sale as “nutty.”
Another said Wachner’s tax-shelter move was “a little two-faced,” since she had promised in a conference call in October that she would aggressively buy Warnaco shares in the open market for her own account, given the cheap stock.
The analyst — who did not want to be identified — recommended that Wachner should quickly buy back her 7.5 percent stake plus more if she was to be true to her word.
Asked why she and Finkelstein — who unloaded about 5 percent of his stake in Warnaco — made such a move, Wachner replied: “I told everyone I would come back and buy [the stock]. I don’t think it upset any shareholders, and our stock went up. I haven’t sold any stock for five years, but this year was too big for me, and that was because of the Authentic Fitness acquisition.”
The company itself bought back 2 million shares in the fourth quarter, and still has 8 million authorized to buy under its buyback program.
Even at currently depressed levels, Wachner’s 20 percent stake in the firm is worth about $120 million.
And whatever her critics say, including those on Wall Street, Morgan Stanley’s Esquivel said the “biggest risk” to Warnaco’s stock would be the departure of Wachner — raw-nerved style and all.
“We consider her instrumental in the continued success of Warnaco,” Esquivel said.