« Endeavor Aquisition Buys American Apparel and Northlake Buys Endeavour | Main | iTunes Sales Are Not Collapsing »

December 21, 2006

Details in Endeavor's SEC Filing Support Bull Case

Endeavor Acquisition Corporation (EDA) submitted an SEC filing yesterday with lots of details about its acquisition of American Apparel. Most importantly, the company provided historical and projected revenue and EBITDA figures. The data is better than I expected, particularly for 2007 and 2008, giving me greater faith in my buy recommendation and leading to more conviction in my $10-12 target. In fact, assuming the company hits the numbers in the filings, I think a stretch target of $14-18 is realistic.

Here is a copy of the investor presentation contained within the SEC filing. The presentation is designed to introduce Wall Street to American Apparel from a financial and operational perspective.

The news articles discussing the acquisition indicated that 2006 revenue and EBTDA would be $275 million and $30 million, respectively. I had initially assumed that EBITDA would grow to $40 million in 2007 and $50 million in 2008. However, one of the closing conditions contained in the filing is that American Apparel will submit its 2007 and 2008 projections following the completion of the 2006 audit and that the projections will show EBITDA of at least $50 million in 2007 and $70 million in 2008.

My stretch target assumes an EBITDA multiple of 12-15 times 2008 results. Given the growth rate, I think this multiple range is very realistic especially with American Eagle Outfitters (AEOS) and Urban Outfitters (URBN) presently trading at 14 times 2007 estimated EBITDA....

The filing contained lots of other information including historical revenue and EBITDA and a breakdown of sales between wholesale and retail. American Apparel has a significant wholesale business providing primarily blank t-shirts to more than 10,000 screen printers and ad specialty companies and 11 U.S. distributors. This business has grown rapidly but stalled in 2006. I presume the stall is due to the company's focus on expanding its retail operations. From just 3 stores in 2003, the company expanded to 38 stores in 2004, 108 in 2005, and 143 in 2006.

EBITDA margins have been fairly stable at 10-11% for the past few years. I also assume that the wholesale business has a lower margin and that the rapid expansion in the store base has penalized margins. The "guidance" provided in the SEC filing implies significant margin expansion in 2007, to 14%. This seems aggressive and is probably the key financial risk related to the shares. I would guess that the margin expansion is the result of a mix shift in favor of retail, a growing base of maturing stores, and less impact from new store openings as they shrink as a percentage of the base.

The filing also contains quarterly historical same stores sales. After very rapid gains in 2005, averaging 45%, same store sales have slowed in 2006. 1Q06 was 16%, but 2Q saw a sharp drop to just 1%. 3Q and 4Q saw a pickup to 4% and 6%, respectively. This slowing could concern some investors, especially as recent gains are below some peer retailers. It is not clear from the filing what the projections assume for same store sales. I would guess that mid to upper single digit growth is targeted with most of the sales gains, projected at 30% for 2007, coming from new store openings.

Not surprising but comforting, the filing also indicates that Endeavor will beef up American Apparel's management team by adding a Chief Operating Officer, Chief Financial Officer, and Chief Information Officer. Additionally, investments will be made inventory management, employee training, and other enterprise resources.

These investments should comfort potential investors who are concerned by the flamboyant and controversial CEO of American Apparel, Dov Charney. A simple Google search on Charney will reveal many profiles (positive and negative) including several that recap the fact that he has been sued four times for sexual harassment and admits to personal behavior and attitudes that would turn off many investors and consumers. In fact, the primary risk I see in EDA/American Apparel is that as the company ramps its store rollout and rapidly increases it sales, the mainstream media will revisit the controversy surrounding Charney. Besides the negative sentiment this would create for the stock, it might also impact sales as the company's reputation as an very progressive organization is tarnished. The addition of a beefed up management team and the experience provided by Endeavor's successful founding investors mitigates but does not eliminate this risk.

I believe that American Apparel's rapid historical and projected growth and hip brand will attract investors and sell-side analysts. With valuation reasonable compared to similar high growth concepts, I think significant upside exists even after the move over the last two days.

Posted by Steve Birenberg at December 21, 2006 08:05 AM in eda