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Levi’s IPO

Levi’s, the makers of the ‘blue jean’, founded in 1853, recently filed for IPO. (the company was taken private around three decades ago). One doesn’t come across many old, history-rich, established companies  in the brands and consumer space filing a prospectus these days. Worth a look through. As I browse through the doc, my quick notes on the business collected here in this catch-all post.

“The company, which has 385.5 million shares outstanding, said it expects to offer 36.7 million shares priced between $14 and $16 per share in an initial public offering. …

The descendants of founder Levi Strauss, the Hass family, will retain 80 percent of voting control in the company following the IPO, the filing showed.

Levi Strauss joins a list of high-profile firms filing to go public this year, such as ride-hailing companies Uber Technologies and Lyft, photo-posting app Pinterest and home-renting service provider Airbnb. (reut.rs/2HiQaaP)”

– Reuters

Objective of the issue seems to be creation of liquidity for existing shareholders. Most of the IPO is expected to be sale of shares rather than money to the company.

The Business

Levi’s recorded revenue of $5.5 billion in 2018 (52 weeks ending Nov 25, 2018). In simple terms, the business is about designing, manufacturing/sourcing and selling through wholesale, retail and online channels.

In a little bit more detail, the business is about two brands – mainly Levi’s  (86% of revenue), and Dockers. The key product is bottoms (74% of revenue) sold through a range of channels: the main channel – wholesale (65% of total revenue, 4/10ths from top 10 customers) to a range of other retailers (leading to presence in 50,000 retail stores throughout the world), retail through company’s own stores (824 stores, 26% revenue), online retail ( 4% revenue) and retail through shop in shops/ franchisee (? – 5% revenue). Levi’s designs these products in San Francisco, and sources the product from contract manufacturers (99% of the product) around the world (and two of its own manufacturing facilities). It then spends dollars on advertising, marketing and promotion of its product. Most of the assets or the cash flow needed are needed for funding the working capital of the business (holding inventory, and the receivables less payables).

Like any other brand/consumer business.  However, given the scale and distribution of business – 110 countries makes the operations a bit complicated.The business generates $3 billion in Americas, $1.6 billion in Europe, and $0.9 billion in Asia. The product itself is sourced from 23 countries (no country accounting for more than 20%).

In terms of future growth, company wishes to  continue growing the profitable core (the five countries of US, UK, France, Mexico and Germany which together contribute 63 % of revenue and which have Levi’s operating as the leader brand (except for Germany) in its category. And then, expand the under-penetrated markets (China is still 3% of its revenue).

The Numbers

Here’s a quick look at the numbers.

A few notes on the numbers:

  • Revenue growth has picked up a lot in the most recent financial year. (13.7% in 2018 compared to 7.7%, 1.3% and negative 5.5% in the previous years).  Exceptional for a large consumer business like this one. Mainly from Europe ~20.8% in constant currency.
  • 26% of total revenue is direct from Levi’s stores of around 1.3 billion or average per store $1.7 million (very rough. 824 company owned store get 26% of net revenue per the sheet)
  • Mixed Gross Profit of 53.8% (better than prior years – channel mix effect? or something better?)
  • Advertising and promotions 7.2% of net revenue or $400 million in FY18. (against $323 of FY17, and 6.2% of FY16)
  • Operating Income of 9.6%. (not much better, in fact worse than 2016)
  • Adjusted EBITDA of 12.7% which has been consistent through the years.
  • Relatively low FCF in 2018. (Why?)  Leverage ratio seems to have improved with low net debt in 2018. (Again Why?)
  • Back of the envelope:  Equity Valuation expected of around $5.8 billion (assuming dilution of 2.5%?).Net Debt is $ 339 million. So EV of around $6.2 or around 9 times 2018 EBITDA (??)

 

As one looks at the numbers, potential growth and the market Levi’s operates in and to contextualise the revenue growth, worth looking at the comparison Bloomberg draws with ‘Athleisure’

“Denim has been fighting with leggings and “athleisure” for its share of the casual clothing market. It’s been tough, with imports of elastic knit pants surpassing those of denim for the first time in 2017. But the one-time staple of American closets has recently staged the beginning of a comeback: The jeans category in the U.S. grew 2.2 percent to $16.7 billion in 2018 after four straight years of declines, according to data from Euromonitor.

The company had been slow to incorporate the comfort of yogawear into its styles by adding stretch, but those efforts eventually paid off, particularly in women’s clothing, which has grown in the double-digits for eight straight quarters and currently represents almost a third of total sales. Global revenue climbed 14 percent in fiscal 2018 from a year earlier.”

BoF/Bloomberg

At $16.7 billion, the jeans market in US is still not yet at its 2015 levels ($17.3 billion) which were lower than 2013 sales of $18.8 billion. A declining market just picking up? Perhaps here, would be worth noting the size of the active wear category itself. A recent New Yorker piece on Outdoor Voices, a new active-wear company yet to break even.

“According to one research firm, the activewear market is now a fifty-five-billion-dollar industry, and accounts for nearly a quarter of all U.S. apparel sales. “

So in terms of valuation, one needs to consider whether the recent growth is long term sustainable and what about the denim category itself?

As one of the risk factors, the company mentions:

Intense competition in the global apparel industry could lead to reduced sales and prices.

We face a variety of competitive challenges in the global apparel industry from a variety of jeanswear, athleisure and casual apparel companies, and competition has increased over the years due to factors such as:

  • the international expansion and increased presence of vertically integrated specialty stores;
  • expansion into eCommerce by existing and new competitors;
  • the proliferation of private labels and exclusive brands offered by department stores, chain stores and mass channel retailers;
  • the introduction of lines of jeans, athleisure and casual apparel by well-known and successful athletic wear companies; and
  • the transition of apparel companies who traditionally relied on wholesale distribution channels into their own retail distribution network.”

 

Dual-Class Shares

And then, one needs to consider that the shares being offered come with a Dual-Class structure.

Following this offering, we will have two classes of common stock: Class A common stock and Class B common stock. The rights of the holders of Class A common stock and Class B common stock are identical, except with respect to voting, conversion and transfer.

Following this offering, the holders of outstanding shares of Class B common stock will hold approximately 99% of the voting power of our outstanding capital stock and will have the ability to control the outcome of matters submitted to our stockholders for approval, including the election of our directors and the approval of any change in control transaction. See “Description of Capital Stock.”

Levi’s is another of those new-age IPOs which plans a dual-class share structure. The dual-class share structure in this case though comes with some sort of sunset in case of transfers and in the case that the total portion falls below 10%.

Following is from the prospectus on the difference in voting:

“Each share of Class A common stock will be entitled to one vote per share, and each share of Class B common stock will be entitled to ten votes per share. The Class A common stock and Class B common stock will vote together on all matters (including the election of directors) submitted to a vote of stockholders, except under limited circumstances described in “Description of Capital Stock—Class A Common Stock and Class B Common Stock—Voting Rights.”

And the related conversion requirement (see underlined).

“Conversion

Each share of Class B common stock is convertible at any time at the option of the holder into one share of Class A common stock. In addition, each share of Class B common stock will convert automatically into one share of Class A common stock upon any transfer, except for certain transfers described in our amended and restated certificate of incorporation. In addition, all Class B common stock will convert automatically into Class A common stock on the last day of the fiscal quarter during which the then-outstanding shares of Class B common stock first represent less than 10% of the aggregate number of shares of the then-outstanding Class A common stock and Class B common stock; provided, that if the first day the shares of Class B common stock first represent less than 10% of the aggregate number of shares of the then-outstanding Class A common stock and Class B common stock occurs within 15 days of the end of a fiscal quarter, such conversion will occur on the last day of the following fiscal quarter.”

 

My impression

Prima facie,  the valuation may not look unreasonable if the company could sustain the growth. And that’s the main caveat, along with:

  • To note that Levi’s is a leader, in a declining market. On a quick look, doesn’t seem like the strategy mentions any new plans to tackle the active wear market. Although one would think that with its infrastructure and its presence, it is a possibility?  Seems like the revenue growth is owed to reduced dependence on men’s wear, and also shows a trend of reduced dependence on bottoms (the growth attributed to new categories in a way – women’s and tops and accessories). The first question is how long is the trend sustainable? And the next is that as there is little information on levels of inventory write-downs etc., and since one gets wary when new lines (products/geographies) of businesses contribute to revenue since the older seasons’ inventory is yet to pass muster for next ones. And the new lines (female, non-bottom wear) are more likely to be seasonal ones than the standard jeanswear. The next few seasons will reveal how it plays out. Just something to keep in mind as one looks at their exceptional 2018 and potential future.
  • The shares carry very little voting rights. Just economic rights.
  • And the offering is primarily to create liquidity for existing shareholders to allow them to offload stake on the IPO or over the following period. Very little funds go to the company’s use.

Eventually it all depends on what returns one is looking for and where else can one deploy funds.


Note: All views are personal. The objective of the note is to get a perspective on the business. I have referred several web-links and data points for this note. Still, the numbers may not be exact, but they are close enough or approximated to get the broad picture. Happy to be corrected if you spot any glaring errors of fact or thinking. And keen to hear more on the open questions.

 

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