Fair Warning: Crocs Is a Legit LBO Target

Why does CROX trade at ~$16 per share today? In 2007, the stock was heavily shorted as many people thought the business was a one-hit wonder. By the end of 2008 the business was $1/share, with its auditors issuing a going-concern qualification, citing operational losses among other things.

CROX is not a one-hit wonder. As proof, CROX has grown revenue since 2008 at a CAGR of ~12%, while EBITDA has turned from (-$70) million in 2008 to ~$200 million in 2012. The business is currently trading at ~6x EBITDA multiple, primarily due to this misplaced one-hit wonder stigma, especially since growth rates help its valuation case versus peers.

LBO Potential
A private equity buyer could take Croc’s private at ~8.5x EBITDA, with modest leverage. Including off-balance sheet operating leases, the lease adjusted leverage is only 2x today, that could support at least an additional 4x. The PE firm would need to bring retail expertise in order to help execute on the strategy. With a 20% 5 yr IRR and a sizable equity check, Crocs seems as though it would attract interest from Leonard Green Partners or Golden Gate Capital, among others. Additionally, Apax Partners recently agreed to purchase Cole Haan from Nike for $570 million in cash.

Relevant Comps
Deckers Outdoor Corp (Ticker: DECK) is primarily known for the UGG brand among others including, Teva, Sanuk, and other brands all over the world. DECK does $1.4 billion of revenues and trades at ~8x EBITDA of ~$220 million and generates somewhat volatile free cash flow. DECK has a clean balance sheet and is very comparable to Crocs.

Steve Madden (Ticker: SHOO) SHOO does $1.3 billion of revenues and trades at ~10x EBITDA of ~$200 million and generates strong free cash flow ($100+m annually). SHOO also has a clean balance sheet and is a very comparable business to Crocs.

Wolverine World Wide (Ticker: WWW) is known for making a wide range of casual footwear and apparel, performance outdoor footwear (Sperry brand) and apparel, industrial work shoes, boots and apparel, and uniform shores and boots. WWW also owns 89 retail stores in North America and 12 in the U.K. WWW does $2.0 billion of revenues and trades at ~16x EBITDA of ~$220 million and generates strong unlevered free cash flows (levered at ~6x).

Skechers USA (Ticker: SKX) is a lifestyle brand for men, women and children, and performance footwear for men and woman under several lines. SKX does $1.6 billion of sales (3% decline yoy) and trades at ~14x EBITDA of $67 million and has volatile cash flows. More recently, SKX settled a lawsuit with for $50 million over its “toning” shoes.

Overall, these branded shoe/lifestyle businesses all trade for reasonably rich EBITDA multiples (>8x) which all capture the brand value of those businesses. CROX has a similarly strong brand compared to the peer group and at today’s multiple of ~6x the market is not giving any value to the Crocs brand. The following catalysts should lead to the closing of this valuation gap.

Catalysts
There are several catalysts fueling the CROX long call: (i) New share buyback program utilizing amended Credit Facility, (ii) Strong growth in Asia, (iii) LBO by PE firm with retail expertise and (iv) Latin American market growth.

In December 2012, the Company expanded its revolving credit line to $100 million from $70 million and also reduced the cost by 50 bps. More importantly, Section 8.2.5 of the Credit Agreement was amended from a very restrictive covenant with a $25 million buyback cap (restricted payments basket) to a $150 million ($50m quarterly) buyback cap or ~10% of the market cap. Additionally, there is a loose 3.25x maximum leverage ratio covenant. Coincidently, it should be noted that the Company bought ~$25 million of stock back in 2012.

The business has been booming in Asia Pacific with sales growing nearly 33% year over year (constant currency) in 1Q 13. Most importantly, the Asia pacific region has the highest operating margins of ~30% compared to ~17% in the Americas. New store openings in Asia should continue to drive strong returns on invest capital as these stores generally have 1 year payback periods with minimal capital investment of ~$140k. The Company is also embarking on an aggressive retail strategy as it now represents ~30% of sales, but will likely be closer to 50% of revenues in a few years.

Latin America market is an attractive opportunity for Croc’s to enter warm climate markets. CFO is quoted in a May ‘12 issue of CFO magazine saying “A big growth opportunity is expanding into countries like Brazil, Argentina, India, and South Africa, where we don’t have much of a portfolio or distribution network today”.

Compelling Long-Term Value
In summary, Croc’s is a real diversified shoe brand that is here to stay after having achieved more than $1 billion revenues in each of the past two years. None of the comparable companies are arguably better, nor do they deserve higher multiples. Crocs brand recognition is amongst the highest in the peer group as well as its current growth rate. For these reasons, I believe the valuation gap will close within a 12-month horizon, particularly given the strong buyback catalyst.