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CIO Of One Of The World’s Most Successful Hedge Funds Presents His Top Long And Short
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What You’ll Learn
- Iconix has fallen close to 80% YTD and is not worth $7
- A look at the valuation of ICON using 4 different angles
- What a good entry price for ICON is
A picture is worth a thousand words.
So much has happened that a quick recap of Iconix’s woes reveals how much trouble it’s fallen into.
- Absurd CEO compensation history
- SEC investigating accounting issues at the beginning of the year
- CEO/chairman quits
- COO quits
- CFO quits
- Shifting in timing of revenue for the The Peanuts movie launch
- Decline of men’s brands
- Multiple lowering of earnings guidance.. by a lot..
- 3 years of financials have to be restated
The recent 52% drop and the effect it has had on the stock is staggering. Here’s a good article going over the possible accounting shenanigans, its effects and an updated valuation.
But I want to look at what the market is factoring in and try to kill the investment further to see whether it makes sense as an investment.
If the current price of $7 over corrected the realistic penalties and cash that Iconix (ICON) has to dish out to fix itself, it’s a great opportunity.
If however, the accounting is so bad that everything has been materially overstated, and the brands continue to decline, it’s overpriced at $7.
At this time, it’s not important what Iconix is exactly worth. What’s important is to be confident in whether Iconix is cheap or not.
I’m not interested in whether ICON is worth $11.34 or $15.64.
I’d be happy with both.
My decision process is to figure out whether $11 is more realistic than $5.
You don’t have to know a man’s exact weight to know that he’s fat. – Ben Graham
Bear Case Earnings Valuation Using the Graham Model
I use multiple valuation methods as a way to look at the company from different angles to see how it stacks up.
With these situations, I always prefer doing some sort of reverse valuation as you can gauge what the market is expecting. Problem is that for ICON, we don’t know the exact numbers.
Plus, instead of placing too much faith on a single valuation method, using different valuation techniques can help you stay objective and not get too excited that you found an undervalued stock.
EPS is now expected to be between $1.35 and $1.40, but with any financial restatement, we don’t know what other cockroaches will come out.
I’ve had plenty of experience seeing companies provide lower guidance, only to reduce it further in a few months. If anything else shows up in Iconix’s books, expect this number to go down.
So let’s chop off an extra arm to try and really kill Iconix and see whether it can still offer anything.
The EPS I’m going down to is $1.10.
Yes ridiculously low. In fact, it’s what the company achieved in 2009.
But take a look at the numbers for yourself.
- EPS is $1.10
- 0% growth rate
Intrinsic value = $8.24
ICON Graham “What If” Valuation | Enlarge
“What If” Cases Using Revenue and EBIT
With restatements affecting operating income, charges to be made for incorrect tax filings and accounting reviews, using revenue and EBIT will make it slightly easier to see from a higher vantage point.
Licensing revenue is now expected to be between $370 million and $380 million, down from a previous range of $410 million to $425 million.
The assumption that I’ll make here is that licensing slows down further as the brands continue to struggle.
Instead of $370-380m in revenue, let’s adjust it down to $330m which is what the company did in 2010.
Again, very low ball assumptions to try and kill the investment.
Due to the issues surrounding Iconix, let’s use very EBIT conservative multiples.
- Conservative case multiple: 7x EBIT
- Normal case: 10x EBIT
- Aggressive case: 12x EBIT
Reduce the cash and short+long term investments balance to $200m to pay for all the charges and any extras Iconix has to take.
Here is what Iconix looks like under these assumptions.
Personally, 7x EV/EBIT at $350m in revenue isn’t realistic.
Even I know that.
But 10x is realistic as it has been the 5 year average with 13x being on the high end.
However, if you think 10x is too optimistic, using a multiple of 9x gives a fair value of $10.41.
What About Multiples?
Free cash flow is going to come way down too.
In 2014, it did $161m and the TTM was $177m.
Let’s continue with the Iconix trashing theme and bring FCF down to $100m based on the low balling of EPS I’m using.
That gives Iconix a P/FCF ratio of 3.62.
From 2008 to 2014, the average P/FCF ratio has been 8.9. Even with the accounting issues, 3.6 is extraordinarily low.
How Much Does it Cost to Replicate the Business?
If a brand new competitor came along, how much would they have to spend up front to reproduce what Iconix has?
You’ll have to focus on the balance sheet to answer this question and I use the Net Reproduction Value method that is part of the Earnings Power Value method created and taught by Prof Greenwald of Columbia University.
Essentially, you go through each item of the balance sheet and adjust it up or down based on what a competitor would pay if they were to reproduce the same asset from scratch.
By simplifying the calculations using the old school value analyzer, I get a net reproduction value of $57 per share. What this means is that a competitor would have to pay $57 per share to obtain the same assets, sales and marketing reach to start competing with Iconix.
In other words, the current price of $7 is a huge discount to the price tag if Iconix put itself up for sale.
Iconix is down in the dumps, but any way I cut it, value is there.
There’s a ton of uncertainty and jitters priced into the stock, but as long as;
- the business fundamentals do not fall off the cliff
- and the restatements are not drastically worse than anyone anticipated
$7 looks like a great entry point.
I’m not concerned about what the exact intrinsic value is at this point. All I need to know is that it is higher than $7.
No position at the moment, but looking to start one.
This post was first published at old school value.
You can read the original blog post here Iconix Is Down 80% YTD and Looks Dirt Cheap.
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