CHICOS FAS INC CHS
October 07, 2015 - 1:06am EST by
pfq783
2015 2016
Price: 15.04 EPS 0 0
Shares Out. (in M): 139 P/E 0 0
Market Cap (in M): 2,085 P/FCF 14 10
Net Debt (in M): -60 EBIT 180 233
TEV: 2,025 TEV/EBIT 11.25 8.69

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Description

Chico’s is trading at a pro forma 10%+ FCF yield, with no net debt, and appears to reflect little value for optionality that reported talks with private equity will lead to an LBO.

Chico’s is a specialty retailer catering to 40+ year-old women with disposable income.  It has four businesses (soon to be three), but does not break out profitability:

  1. Chico’s – Founded in the 1980’s, the footprint is essentially mature.  Stores have grown 1-2% per year since 2007.  Now up to 740 stores.  Print and color-oriented fashions.

 

  1. WH | BM – Also founded in the 80’s, CHS ramped up the growth after 2010, now up to 514 stores.  Black and white fashions.

 

  1. Soma Intimates – A buried gem.  Underwear / bras (think more functional vs. Victoria Secret sexy).  25 straight quarters of positive comps.  The chain has grown to 300 stores today and is reaching national scale.  Stores take 5-6 years to mature as customers take time to change their habits in this area.

 

  1. Boston Proper (closing) – Strike out.  Direct to consumer fashion catalog business purchased by current CEO for $200mm in 2011.  Store rollout was a bust.

The write-up uses OCF and FCF (OCF – capex) for valuation and shies away from EBITDA.  Cash rent expense is higher than GAAP expense due to deferred rent and lease credits.

CHS overall comps have been stable but middling the past few years.  Company OCF has dropped from a peak of $360mm in 2012 to $240mm today, with FCF declining similarly from a $220mm peak to $145mm:

 

Chico's                                                  
                                                     
          May '11     Feb '12   May '12     Feb '13   May '13     feb '14   May '14     Feb '15   May '15  
          Q1 Q2 Q3 Q4   Q1 Q2 Q3     Q1 Q2 Q3 Q4   Q1 Q2 Q3 Q4   Q1 Q2
                                                     
Shares out       176.2 172.2 167.7 167.4   167.7 166.0 166.4 163.1   162.2 160.8 158.8 153.1   153.2 152.8 152.9 154.2   143.4 139.3
                                                     
Net sales         537 551 539 569   651 642 637 652   671 650 656 610   682 671 666 657   693 680
COGS         -219 -242 -237 -271   -272 -280 -272 -305   -284 -293 -292 -301   -299 -320 -302 -329   -298 -314
Gross profit       318 309 301 298   379 362 364 347   387 356 364 310   383 351 364 328   396 366
% margin       59.1% 56.1% 56.0% 52.3%   58.2% 56.4% 57.2% 53.2%   57.7% 54.8% 55.5% 50.7%   56.2% 52.4% 54.7% 50.0%   57.1% 53.8%
                1,226   1,287 1,340 1,403 1,452   1,460 1,454 1,454 1,417   1,413 1,408 1,408 1,426   1,439 1,454
                                                     
SG&A         -245 -240 -255 -259   -292 -276 -297 -296   -305 -286 -309 -261   -319 -305 -322 -318   -328 -308
Restructuring / impairments     0 0 -5 0   -1 0 0 -2   0 0 -72 -1   0 0 0 -17   -15 -83
Operating income       73 69 42 39   86 86 67 49   82 70 -17 47   64 47 42 -6   53 -26
% margin       13.6% 12.5% 7.8% 6.8%   13.3% 13.4% 10.5% 7.5%   12.2% 10.8% -2.6% 7.8%   9.4% 7.0% 6.3% -1.0%   7.6% -3.8%
Adj. % margin       13.6% 12.5% 8.7% 6.8%   13.4% 13.4% 10.5% 7.8%   12.2% 10.8% 8.5% 7.9%   9.4% 7.0% 6.3% 1.6%   9.7% 8.5%
                                                    180
(+) D&A       24 24 25 26   26 27 27 28   29 30 29 30   30 30 30 32   31 31
(+) stk comp       4 5 3 4   5 6 8 8   7 7 5 8   6 6 7 6   8 6
(+) Restructuring / impairments / other 0 0 5 0   1 0 0 2   0 0 72 1   0 0 0 17   17 83
Adj. EBITDA       101 98 74 69   118 118 102 87   119 106 90 86   100 83 80 49   108 95
% margin       18.7% 17.8% 13.8% 12.2%   18.2% 18.4% 16.1% 13.3%   17.7% 16.3% 13.8% 14.1%   14.7% 12.4% 12.0% 7.4%   15.6% 13.9%
LTM               342   360 380 408 426   426 414 402 401   383 360 349 312   320 331
                                                     
Interest         0.4 0.4 0.6 0.2   0.2 0.2 0.2 0.2   0.2 0.1 0.1 0.1   0.0 -0.1 0.0 0.1   -0.5 -0.5
PBT         73.2 69.4 42.6 38.8   86.6 86.0 66.9 49.3   82.1 70.0 -16.9 47.4   63.9 46.6 42.3 -6.2   52.2 -26.0
Taxes         -27.3 -26.0 -16.1 -13.7   -32.9 -32.6 -25.2 -17.5   -30.1 -26.4 -11.6 -7.7   -24.0 -16.6 -15.8 4.6   -19.7 28.2
Net income       45.9 43.4 26.5 25.1   53.7 53.4 41.7 31.8   52.0 43.6 -28.5 39.7   39.9 30.0 26.5 -1.6   32.5 2.2
  Tax rate       37.3% 37.5% 37.8% 35.3%   38.0% 37.9% 37.7% 35.5%   36.6% 37.7% -68.7% 16.2%   37.6% 35.6% 37.4% 73.6%   37.7% 108%
                                                     
OCF         77 46 59 74   137 89 64 78   63 80 32 62   67 86 28 101   42 70
Addback excess tax benefit from stk comp 1 1 0 1   3 0 3 1   1 0 0 1   1 0 0 0   2 0
Capex         -16 -40 -42 -34   -41 -38 -41 -45   -35 -37 -42 -25   -35 -28 -35 -22   -20 -23
FCF         62 6 17 41   99 51 27 35   30 43 -10 38   34 58 -7 80   24 48
  LTM FCF             126   164 208 218 212   142 134 98 101   105 120 122 165   155 145
  LTM OCF             255   315 358 364 368   295 286 253 237   241 247 243 282   257 241
  LTM Capex           -132   -156 -154 -153 -165   -158 -158 -158 -139   -138 -130 -123 -120   -105 -100
                                                     
Deferred rent and lease in OCF     -4 -5 -5 -5   -4 -4 -4 -5   -4 -4 -5 -6   -5 -5 -5 -6   -4 -5
Share repurchase       -37 -61 -60 -25   -3 -26 -12 -70   -62 -28 -36 -125   -6 -10 -1 -1   -258 0

 

CHS has operated in growth mode for the last decade, as it opened net stores even through the recession.  Capex was elevated from 100+ store openings in each of the past four years.  Corporate HQ expanded.  Boston Proper happened and capital allocation was not a strong point.  Until Q1 of this year, CHS had not seen layoffs since cutting 10% of HQ staff in 2009.

Today, CHS has scaled back future store openings (except Soma), cut capex, found SG&A savings, is closing/selling Boston Proper, and is culling about 10% of the store base over the next 3 years for additional profitability.

CHS is trading at an unlevered 10% FCF yield, pro forma for a few “in the bag” adjustments:  

CHS announced $65mm of pre-tax expected savings from closing 150 stores over the next three years.   Based on the footprint, I estimate $10mm of the $65mm is non-cash D&A.  Taxing the remaining $55mm leaves an incremental $34mm for FCF by the end of the third year.

$208mm + $34mm = $242mm = 12.1% FCF

Note the FCF yields are quoted against CHS market cap, and make no adjustment for net cash or net tangible assets, which would push the yields a bit higher.

Deal Optionality

In February 2015, Sycamore was reported to be in advanced talks to purchase CHS:  http://www.wsj.com/articles/private-equity-firm-in-advanced-talks-to-buy-chicos-fas-1423604404

2 weeks later, abandons the effort:  http://www.wsj.com/articles/sycamore-partners-abandons-attempt-to-buy-chicos-fas-1424823457

Reuters said they had an agreement-in-principle and NYT quoted “upward of $3B” (http://dealbook.nytimes.com/2015/02/10/chicos-clothing-stores-near-sale-to-sycamore-partners/?smid=tw-dealbook&seid=auto)

Assuming that refers to market cap, $3B would have been a ~$19.50 deal.  After six months of cash flow and execution of an ASR, a deal today at the same enterprise value would be priced at $20.50.

Last month, Bloomberg reported that Sycamore and others had re-approached CHS about an LBO:  http://www.bloomberg.com/news/articles/2015-09-11/chico-s-said-to-weigh-sale-amid-new-interest-from-private-equity

Last week, Reuters reported that Sycamore’s bid again faced obstacles, and the stock now actually trades a touch below where it was before Bloomberg’s report that talks had rekindled:  (http://www.reuters.com/article/2015/10/02/us-chico-s-fas-m-a-sycamorepartners-idUSKCN0RW1Z720151002).

I think the probability of a sale is 50%, with an expected price of $19 – 20.  Major factors in my thinking:

  1. The math works.  Borrow 5.8x EBITDA at an avg coupon of 7.5% and it only takes a $750mm check for the equity.  Adjusted FCF is a 15% yield on that check.  Pro forma for store closures three years out, it’s a 20% levered yield.  Interest is covered well over 2x.  Upside to more aggressive financing, Soma growth, operational improvement, further SG&A saves, cutting capex.  I think all the above FCF adjustments are on the conservative side.

  2. CHS CEO is retiring in the spring and owns 1% of the company.  He sold his two previous companies (Lands End to Sears and Hilfiger to Apax).  Should be a proponent (or at least not an obstacle) to shareholders voting on whether the best deal price is an acceptable premium.

 

  1. Sycamore is very savvy.  I am inclined to think they will pull any lever to get a price cut, including negotiating in the press.  This deal would be funded from their 2nd fund ($2.5B) after their 1st fund ($1B) was a home run, so the deal means a lot more to Sycamore than it would to one of the mega funds, which means more incentive to act sharply.  Precedent lies with how they cut price in the Talbots deal (the background in that proxy is a fun read).

 

  1. Talbots, a CHS competitor, proved to be a fantastic deal.  Sycamore should run the same playbook:  cut SG&A costs, run the business well for a season or two and take big money out via dividends https://www.moodys.com/research/Moodys-assigns-B3-Corporate-Family-Rating-to-Talbots--PR_294069.  From another Moody’s report:  “Through the last four quarters ended May 2, 2015 Talbots has grown revenue in the high single digit range, improved its EBITDA margin, and increased Moody's adjusted EBITDA by almost 30%.”  I think CHS’s growth and success has probably left them marbled with opportunity to cut costs and capital spending.     

Some risks and points against:

  1. Federal Reserve guidance cautioning banks from leveraged loan commitments > 6.0x EBITDA.  Banks don’t want more trouble with regulators, and there are no bright lines on how strict the 6.0x really is, which if any EBITDA adjustments are acceptable, how leases should be treated, penalties for violation, etc.  Deals are getting done, but financing is not the smooth process it used to be:  SLH sale to Vista used a preferred equity commitment, BEE sale to Blackstone has “fill in the blank” financing with BX being big enough to commit to whatever the equity check ends up being, etc.

 

  1. If the HY market hiccup turns into a major buyers strike.

 

  1. If the negative data-point on CHS’ Q2 call marks the start of a trend.  On the call, the CEO cited a ship collision in China for why comps trended down 4% in early Q3, although CHS thought they weren’t indicative of the current business and kept guidance intact.
I hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Sale to private equity

Further capital investment into repurchasing shares trading at unlevered 10%+ pro forma FCF yield

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    Description

    Chico’s is trading at a pro forma 10%+ FCF yield, with no net debt, and appears to reflect little value for optionality that reported talks with private equity will lead to an LBO.

    Chico’s is a specialty retailer catering to 40+ year-old women with disposable income.  It has four businesses (soon to be three), but does not break out profitability:

    1. Chico’s – Founded in the 1980’s, the footprint is essentially mature.  Stores have grown 1-2% per year since 2007.  Now up to 740 stores.  Print and color-oriented fashions.

     

    1. WH | BM – Also founded in the 80’s, CHS ramped up the growth after 2010, now up to 514 stores.  Black and white fashions.

     

    1. Soma Intimates – A buried gem.  Underwear / bras (think more functional vs. Victoria Secret sexy).  25 straight quarters of positive comps.  The chain has grown to 300 stores today and is reaching national scale.  Stores take 5-6 years to mature as customers take time to change their habits in this area.

     

    1. Boston Proper (closing) – Strike out.  Direct to consumer fashion catalog business purchased by current CEO for $200mm in 2011.  Store rollout was a bust.

    The write-up uses OCF and FCF (OCF – capex) for valuation and shies away from EBITDA.  Cash rent expense is higher than GAAP expense due to deferred rent and lease credits.

    CHS overall comps have been stable but middling the past few years.  Company OCF has dropped from a peak of $360mm in 2012 to $240mm today, with FCF declining similarly from a $220mm peak to $145mm:

     

    Chico's                                                  
                                                         
              May '11     Feb '12   May '12     Feb '13   May '13     feb '14   May '14     Feb '15   May '15  
              Q1 Q2 Q3 Q4   Q1 Q2 Q3     Q1 Q2 Q3 Q4   Q1 Q2 Q3 Q4   Q1 Q2
                                                         
    Shares out       176.2 172.2 167.7 167.4   167.7 166.0 166.4 163.1   162.2 160.8 158.8 153.1   153.2 152.8 152.9 154.2   143.4 139.3
                                                         
    Net sales         537 551 539 569   651 642 637 652   671 650 656 610   682 671 666 657   693 680
    COGS         -219 -242 -237 -271   -272 -280 -272 -305   -284 -293 -292 -301   -299 -320 -302 -329   -298 -314
    Gross profit       318 309 301 298   379 362 364 347   387 356 364 310   383 351 364 328   396 366
    % margin       59.1% 56.1% 56.0% 52.3%   58.2% 56.4% 57.2% 53.2%   57.7% 54.8% 55.5% 50.7%   56.2% 52.4% 54.7% 50.0%   57.1% 53.8%
                    1,226   1,287 1,340 1,403 1,452   1,460 1,454 1,454 1,417   1,413 1,408 1,408 1,426   1,439 1,454
                                                         
    SG&A         -245 -240 -255 -259   -292 -276 -297 -296   -305 -286 -309 -261   -319 -305 -322 -318   -328 -308
    Restructuring / impairments     0 0 -5 0   -1 0 0 -2   0 0 -72 -1   0 0 0 -17   -15 -83
    Operating income       73 69 42 39   86 86 67 49   82 70 -17 47   64 47 42 -6   53 -26
    % margin       13.6% 12.5% 7.8% 6.8%   13.3% 13.4% 10.5% 7.5%   12.2% 10.8% -2.6% 7.8%   9.4% 7.0% 6.3% -1.0%   7.6% -3.8%
    Adj. % margin       13.6% 12.5% 8.7% 6.8%   13.4% 13.4% 10.5% 7.8%   12.2% 10.8% 8.5% 7.9%   9.4% 7.0% 6.3% 1.6%   9.7% 8.5%
                                                        180
    (+) D&A       24 24 25 26   26 27 27 28   29 30 29 30   30 30 30 32   31 31
    (+) stk comp       4 5 3 4   5 6 8 8   7 7 5 8   6 6 7 6   8 6
    (+) Restructuring / impairments / other 0 0 5 0   1 0 0 2   0 0 72 1   0 0 0 17   17 83
    Adj. EBITDA       101 98 74 69   118 118 102 87   119 106 90 86   100 83 80 49   108 95
    % margin       18.7% 17.8% 13.8% 12.2%   18.2% 18.4% 16.1% 13.3%   17.7% 16.3% 13.8% 14.1%   14.7% 12.4% 12.0% 7.4%   15.6% 13.9%
    LTM               342   360 380 408 426   426 414 402 401   383 360 349 312   320 331
                                                         
    Interest         0.4 0.4 0.6 0.2   0.2 0.2 0.2 0.2   0.2 0.1 0.1 0.1   0.0 -0.1 0.0 0.1   -0.5 -0.5
    PBT         73.2 69.4 42.6 38.8   86.6 86.0 66.9 49.3   82.1 70.0 -16.9 47.4   63.9 46.6 42.3 -6.2   52.2 -26.0
    Taxes         -27.3 -26.0 -16.1 -13.7   -32.9 -32.6 -25.2 -17.5   -30.1 -26.4 -11.6 -7.7   -24.0 -16.6 -15.8 4.6   -19.7 28.2
    Net income       45.9 43.4 26.5 25.1   53.7 53.4 41.7 31.8   52.0 43.6 -28.5 39.7   39.9 30.0 26.5 -1.6   32.5 2.2
      Tax rate       37.3% 37.5% 37.8% 35.3%   38.0% 37.9% 37.7% 35.5%   36.6% 37.7% -68.7% 16.2%   37.6% 35.6% 37.4% 73.6%   37.7% 108%
                                                         
    OCF         77 46 59 74   137 89 64 78   63 80 32 62   67 86 28 101   42 70
    Addback excess tax benefit from stk comp 1 1 0 1   3 0 3 1   1 0 0 1   1 0 0 0   2 0
    Capex         -16 -40 -42 -34   -41 -38 -41 -45   -35 -37 -42 -25   -35 -28 -35 -22   -20 -23
    FCF         62 6 17 41   99 51 27 35   30 43 -10 38   34 58 -7 80   24 48
      LTM FCF             126   164 208 218 212   142 134 98 101   105 120 122 165   155 145
      LTM OCF             255   315 358 364 368   295 286 253 237   241 247 243 282   257 241
      LTM Capex           -132   -156 -154 -153 -165   -158 -158 -158 -139   -138 -130 -123 -120   -105 -100
                                                         
    Deferred rent and lease in OCF     -4 -5 -5 -5   -4 -4 -4 -5   -4 -4 -5 -6   -5 -5 -5 -6   -4 -5
    Share repurchase       -37 -61 -60 -25   -3 -26 -12 -70   -62 -28 -36 -125   -6 -10 -1 -1   -258 0

     

    CHS has operated in growth mode for the last decade, as it opened net stores even through the recession.  Capex was elevated from 100+ store openings in each of the past four years.  Corporate HQ expanded.  Boston Proper happened and capital allocation was not a strong point.  Until Q1 of this year, CHS had not seen layoffs since cutting 10% of HQ staff in 2009.

    Today, CHS has scaled back future store openings (except Soma), cut capex, found SG&A savings, is closing/selling Boston Proper, and is culling about 10% of the store base over the next 3 years for additional profitability.

    CHS is trading at an unlevered 10% FCF yield, pro forma for a few “in the bag” adjustments:  

    CHS announced $65mm of pre-tax expected savings from closing 150 stores over the next three years.   Based on the footprint, I estimate $10mm of the $65mm is non-cash D&A.  Taxing the remaining $55mm leaves an incremental $34mm for FCF by the end of the third year.

    $208mm + $34mm = $242mm = 12.1% FCF

    Note the FCF yields are quoted against CHS market cap, and make no adjustment for net cash or net tangible assets, which would push the yields a bit higher.

    Deal Optionality

    In February 2015, Sycamore was reported to be in advanced talks to purchase CHS:  http://www.wsj.com/articles/private-equity-firm-in-advanced-talks-to-buy-chicos-fas-1423604404

    2 weeks later, abandons the effort:  http://www.wsj.com/articles/sycamore-partners-abandons-attempt-to-buy-chicos-fas-1424823457

    Reuters said they had an agreement-in-principle and NYT quoted “upward of $3B” (http://dealbook.nytimes.com/2015/02/10/chicos-clothing-stores-near-sale-to-sycamore-partners/?smid=tw-dealbook&seid=auto)

    Assuming that refers to market cap, $3B would have been a ~$19.50 deal.  After six months of cash flow and execution of an ASR, a deal today at the same enterprise value would be priced at $20.50.

    Last month, Bloomberg reported that Sycamore and others had re-approached CHS about an LBO:  http://www.bloomberg.com/news/articles/2015-09-11/chico-s-said-to-weigh-sale-amid-new-interest-from-private-equity

    Last week, Reuters reported that Sycamore’s bid again faced obstacles, and the stock now actually trades a touch below where it was before Bloomberg’s report that talks had rekindled:  (http://www.reuters.com/article/2015/10/02/us-chico-s-fas-m-a-sycamorepartners-idUSKCN0RW1Z720151002).

    I think the probability of a sale is 50%, with an expected price of $19 – 20.  Major factors in my thinking:

    1. The math works.  Borrow 5.8x EBITDA at an avg coupon of 7.5% and it only takes a $750mm check for the equity.  Adjusted FCF is a 15% yield on that check.  Pro forma for store closures three years out, it’s a 20% levered yield.  Interest is covered well over 2x.  Upside to more aggressive financing, Soma growth, operational improvement, further SG&A saves, cutting capex.  I think all the above FCF adjustments are on the conservative side.

    2. CHS CEO is retiring in the spring and owns 1% of the company.  He sold his two previous companies (Lands End to Sears and Hilfiger to Apax).  Should be a proponent (or at least not an obstacle) to shareholders voting on whether the best deal price is an acceptable premium.

     

    1. Sycamore is very savvy.  I am inclined to think they will pull any lever to get a price cut, including negotiating in the press.  This deal would be funded from their 2nd fund ($2.5B) after their 1st fund ($1B) was a home run, so the deal means a lot more to Sycamore than it would to one of the mega funds, which means more incentive to act sharply.  Precedent lies with how they cut price in the Talbots deal (the background in that proxy is a fun read).

     

    1. Talbots, a CHS competitor, proved to be a fantastic deal.  Sycamore should run the same playbook:  cut SG&A costs, run the business well for a season or two and take big money out via dividends https://www.moodys.com/research/Moodys-assigns-B3-Corporate-Family-Rating-to-Talbots--PR_294069.  From another Moody’s report:  “Through the last four quarters ended May 2, 2015 Talbots has grown revenue in the high single digit range, improved its EBITDA margin, and increased Moody's adjusted EBITDA by almost 30%.”  I think CHS’s growth and success has probably left them marbled with opportunity to cut costs and capital spending.     

    Some risks and points against:

    1. Federal Reserve guidance cautioning banks from leveraged loan commitments > 6.0x EBITDA.  Banks don’t want more trouble with regulators, and there are no bright lines on how strict the 6.0x really is, which if any EBITDA adjustments are acceptable, how leases should be treated, penalties for violation, etc.  Deals are getting done, but financing is not the smooth process it used to be:  SLH sale to Vista used a preferred equity commitment, BEE sale to Blackstone has “fill in the blank” financing with BX being big enough to commit to whatever the equity check ends up being, etc.

     

    1. If the HY market hiccup turns into a major buyers strike.

     

    1. If the negative data-point on CHS’ Q2 call marks the start of a trend.  On the call, the CEO cited a ship collision in China for why comps trended down 4% in early Q3, although CHS thought they weren’t indicative of the current business and kept guidance intact.
    I hold a position with the issuer such as employment, directorship, or consultancy.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

    Sale to private equity

    Further capital investment into repurchasing shares trading at unlevered 10%+ pro forma FCF yield

    Messages


    SubjectRe: Credit market
    Entry10/12/2015 12:26 PM
    Memberpfq783

    Thank you for the question.

    I think the EMC announcement today shows that banks are there to commit financing, for the right deal.

    Olin is in a cyclical industry and sold notes after a big decline in market values of chemical assets.

    The leverage in the Altice deal almost speaks for itself.

    A CHS deal should have strong interest coverage with low future investment, and hopefully the 5-6 days straight tick up in HYG/JNK is more indicative of a HY market slowly re-opening to deal-specific (and non-energy) issues from the total halt of a few weeks ago.

     

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