Value Investors Club / Men's Wearhouse (MW)

Description

Investors view Men’s Wearhouse (MW) as a category killer with an excellent business model driven by

the combination of a menswear store with tuxedo rentals. Investors are also betting on continued

resurgence of suits and further upside with revenue synergies. I believe that MW is encountering a

major threat from online tuxedo rental upstarts, will likely encounter problems with the integration of

Jos A. Bank, and is still in the middle of a long-term down trend in Menswear.

How MW works:

MW executes extremely well. The sales staff is attentive and friendly but does not pester. The company

is not promotional but rather brand-oriented. I would say from the 90’s till the mid-2000’s, MW

benefited primarily from the shrinking of department store menswear departments and the closing of

many regional chains. I would point out that I cannot think of one successful retailer that has been

successful after its competition went away due to a fall in demand.

More recently, MW has found a new way to prosper by adding tuxedo rental into the stores. Tuxedo

rentals are extremely high margin. The gross margin is over 80%, and even with incremental SG&A, the

contribution is 60%. Margins on tuxedo rental equate roughly to the entire operating income of the

firm. It is also a primary source of customer acquisition. I believe it is responsible for over 15% of MW’s

new customers every year and over 7% of new sales. MW’s national footprint gives it a large

competitive advantage over local and regional competition. A typical groom will likely have a member

of his wedding party in another location, or the wedding could very well be far from his current home.

The solution was MW, which allows coordination of the same tuxedo across multiple sites across the

nation.

Of course, the obvious solution to this is online sales. However, the logistics of such a process is

extremely difficult. You need to have several styles and colors in a range of sizes. To get a discount, you

must purchase in the thousands of dollars. So there is some initial scale required, which is the easiest

part. Think about the logistical nightmare of sending out different variations of tuxedo combinations

and then tracking them as they come back, making sure you know which one was ripped, who ripped it,

and when. Of course, there is the problem of being fit for a tuxedo. For years, MW saw this as too big a

hurdle to surmount, and they were right, as little, if any, inline sales materialized. But ecommerce

knowledge has greatly increased, and now some companies have started up and entered the space. The

fitting problem has been overcome by a choice of algorithms (by entering height and clothes sizes),

measuring yourself (which of course they have a tutorial for) or referrals to tailors who measure people

for free or one may already know your measurements from a previous fitting. The bar of the current

rental tuxedos is fairly low, and these appear to be far superior, though that is admittedly subjective.

The early results show incredible promise, and it appears these companies are executing as planned.

The largest by far is theblacktux.com. The company has already received venture funding from name

brand VC firms, has shown incredible growth, and even has a wait list for a rental.

Exhibit 1: Growth of Online Upstarts (Monthy Unique Visitors)
	Theblacktux	Menguin	Nationaltuxedorental.com	Tuxship	Simpletux	Total	MW	Ratio of Online to MW
April-14	2,759	3,174		3,469	676	10,078	319	31.6
May-14	21,113	472	392	4,843	295	27,115
June-14	7,986	431	1,317	2,016	317	12,067	1,294	9.3
July-14	13,450	2,039	276	2,589	979	19,333	2,548	7.6
August-14	15,976	1,127	2,004	1,774	1,171	22,052	137	161.0
September-14	20,186	1,245	1,098	2,481	626	25,636	1,140	22.5
October-14	24,309	4,001	2,241	2,877	1,543	34,971	1,171	29.9
November-14	16,530	2,427	4,834	1,929	1,641	27,361	1,017	26.9
December-14	24,525	4,165	3,471	513	1,778	34,452	112	307.6
January-15	43,876	6,667	757	914	2,349	54,563	1,387	39.3
February-15	52,012	13,668		7,892	8,630	82,202	235	349.8
March-15	76,571	17,337		3,676	2,186	99,770	1,286	77.6
April-15	91,220	12,801		2,198	3,513	109,732	8,950	12.3
Source: Compete.com

As we can see from Exhibit 1 above, the new entrants are still relatively small. My best guess is the

current penetration is around 1%. However, the growth is simply phenomenal: over 10x YoY in April. A

quick check of Google shows that these companies do not appear to be buying this growth, and

amazingly, they are not undercutting MW on price as of yet. The start-ups compete on better style,

eliminating likely three trips to the store (sizing, pickup and drop-off). The huge growth appears to all be

viral. This makes sense as today’s groomsman is tomorrow’s groom, and even younger, today’s prom

goer is tomorrow’s formal attender. Social media, of course, is their friend. Additionally, the

demographics of tuxedo rental customers is essentially the internet generation, which should naturally

lead to high penetration.

The effect of lost tuxedo rental sales over time should be devastating for MW. I estimate that over the

next 10 years, 20% of the tuxedo market will go online and that MW will lose 25% of unit sales. Further,

retail product sales will suffer due to the lack of customer acquisition from tuxedo rental. I believe this is

extremely conservative. I assume that retail product will grow at 2% (in-line with inflation) with a decline

of 20 basis points each year from lower customer acquisition.

Valuation:

I assume that costs grow at just 2% minus expected synergies of 104 mln and any lowered SG&A from

tuxedo rental. I am furtherly generous in assuming that LIBOR stays at just 0.50% for the next 10 years.

The company does not buyback shares (instead pays a one-time dividend) at what would be inflated

prices, refinances with lower yielding debt, faces no recession over the next ten years, meets cost

synergies, maintains sales at Jos. A Bank, and the store count says flat. After all this, investors can expect

to get a company that earns $1.84 per share in FY2025 and $20.50 in cumulative dividends over the 10

year period. Therefore investors will likely be down over a 10 year period. The discounted value (very

low 6% rate) is $25.34 per share. For a price target, I assume an even more generous $35.00 or 12x

FY2018 EPS.

Potential Integration Problems:

MW closed on the acquisition of Jos A Bank (Bank) on June 18, 2014. The company has announced over

$100 mln in cost synergies with another $50 mln of revenue synergies. First a little background on the

deal. Bank actually offered to buy the larger MW first before, and MW eventually purchased Bank. It

appears to us that MW may have never really wanted to buy Bank but had its hand forced by the offer

and Bank’s move into the Tuxedo rental business. Bank was a notoriously promotional business, with

commercials offering Buy One, Get Two and even sometimes Three suits free. The campaign was even

lampooned on Saturday Night Live http://www.nbc.com/saturday-night-live/video/jos-a-bank-cleaning-

product/2768588, comparing the suits price to paper towels. MW is not promotional, and they have

been cutting discounting at Bank since the acquisition. Of course, a retailer eliminating discounts has

never faired too well and has never been a blueprint for success, with JC Penney (a painful experience

for the author) being the most primary example. Investors expect sales to rebound with easier comps,

but if you look at the results so far, things could be getting worse, not better.

Exhibit 2: Same Store Sales Showing Disturbing Trend
	2013				2014
	1Q	2Q	3Q	4Q	1Q	2Q	3Q	4Q
Men's Warehouse	1.6%	0.7%	2.6%	-2.5%	2.9%	4.4%	2.2%	6.8%
Joseph A Bank		-15.5%	2.4%	1.8%		1.0%	-8.1%	-6.6%
MW - Joseph Bank	1.6%	16.2%	0.2%	-4.3%	2.9%	3.4%	10.3%	13.4%

Bank, as you would expect, has had weak sales since the acquisition (highlighted in Exhibit 2 above), but

it appears, based on headline numbers, to be slowly improving. However, by analyzing further, we can

see that the delta between MW and Bank stores has gotten worse every quarter. Therefore, it is likely

that Bank was just benefiting from a very good quarter in suit sales industry wide but is losing market

share and at an increasingly rapid pace. The lost sales are unlikely to be picked up by other MW stores,

since there is only a roughly 20% overlap in customers.

I do believe that MW will fully execute on the $100 mln of cost synergies, with possibly some small

upside. I am extremely skeptical that the company will get much, if any, of the projected $50 mln in

revenue synergies. These are largely from things like more slim-fit suits and increasing Big & Tall sizes,

which basically assumes that Bank, a fairly well-run store, was too stupid to sell these products to begin

with. The one area where there could be some upside is increasing tuxedo rentals at Bank, but that will

likely cannibalize MW.

Long-term Downward Trend in Suit Sales and Newer Competitors:

Data on suit sales is tough to get, but it does seem like the industry is picking back up as millennials

appear to enjoy occasionally getting dressed up. This compares to the roughly 100-year trend towards

more casual dress. I believe that the recent surge in men’s suits will just be a blip on its long-term

decline. If the trend towards more suits just showw more staying power, it is not fully clear that MW will

be able to fully participate. There seems to be a new much hipper wave of online upstarts like

Jackthreads looking to outfit more style-oriented millennials. The competition is not limited to online, as

Suit Supply, a very fashion forward chain in Europe, is rapidly expanding into the U.S. with 13 stores

currently and 5 opening soon. These are still small compared to MW, but if menswear continues to grow,

I believe competition will grow with it. MW is like Icarus, fly to close to the sun and you will get burned; too close to the ground and be swallowed by the water. Either way, MW appears to be headed for trouble.

grow, I believe competition will grow with it. MW is like Icarus, fly to close to the sun and you will getgrow, I believe competition will grow with it. MW is like Icarus, fly to close to the sun and you will get burned; too close to the ground and be swallowed by the water. Either way, MW appears to be headed for trouble.

Betting against an easy opponent:

The best person to fight against is the one who will not hit back. MW is at the point of saturation in an

investment presentation the company cites Alaska as a potential growth market, so our short thesis is

unlikely to be overrun by unit growth. After the acquisition, the company will be focused on paying

down debt, which yields only Libor + 3.25%. I see no natural acquisition candidates for MW, unless the

company makes the very risky move of going overseas. While we believe MW has very good and

capable management, there appears to be no levers left to pull.

Risks:

Better than expected synergies.

Continued rise in suit sales.

Online tuxedo rental business does not take off.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.

Catalyst

Integration problems.

Growth of online tuxedo rental competitors.

Slow-down in suit sales.

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			2015	2016
Price:	58.47	EPS	2.14	2.55
Shares Out. (in M):	48	P/E	0	0
Market Cap (in $M):	2,815	P/FCF	0	0
Net Debt (in $M):	1,625	EBIT	0	0
TEV (in $M):	0	TEV/EBIT	0	0
Borrow Cost:	General Collateral