Description

Disclaimer:  This is a relatively illiquid Korean small cap opportunity.  That should discourage a significant proportion of you from reading further. (All figures in Korean Won unless  otherwise noted)

 

Overview: Obzee is a fashion retailer based in Seoul with 90%+ of revenue from South Korea.  The company has five primary brands which it designs then outsources manufacturing and then retails within the large Korean department stores.  The brands in order of current revenue contribution are Obzee, O2nd, Rouge and Lounge, Club Monaco, Hanni-Y, and Y&K.  All of the brands are owned by Obzee except Club Monaco, for which they have recently acquired the South Korean license from Ralph Lauren.  All figures are in Korean won.  To convert use 916 won/dollar.

 

Executive Summary:  Obzee and O2nd brands continue to grow 5%/year, Club Monaco brand, launched in July, is on a massive growth trajectory and should hit 31 bill in revenue by 2008.  Hanni-y is also on a massive growth trajectory and could grow to be the largest of the 4 top brands by 2009/2010 according to management.  So we have a 102 bill won revenue company today growing revenue 20%+/year for at least the next 3 years with operating margins that should approach 10-12% in 2008 selling for a 35 bill won enterprise value (12 bill net cash).  Our 2008 EBITDA estimate is 19 bill.  The CEO is a very young, aggressive design oriented CEO with 53% ownership (including his wife’s stake).  The catalyst is sales growth, time and investor exposure.  As the analyst community in Korea understands the dynamic growth potential of the Club Monaco and Hanni-Y brands they will, as is typical, become very excited about the name and push the multiple at least to a market 2008 multiple of 12x EPS.  Our 2008 financial estimates are Rev= 158 bill, OP Inc= 15 bill, Unlev NI= 12.5 bill, EBITDA= 19 bill.  So at 12x 2008 Unlev NI our target price would be a 167 bill market cap or 16,000 won/share vs. 4,770 today, and that is only at a 12 P/E.

 

Detail

CEO, Mr. Kang - We have met and spoken to the CEO a number of times.  He is a young 40ish executive (the younger the better in Korea as far as we are concerned) who is single mindedly focused on growing Obzee into the most respected fashion retailer in Korea.  He and his wife are designers and were educated in fashion design in the U.S.  They are the lead designers for the company.  Mr. Kang is acutely aware of his weaknesses, primarily finance and operations, and has hired 3 senior mangers that manage the manufacturing/marketing and finance departments.  We have been very impressed with his quick understanding of basic ROIC ideas.  He recently has implemented a plan to become the best Korean fashion retailer in terms of inventory turnover.  In short, he is motivated (50% ownership) and intelligent.  We like him.

 

Brand Descriptions:

Obzee – Obzee is the company’s largest brand.  It is a mid/high end casual brand focused on females age 24-35.  We don’t expect much growth out of this brand and don’t need it to complete our thesis.  The one potential risk is that the Obzee brand begins to decline at a significant pace offsetting growth in Club Monaco and Hanni-Y.  We don’t see that happening.

O2nd - This is an offshoot brand to Obzee which targets a slightly younger demographic than Obzee, 18 – 27 year old females.  It is a slightly more casual, more wearable brand than Obzee.  Growth should be slightly higher for O2nd than for Obzee as O2nd is a younger brand with few department stores than Obzee.  We forecast 4-8% YOY growth in this brand. Obzee and O2nd have been the heart of the company up until this year.  We believe previous year’s valuations have been hampered by the large concentration of revenue in these two brands (2005 = 95% of revenue).  This is about to change.

Club Monaco - The Club Monaco brand was recently purchased by Ralph Lauren.  Obzee singed a deal earlier this year to become the exclusive licensee of the Club Monaco brand for 5 years.  Obzee also has an option to extend the license arrangement for another 5 years.  Mr. Kang is personally selecting the Club Monaco designs that he and his wife feel are most appropriate for Korean tastes.  They are also adding some of their own designs to the portfolio.  They launched the brand in one of the largest and most prestigious Korean department stores, Lotte Department Store’s flagship Seoul store in July, and according the department store manager, Club Monaco is now the highest selling brand in its category in the store.  Management has also commented that sales performance of the brand is beating their initial expectations.  With Management’s assistance, we are projecting 2008 Club Monaco sales of $34 mill with continued double digit growth in 2009.

Hanni-Y – This is the brand that the CEO is most excited about.  His wife is the chief designer.  It is a high end female casual wear brand similar to Dolce & Gabbana.  The strategy has been to start the brand in the U.S. and build traction in the high end department and specialty stores.  The brand has definitely gained traction in the U.S. and sales are growing nicely.  Mr. Kang is next going to roll out the line in Western Europe and then in the 2008/2009 season to Korea.  Mr. Kang believes this brand could be their largest brand by 2010.  We have 2008 sales modeled at $10 mill and we could be very low.

Roughe & Lounge – This brand is an accessory offshoot of the Obzee and O2nd brands.  Sales are growing nicely, but growth past 2008 will be moderate as the accessory market is not as large as either the Obzee or O2nd markets.

Sales Forecast (Korea Won millions)

	2005	2006E	2007E	2008E
Obzee	50,536	54,000	57,727	60,000
O'2nd	34,380	36,000	39,000	43,000
Y & Kei	896	-	-	-
Rouge & Lounge	1,581	4,946	8,864	12,091
Club Monaco	-	3,000	16,000	31,000
Hanni Y	942	3,000	5,000	9,000
Obzee China	30	610	1,656	2,580
Y & Kei Export	653	890	1,091	1,312
Total	89,018	102,246	129,338	158,983

Balance Sheet:

Inventory - Unlike U.S. fashion companies like Ralph Lauren, Guess? And others, in Korea the department stores effectively lease out space to fashion designers and the designer holds and manages the inventory and pays a commission to the department store.  Thus, inventory is much larger but receivables are very small.  The CEO has recently stated that he is focused on increasing inventory turns.  This is really the only material asset required to run this business.

Land/Bldg – The Company has what is conservatively valued at $20 mill US of owned land and buildings in Seoul.  They have chosen to own versus lease primarily because they couldn’t figure out what to do with their excess cash.  This along with the excess cash of $12 mill US equal 60% of the current market cap. 

Cash – Cash balance at 12/06 should be around $13 mill US. 2007 will be neutral cash build year due to $3-4 million US capex associated with a building they are building and working capital drain.  2008 will be a + cash year.  We project $19 mill US of cash by end of year 2008 and growing rapidly thereafter. After buying back 2% of the shares outstanding in 2006, the company will not repurchase more shares for fear of the shrinking float.

 

Financials (Korean won millions) Stock px is 4,770 won now.

				2005		2006E		2007E		2008E
	Sales			89,134	100.0%	102,447	100.0%	129,339	100.0%	158,984	100.0%
		YoY%				14.9%		26.2%		22.9%
	COGS			36,515	41.0%	41,747	40.8%	51,736	40.0%	62,401	39.3%
	Gross Profit			52,619	59.0%	60,700	59.3%	77,603	60.0%	96,583	60.8%
	SG&A			47,790	53.6%	54,938	53.6%	67,332	52.1%	80,788	50.8%
		Commish		31,197		35,856		45,269		55,644
		Non Commish SG&A		16,593	18.6%	19,082	18.6%	22,064	17.1%	25,144	15.8%
	Oper. Inc			4,829	5.4%	5,761	5.6%	10,271	7.9%	15,795	9.9%
		YoY%				19.3%		78.3%		53.8%
	Rec. Inc			7,062	7.9%	6,761	6.6%	11,271	8.7%	16,795	10.6%
	Tax			1,745	2.0%	1,584	1.5%	2,825	2.2%	4,344	2.7%
	Unlev Net Inc			5,317	6.0%	5,177	5.1%	8,447	6.5%	12,451	7.8%
		FDSO				10,141		10,141		10,141
		EPS		524		510		833		1,228
		Invested Capital				33,149,593		42,454,350		48,802,196
		ROIC				15.6%		19.9%		25.5%
		ROIC if Sell Bldg		20,000	8.5%			32.9%		39.5%

Valuation (Won 000’s except share price)

Current Valuation				Current Multiples				Target Valuation
Px (won)		4,770		EV/2007 EBITDA		2.4		2008 Unlev NI		12,500,000
FDSO		10,140		EV/2008 EBITDA		1.4			Mult	12
Market cap		48,367,800							EV	150,000,000
				2007 P/E Net of Cash		3.9			Net Cash	17,000,000
Excess Cash		12,000,000		2008 P/E Net of Cash		2.2			MC	167,000,000
	EV	36,367,800							FDSO	10,140
									Px	16,469
Land & Bldg		20,000,000

Risks

-        We and the CEO are overly aggressive on Club Monaco and Hanni-Y projected sales.

-        Obzee and O2nd sales begin to decline offsetting new brand growth

-        Margin expansion does not follow revenue growth

-        North Korea nukes Seoul

-        The CEO dies or divorces his wife, a key designer.

-        CEO speaks decent English, but the CFO does not. 

Catalyst

Catalyst – Escalating sales growth starting in the December quarter and getting stronger year over year into the summer of 2007 when Club Monaco sales are the strongest. Increased local analyst coverage (none right now) as the sales begin to surprise on the upside.