Description

Description

New York City-based XCel Brands, founded in 2011, licenses a portfolio of high-end apparel and home goods brands to retailers including QVC, HSN, Best Buy and Bed, Bath and Beyond.  The company owns the IP for the following brands: Isaac Mizrahi, Judith Ripka, Halston, C Wonder, LOGO by Lori Goldstein and Longaberger (50% interest).  XCel uses an omni-channel sales strategy, promoting its brands through interactive television, digital live-stream shopping, brick-and-mortal retail, wholesale and e-commerce channels.  Its brands have generated over $3 billion in retail sales via live streaming in interactive TV and digital channels alone.  

This is an event-driven microcap transformation story, suitable only for small accounts and PAs given the low liquidity (typically $10K to $50K traded per day) and small market cap (roughly $30M).  I’m not going to go into too much detail on the fundamentals here, as this is really an asset-based mispricing pitch that happened to cross my desk.  Yesterday at 3:00pm XCel announced a deal with private global brand management company WHP Global ($4B in global retail sales generated from its brands which include Toys“R”Us, Babies“R”Us, Lotto, and Joseph Abboud) where WHP purchased a controlling 70% interest in fashion brand Isaac Mizrahi for $68M ($46M in net cash, $2M earn-out).  XCel’s balance sheet goes from $32M in net debt to $17M in net cash, and the enterprise value goes from $62M to $13M.  Adjusted book value goes from $71M to $84M ($4.24 per share).  Prior to the announcement, after losing $2.5M in EBITDA and incurring a net loss of $6.2M in CY21, the shares had been left for dead, hovering around $1.00 per share.  Almost 3M shares traded (28% of the float) after the announcement yesterday, with the stock nearly touching $2.00 per share before fading.  

I think the stock is significantly mispriced here.  With an EV of $13M and a 30% equity interest in the Mizrahi brand that is worth $68M * 30% = $20M, this business is essentially “free”.  Management noted that even after the deal (selling down its crown jewel Mizrahi brand from 100% to 30% ownership) it was expected to generate positive EBITDA in 2022, and its strong pipeline of projects should drive revenue growth from here.  I think the stock is worth at least $2.50 per share for over 70% upside.  This would still be only a $33M EV, well below book value. If the remainco is able to get back to successfully offset the lost profit contribution from Mizrahi, upside is even greater.

Background

Brands: Below are quick descriptions of the 5 brands in the portfolio:

• Isaac Mizrahi is an iconic American brand founded by the eponymous designer in 1987 - it stands for timeless, cosmopolitan style.  It has over 150 product categories including sportswear, footwear, handbags, watches, eyewear, tech accessories, home and other merchandise.  The brand is available across various distribution channels including Saks and Hudson Bay department stores, QVC and The Shopping Channel.  The brand was bought in 2011.  

• Judith Ripka is a luxury jewelry brand founded by Judith Ripka in 1977.  The brand is known for its distinctive designs featuring intricate metalwork, vibrant colors and distinctive use of texture.  The brand was launched on QVC in 1996, and it has other retail and wholesale operations.  It was acquired by XCel in 2014.

• Halston was founded by Roy Halston Frowick in the 1960s, and quickly became one of the most important American fashion brands in the world, becoming synonymous with glamour, sophistication, and femininity. The brand was acquired by XCel in 2014, and it is available across various distribution channels including department stores (Neiman Marcus, Bloomingdales, Nordstrum), e-commerce, interactive television (QVC, HSN), and national specialty retailers. 

• C Wonder was founded by J. Christopher Burch (who co-founded Tory Burch) in 2011 to offer a wide-ranging assortment of beautiful, versatile, and spirited products.  It offers women’s clothing, footwear, jewelry and accessories.  XCel acquired the brand in 2015 and it is available at mass merchant retailers (Walmart), clubs, and certain off-price retailers (Nordstrum Rack).

• Longaberger is an iconic American heritage home and collectibles brand that began making baskets in 1896 and launched a direct sales company in 1973 by the Longaberger family. The brand is best known for its distinctive handwoven baskets. XCel acquired a 50% interest in the brand in 2019, and it is available on QVC.

• Lori Goldstein is a sophisticated lifestyle brand launched in 2009 on QVC that embraces Lori's aesthetic and speaks to everyday women. XCel acquired the Lori Goldstein brands including LOGO in April 2021 and the brand is currently available through the QVC channel.  

Note that Qurate (ticker QRTEA, owner of QVC, HSN, Zulily) accounted for 50% of total net revenue in CY21 and this relationship prohibits the sale of these brands at retailers who are restricted by Qurate.  

Financials

A quick glance at the historical financials shows that the company has had a pretty checkered operating history with large impairments every year, but until 2021, it had been generating positive free cash flow 7 years in a row, averaging $4M/yr (roughly 14% avg margin on revenue).  The company was heavily impacted by COVID-19, and the consequent supply chain issues, and they transitioned from a couple licensing arrangements to a wholesale and direct-to-consumer model, all of which pressured gross margins, and increased SG&A as a percent of revenue.  In addition, there was a QVC warehouse fire in 4Q21 that impacted sales and margins.  Finally, working capital swung from a source of cash to a use of cash, and an expensive debt refinancing tripled interest expense from $1.2M to $3.6M.  The combined impact of all these changes is pretty clear in the tables below: the 7 year stretch of positive free cash flow came to an abrupt end, with a cash burn of $7.7M in 2021.

While supply chain issues are likely to persist in 2022, the step change in the company’s cost structure was more of an offensive move, building up inventory, and up-fronting sales and marketing to help grow the business.  To be fair, the company has been successful in building up brands: the Isaac Mizrahi brand generated $30M in retail sales when it was acquired in 2011 and is now generating over $350M in annual retail sales (28% CAGR).  In 2021, Judith Ripkla, Longaberger and wholesale apparel saw a 75% increase in sales.  The number of Longaberger brands stylist or nano influencers (the driving force of live streaming in that business) was up 48% in 2021 and is expected to accelerate in 2022.  Note also that in the 9 month period ending 9/30/21 the company generated positive $1.0M in EBITDA - 4Q21’s negative $3.5M EBITDA print was largely due to the QVC fire.  While difficult to model, there does appear to be some positive momentum underneath the surface here. 

Conference Call

At 4:30pm yesterday, management hosted a twenty minute conference call (10 minutes of prepared remarks and 5 questions).  Importantly on the call, management said they anticipate that they will be adjusted EBITDA positive in FY 2022 despite selling the 70% stake in the Isaac Mizrahi brand.  In FY 2021, the Mizrahi brand generated $14.5M of revenue and $9.3M of operating profit (total XELB revenue was $37.9M and adjusted EBITDA was -$2.5M).  In the Q&A there was some discussion around the amount of capital invested by XCel to acquire its brands.  The cumulative figure is $112M, and as mentioned previously, the book value pro forma for the deal is $84M.  Management also said “we believe we will be able to quickly replace the earnings from the Isaac Mizrahi brand based upon the pipeline of projects and opportunities that are currently either planned or being considered.

On the question regarding the remaining 30% interest in the Mizrahi brand, the company said “we believe there is still significant upside with the Isaac brand both in interactive television and in bricks and mortar distribution - one of the limiting factors we had is we need capital to grow the Isaac brand in bricks and mortar and this transaction gives us the ability to do that.”

Risks

• Qurate accounted for 50% of revenue in 2021.  If Qurate were to have financial difficulties or if Qurate decided not to renew or extend its existing agreements with XCel, revenue and cash flow could be reduced substantially.

• Isaac Mizrahi is the crown jewel of the business, generating a significant portion of the company’s operating profits (it’s unclear how much of the $9.3M in “operating contribution” flows through to adjusted EBITDA but with total companywide adjusted EBITDA of $8-9M in peak years, clearly this brand is a major driver, and while XCel management is guiding to positive EBITDA excluding the 70% stake that it is selling, a lot rests on improved profitability of the remaining portfolio of brands.

• Checkered operating history: there are impairments pretty much every year - execution risk is high.

Catalyst

• 8K to be filed next week detailing pro forma financials

• In August, XCel will report its first full quarter post transaction, will likely show positive EBITDA, the recapitalized debt free balance sheet with net cash, and in the call management will reiterate positive EBITDA guidance for 2022.