value and opportunity

On Thursday after close, Fossil came out with their Q3 numbers. Without adjusting for currencies, numbers looked pretty bad. Sales were down 14%, watches even -17%. In the earnings call they blame most of the decline on Michael Kors:

Turning to our multi-brand watch portfolio. During the third quarter, our multi-brand watch portfolio was down 11% to last year in constant currency, a disappointing performance with declines across our three regions and with a single brand driving the vast majority of that decline. We expected a tough quarter given last year’s strong performance, the historical strength of the Michael Kors brand and consumers gravitation towards technology.

So Michael Kors seems to have went out of fashion fast and hard and it was not possible to directly replace it.

For me the more critical issue is however the wearables part. This is what I wrote in my last post on Fossil:

Cons
– overall market for “trendy watches” seems to be shrinking (mobile phones, fitness trackers etc.)
– buy backs started at 100 USD+
– increased debt to repurchase stock (loans with covenants)
– falling knife stock chart
– change of reporting segments in 2015, less easy to track progress
– best-selling licensed brand (Michael Kors) seems to be out of fashion, original Fossil brand is not a “strong” brand
– missed wearable trend, current line-up does not look promising
– no moat, new trendy watch brands can be created and distributed easily by anyone
– general problems for “mall based” or “department store” retailers
– risk of “familiarity bias

Well, management seems to have shared my concern and their answer was a 260 mn USD transaction: The purchase of “MisFit” a wearables startup company. They effectively stopped share buy backs most likely to finance this purchase.

MisFit itself seems to be the “cheap version” of FitBit and active mostly in China. There they seem to sell more trackers than FiBit whatever that means.

According to Amazon reviews, the quality of MisFit’s gadgets seems to be however very bad. For instance the water proof devices don’t sem to be water proof and other quality issues are quite common.

The problem in my opinion with this transaction is that this will most likely be only the start for more investments. It looks like that they want to go head to head against FitBit but also the other players like Apple and Samsung. But Fossil in my opinion is clearly not a technology company. Fossil’s strength are marketing and distribution. This changes the business case and makes Fossil a lot riskier.

This abrupt strategy change in my opinion was not very well communicated. The strategy presentation is in my opinion pure b…s…ing.

From a capital management perspective, Fossil has now bought back a lot of stocks at 100 USD and more and piled up around 500 mn net debt even before the Misfit purchase. Now that the stock is really cheap, they stop repurchasing shares and decide to get into the technology game with potential high capital expenditures into a field where competitors have a 1-2 year head start and most likely bigger resources. It is pretty clear now that the massive share buy backs at 100 USD/share did not create shareholder value, at least not for those investors who kept the shares. Only for those who sold out at 100 USD.

If we only look at Fitbit, the recently IPOed specialist for Fitness trackers. According to their Q3 report, they are doing annualized sales of 1,5 bn USD and have around 600 mn USD NET cash.

This is what I said in my summary for Fossil:

Summary:

Looking at those points, I am not convinced that Fossil is a good investment based on a 3-5 year period. Yes, there is clearly a potential for a short-term rebound but in general I don’t think that it will be easy for Fossil to even maintain current sales and profits. It is just too easy to introduce and distribute new watch brands in the price category where Fossil is strongest. I think this is the bigger direct threat to Fossil,bigger than Smart Watches and fitness trackers although those devices will cannibalize the wallets of consumers who would otherwise buy a third or fourth Fossil or Armani watch.

The purchase of MisFit in my opinion does not much to improve their position, but rather looks like a kind of “panic purchase”. They could have concentrated on branding and trying to cooperate with some tech companies instead. So all in all I don’t think that Fossil for me is really an investment, not even at significantly lower prices. Yes, they do look cheap but clearly “cheap for a reason”. If they manage to turn around the branded watches and even become succesful in the wearables markets, the upside could be huge, as for instance FitBit trades at much higher multiples. But in my opinion it is too early to tell and there is less downside protection now as they will have less money to spend on buy backs and wil not be able to increase leverage much more.

As value investing is about protecting the downside, I don’t think that Fossil qualifies as a value investment anymore, despite the optically cheap multiples.

It will be interesting how Movado‘s numbers look like, but I think they will not look that much better as there seems some overall weakness in US consumer behaviour at the moment, especially in the important department store category which sells most of the watches in the US.

Update: I wrote this before the stock market opened. I tlooks like that investors are spooked by this as much as I am…..stock now at 36 USD.

Edit: In this SeekingAlpha post about Fitbit I found the following quote:

Maybe the good news for Fitbit is that Misfit isn’t all that successful in grabbing market share. The company only expects hitting revenues of $30 million for 2015. Fossil did pay a pricey multiple for $30 million of revenue, but any successful market share gains by Misfit would’ve warranted holding out for considerably higher valuations.