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Wednesday, April 14, 1999

An Investment Opinion
by Louis Corrigan

Delia's iTurf Kicks Grass

I'm not a teen, but I watch them on TV. And at the local multiplex. Lately I've been jonesing for new episodes of Dawson's Creek, despite the fact that the denizens of Creekside have been awash in troubles this year. You know, there's Andie's ongoing crack-up, her brother Jack's torturous coming out of the closet, and Dawson's general angst about Joey leaving him. What happened to the good old days when Pacey could indulge his Mrs. Robinson fantasies? Yet by comparison, the lack of a new Party of Five lately has been almost a relief. What was Julia thinking putting up with the abusive Ned for so long? After a while, I just about wanted to hit her, too.

Of course, during these post-sweeps doldrums, I've caught up on some of the latest teen flicks. For starters, there's She's All That (two thumbs up, a terrific Pygmalion riff on the classic teen plot), 10 Things I Hate About You (shrew Julia Stiles was great, the film so-so), and Cruel Intentions (Selma Blair's gooey kiss with Sarah Michelle was a turn-on, but this Dangerous Liaisons remake lacked the appeal of the classic teen storyline). Of course, my dance card is still full, with Claire in The Mod Squad, Katie in Go, and Drew in Never Been Kissed yet to be seen.

Clearly, I'm still working through some issues about my high school years. Or something. Of course, if all this sounds foreign to you, then you're probably clueless about why iTurf (Nasdaq: TURF), a new e-commerce issue with about $4 million in FY98 revenue, could possibly be valued at a billion dollars.

Spun off last week from catalog queen Delia's (Nasdaq: DLIA)-- or dELiA*s as the company cutely prefers -- iTurf was initially priced at $10 - $12. Last Tuesday, the underwriters boosted the range to $16 - $18. The stock finally priced at $22 a share on Friday and quickly soared, today touching an all-time high of $66 before closing down $4 1/8 to $58 1/2. Great expectations had pushed Delia's to an all-time high of $40 last week before the now predictable sell-off. However, investors' exuberant embrace of iTurf actually had Delia's running back up in recent days before closing down $5 1/2 to $30 7/8 today.

The story here is pretty simple. In pure numbers, the teen market is huge and getting huger. According to the U.S. Census Bureau, the number of 10-to-19 year olds reached a fifteen-year low of 35.2 million in 1992, but it's been expanding ever since. This segment of the population will reach 40 million by 2000 and will continue growing at twice the rate of the overall population through 2010. Also, what's often called "Generation Y" includes folks in the 10-to-24-year age bracket. This group will increase in number from 56.2 million in 1998 to 63.1 million in 2010. This is the Baby Boomers' baby boom, and it's creating a wave of teenploitation films and TV shows that's changing the entertainment industry.

Better yet, Gen Y has a lot of money to spend, thanks to the surging economy. Delia's puts the figure at $275 billion annually. Various studies put spending by the core teen population at between $90 billion and $120 billion in 1997. What's more, this is a population that increasingly is growing up on the Internet. They're wired, savvy, and loaded.

Happily, Delia's and iTurf target exactly this market. Delia's catalog serves females ages 10 to 24, selling Delia's own trendy clothes plus hot brands like Quiksilver (NYSE: ZQK), Vans (Nasdaq: VANS), and Paris Blues. Working with a mailing list of over 5.4 million potential customers, more than 1.6 million of which had actually bought something recently, the company expected to mail out about 55 million catalogs last year, up from 13 million in 1996. Thanks to acquisitions, Delia's also operates TSI Soccer stores selling sports apparel plus Screeem! stores selling unisex apparel. About 40% of total teen spending goes to apparel and sporting goods, including sports-related apparel.

Better yet, Delia's picked up the website, a smart and humorous content site for girls (eh, grrrrls) developed by three New York University grad students as part of their masters thesis and all about grrrl power. Delia's built up this site a bit and linked it to the company's online apparel store and to sites for its physical store concepts (like Thanks to cross-promotions with the popular Delia's catalog, page views have increased from just 800,000 per month in February of 1998 to around 35 million a month just one year later.

Unfortunately, Delia's encountered some rough going last year as it spent its IPO money to broaden its reach to boys and to store-based retailing while its more fashion-forward clothes ran into the juggernaut that is Gap (NYSE: GPS) basics. The stock plunged as low as $4 1/8. Running out of financing, management got the bright idea to package its websites (including its e-commerce business) into a separate company since its sites had in fact proven popular with exactly that group of free-spending teen girls that is hard to reach. Voila, iTurf.

The basic numbers look like this. iTurf did $4.01 million in sales in FY98, generating net income of $0.46 million, or about $0.04 per share based on 12.5 million shares outstanding. Given preliminary Q4 results and pro forma numbers for the first nine months of FY98, Delia's itself did about $172 million in revenue and $0.31 a share in profits. As of October, the company had just $3.5 million in cash and book value minus intangible assets of $34.8 million.

Delia's offered the public 4.2 million class A shares of iTurf, maintaining control of the company through 12.5 million class B shares. So excluding other potential common share equivalents (a possible over-allotment of 630,000 shares, 1.42 million shares issuable based on options that exercise at $9.36 per share, and 2.63 million shares for an employee incentive plan), there are now 16.7 million shares of iTurf, giving the firm a market cap of $977 million. Its cash is roughly equal to book value at around $75 million. Meanwhile, Delia's has about 14.35 million fully diluted shares now valued at $443 million. In other words, with more than 40 times iTurf's revenue and ten times its total profits, Delia's is trading for substantially less than half what investors are paying for iTurf.

Frankly, I love Delia's clothes. I hope that if I were a teen girl, I would feel cool enough to wear them. This generation's role models (check out the stars of the above TV shows and films) at least look like they're clad in Delia's wear. I'm sure the world would be a better, more interesting place if Delia's fashion sense ruled. And I like iTurf's online sites. Cool. Cool enough to actually attract customers. But do these companies' valuations make any sense? Not exactly.

With Delia's carrying a trailing net profit margin around 2.7% in a high-risk part of the apparel market, figure it's worth 1 times sales, or $172 million divided by 14.7 million shares, or $11.70 per share. That's about 20 times the estimate of $0.60 per share for the fiscal year ending next January. Actual rather than pro forma EPS for FY98 should be about $0.40, so that's 30 times trailing earnings. Add in at least $10 million which Delia's pocketed from the IPO (iTurf is using this amount of money -- and 60% of funds raised from any exercise of the over-allotment -- to buy Delia's stock), and the adjusted tangible book value goes to around $44.8 million. So my target value is about 3.8 times book.

But then we must figure in the value of Delia's roughly 75% stake in iTurf. Three-quarters of $977 million is $733 million. As I noted last week with Ziff-Davis (NYSE: ZD) and ZDNet (NYSE: ZDZ), you need to discount such majority holdings by at least 40%, owing in part to what the supply/demand effects of trying to actually sell that stock would be. So $733 million times 0.6 equals $440 million. Add in our $172 million target value for Delia's proper, and we can guesstimate that Delia's stock is worth roughly $612 million. Divide that by 14.35 million shares, and we get a fair value of $42.65.

Either Delia's core business is worth less than I'm giving it credit for, or Delia's stock is discounting an iTurf price of about $45. Of course, if Delia's core business is worth more than $11 1/2 (and a year ago, investors valued it at twice that amount), then iTurf shares could soon be eating grass rather than kicking it. Then again, iTurf investors haven't yet had a chance to see Delia's complete full-year results, so it's hard to draw firm conclusions.

Those results are expected to be released tomorrow and coincide with a conference call. However, yesterday's announcement regarding the death of director Sidney Kahn, father of CEO Stephen Kahn, might alter that plan. (Our condolences.)

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