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TMF Style on Polo

RALPH LAUREN (NYSE: RL) RISES SHARPLY FROM ITS INITIAL PUBLIC OFFERING PRICE -- And now, out on the catwalk, might it turn around and return behind the curtain? Or will investors just keep on clapping?

by Risa Kaplan (TMF Style)
Retail Industry Area

SAN FRANCISCO, CA, (June 11, 1997) /FOOLWIRE/ -- The name "Ralph Lauren" has been a symbol of investment-caliber apparel and accessories for many years. The classic Polo and other Lauren collections are considered timeless, and are regarded as beautifully crafted, with superior fabrics and designs. Today -- like a finely-tuned production -- the fashion empire behind the styles, POLO RALPH LAUREN (NYSE: RL), walked the catwalk to the New York Stock Exchange trading floor. Whether or not Ralph Lauren will stand the test of time and become a true investment-quality stock has Wall Street in a bit of a quandary, as investors hope that this won't become another fickle fashion initial public offering (IPO).

RETAIL IPO MANIA

Many investors are weary of retail IPO's, since several of these issues have initially flown up into the stratosphere, only to come toppling back down like the price of tangerine orange jeans.

Apparel firms that went public last year faltered dramatically after poor quarterly performances, productions ills and bloated costs. Companies like GUESS (NYSE: GUS), MOSSIMO (NYSE: MGX), and DONNA KARAN (NYSE: DK) were marked down, down, down, by investors and are now trading below their initial price offerings.

However, even the critics of fashion stocks know that designer and businessman, Ralph Lauren, age 57, has owned his company since 1968 and that he brings a colorful fabric of business wit to the table, the likes of which most fashion leaders don't command. Mr. Lauren has experienced nearly all of the major retailing mistakes by now, and is arguably too much of a seasoned veteran of Seventh Avenue to mis-step like many of his younger fashion counterparts.

Mr. Lauren and family will be controlling 90% of the voting stock, even after the initial public offering.

WHY GO PUBLIC NOW?

IPO's are created in order to raise as much money as realistically possible. Ralph Lauren and his major investment partner, Goldman Sachs, wanted to raise as much capital as possible while diluting ownership in the company as little as possible.

In 1994, Goldman Sachs (lead underwriter of the IPO) bought a 28% stake in the company and is now selling about 2%. The Ralph Lauren family is selling about 17.9 million shares, which is nearly 66% of the 29.5 million shares being sold. Smart investment houses strategically plan and wait to go public at the "right" time. In this case, we heard for weeks that Lauren was going public this summer with no definite date. This past Friday was a major bull run and voila!, the company announced that it would go public this week.

The initial public offering price was set between $22 and $25, but finally ended up being $26. The stock rose immediately and first traded above $31. For those interested in the proceeds of this sale, the S-1 states that the company will not receive any of the proceeds from the sale of the shares being sold by the "Selling Shareholders" (Lauren family). Guess we don't have to worry about any restricted shares being dumped in order for the Lauren family to cash out and buy that new house later on. They're doing all their selling today, and they'll be even more "set for life" with the money they've made. Meanwhile, the company itself is only selling 9.4 million shares -- though that does raise a hefty $244 million for Ralph Lauren the company, before fees.

POLO - THE COMPANY

Lauren has a ready-to-wear line in both mens and womens' clothing. Through licensing he has evolved into cosmetics, jewelry, handbags, luggage, home furnishing, and skin care. Most of these lines have been around for over 10 years and are profitable.

In terms of numbers, over the past five years the company has seen pretax profits surge 156% to $109.7 million. The company's worldwide wholesale revenues, including sales from licensing, was $1.1 billion in the most recent fiscal year, ended March, as sales rose 15.7%. In that fiscal year, Ralph Lauren's operating earnings rose 28%. However, since 1994, the earnings growth has apparently slowed, from up 50% in 1995, to up only 18% in 1996. But these are strong numbers -- well above the average growth rate of 8 to 12% on the average Dow stock.

THE OFFERING

There is a tremendous amount of hype and hoopla that surrounds this initial public offering based on the name recognition (what Wall Street guy isn't wearing a Polo on the weekends out in the Hamptons?). Many have compared this IPO to the most successful in the past two years, which was GUCCI (NYSE: GUC). To do this without understanding the difference is a little dangerous.

The day Gucci first traded it opened at $23 and barely moved. Only a few fashion people even knew who Gucci or the new director Tom Ford was when the IPO hit the exchange floor. Over time, revenues and high margins equaled good earnings, and expectation grew and therefore the stock price followed. The price of the stock barely dipped until it hit a high of $86. It now trades around $72.

Here, as previously mentioned, not only the Street but the general public was excited about Ralph Lauren's stock. Expectations are very high and if one believes that the IPO is fairly-valued at the intial price of $26, then what about after a major run up?

Notwithstanding the glamour of this offering, and whether increased earnings rates can be sustained, whether or not the stock price can remain proportionately more expensive to the earnings growth rate is the issue. The P/E ratio may arguably be or become unbalanced due to momentum and expectations arising from overenthusiastic and speculative players. What will happen when the first set of pro forma earnings come out if they only equal expectations? The risk is there.

Meanwhile, an issue that has been raised is that of Lauren's future tax liability as it relates to earnings. In the past, due to a partnership structure, the company had tax advantages that will no longer apply.

For fiscal year 1997, the tax bill, according to SEC documents, would have been $57 million, instead of $22 million. Therefore the private Polo Ralph Lauren had earnings $117 million, but a public company would have had only $79 million. This latter figure is, according to the IPO documents, used to calculate the reported pro forma earnings of $0.87 per share.

At a $22-$25 price the stock would trade about 27 times earnings, which is higher than TOMMY HILFIGER (NYSE: TOM), which trades now at about 21 time earnings, while Gucci which carries a multiple of 25. As a group, the average P/E of clothing retailers is around 16.

At the opening price just above $31, the stock of Polo Ralph Lauren trades at 35 times trailing earnings -- quite a premium to the industry at nearly twice the industry average. But the premium placed on the Ralph Lauren company may be very warranted.

WHERE IS POLO HEADED?

Ralph Lauren had licensing revenues of $110 million for the past year. What this licensing revenue means, in part, is that companies like Ralph Lauren have become "brand management" firms. The main focus is to run the business in order to sustain the brand. If they make money from their own operations, super -- but they can profit very well from licensing income alone, ideally.

In terms of merchandise and the appeal of Ralph Lauren clothes and accessories: It has not dwindled, even as competition has evolved. There is arguably a style and class in his lines that are not found anywhere else, only poor imitations.

Some analysts were concerned that the plan is to only open five new stores in the near future. But beyond that, and perhaps diluting that concern, is the fact that Ralph Lauren is the quintessential American style, and has lasted this long because not only does Mr. Lauren have an appeal that is timeless, but part of the allure is that his high-priced items are still not within everyone's reach. A keen investor should hope that it remains this way, as a name never diluted always is in demand.

For those interested in this area of retail, other stocks worth looking at are ST JOHN KNITS (NYSE: SJK) , and JONES APPAREL GROUP (NYSE: JNY). Both are higher-scale apparel companies.

Next Article: Tom Gardner on Ralph Lauren

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