The good news is L Brands (BBWI) has successfully offloaded its troubled Victoria's Secret business, coming to an agreement with private equity firm Sycamore Partners earlier this month. The bad news is, the price paid values Victoria's Secret at a paltry $1.1 billion, and even then, Sycamore only acquired a 55% stake in the lingerie retailer. That's just enough to control it, but the deal leaves L Brands needing Sycamore Partners to work a little magic that somehow couldn't be worked when the now-minority parent was in charge.
The terms of the deal should gnaw at shareholders. Not only does Sycamore have something of a reputation for making matters worse before making them better, in some regards, the price suggests L Brands just wanted off a doomed ship.
An oddly low valuation
Whether or not L Brands got a square deal is largely a matter of perspective.
Compared to sales, it didn't. For all its woes, Victoria's Secret still drove $6.8 billion worth of revenue in 2019. A valuation of $1.1 billion translates into a price/sales ratio of around 0.16. For perspective, the S&P 500's trailing price-to-sales ratio is currently more than 2.1.
Image source: Getty Images.
The argument changes, of course, when using profitability as a valuation yardstick.
Victoria's Secret's operating income has been subpar and shrinking for some time. Last year, it reported a disappointing $114.6 million in operating profits when its final figures for 2019 were released on Feb. 26. That is just one-fourth of 2018's tally, with the trend still pointed lower. From that perspective, if Victoria's Secret can't be turned around by Sycamore, then the price tag makes more sense. Throw in how Sycamore absorbed $2.5 billion worth of Victoria's Secret's lease obligations, and Sycamore Partners was potentially ripped off.
Data Source: L Brands Quarterly Presentation. Chart by Author.
More of the same doesn't seem likely for Victoria's Secret, though. While it may never revisit its glory days, it's still a respected, well-known brand. That's something to build on, which is why a revitalized Victoria's Secret that's just modestly more profitable than it is now is worth more than $1.1 billion.
In that vein, Victoria's Secret generated operating income of a little more than half a billion dollars in 2018 and got within sight of $1 billion in operating income in 2017. Even restoring 2017's subpar operating profit -- without any consideration of interest payments, taxes, and depreciation -- would suggest a fair price closer to $3 billion, according to numbers from research firm BVR suggesting acquisition prices of service-related businesses have been around three times EBITDA lately. Equidam's data suggests the sale price should have been even higher, assuming Victoria's Secret can just claw its way back to 2017 profitability levels.
A partner with a past
The other subtle hint L Brands simply wanted to be done with Victoria's Secret? Choosing to team up with Sycamore Partners.
To the firm's credit, it has been able to work a few retail miracles. Office supply store chain Staples is still around (albeit in a smaller form) thanks to Sycamore, and the private equity outfit has given consumer-facing names like Talbots and Belk a fighting chance at survival they may not have otherwise had.
Other acquisitions haven't been quite as amicable. Its relationship with Aeropostale was so contentious, in fact, that the then-struggling retailer accused Sycamore of a "loan to own" scheme. That is, Aeropostale argued that the creditor deliberately made a loan to the retailer with the intent of pushing it into bankruptcy, where it could be purchased out of bankruptcy at a fraction of its actual value.
It's not the first time such an accusation has been made of Sycamore either. The Financial Times' Sujeet Indap suggested last year that the firm's financial engineering practices made it "feared as well as admired." Our very own Rich Duprey pointed out how Sycamore had acquired several other struggling retail names like Nine West and Jones Group under the auspice of a turnaround. But in many cases, the new owner ended up selling off key assets and closing stores, pushing the purchased company into bankruptcy rather than away from it.
Sycamore's intentions with Victoria's Secret remain unclear. L Brands' management and board of directors had to know, however, that the new majority owner has something of a history of breaking companies down as much as it does building them up.
Connect the dots
Critics of the premise will argue that removing the $2.5 billion in lease obligations was worth the low price alone. And there's a certain logic to the argument. If Victoria's Secret can't pay all of its bills going forward, then at least L Brands is off the legal hook.
It's still got a vested interest though. The 45% stake will show up as an asset on the balance sheet, which should (ideally) bolster the income statement. The latter may never actually happen, however, and the former could lead to another sizable writedown (in addition to the $725 million charge it booked last quarter) in the future if Victoria's Secret proves incapable of bearing fruit again. More than a few people fear it won't.
The tepid valuation and the decision to work with Sycamore rather than holding out for any other help suggests L Brands just wanted to be rid of the lingerie retailer before it lost any more marketable value.
