Sometimes, people can't resist getting excited over an IPO with a familiar name. I would imagine that J. Crew's
In August 2005, I took a look at J. Crew when it first filed for its IPO. At the time, I had some points of contention, including its massive debt. Despite delays in late 2005, J. Crew's IPO is now being touted as a great success. Curious, I printed up the SEC filing (which is so long it would make a good doorstop, with all of the complicated legalese connected to transactions the retailer has made in connection with its debt and preferred stock) and took a look.
But is the current market a better one for retail? Given some investors' panicky responses to macroeconomic concerns, shares of many retailers have lately taken a nosedive. Two historical highfliers, Urban Outfitters
So what's so special about J. Crew?
On the balance
Some of the issues I initially had with J. Crew are still present. J. Crew's IPO is earmarked toward reducing its debt load. The proceeds and transactions connected to the IPO will cut its debt and preferred stock obligations to $281 million from a whopping $740 million, which, of course, does strengthen its balance sheet going forward.
Still, although debt isn't always bad for a retailer, in this case it does present a risk to shareholders (and the risks are well outlined in J. Crew's IPO). For example, debt can strangle cash flows from operations as a company moves to pay interest and principal, as well as make it harder for a retailer to react to fashion turbulence and open new stores. And many of us have heard that J. Crew has some new concepts in the pipeline, such as Madewell (which I wrote about recently) and a children's retailer, Crewcuts.
Meanwhile, if you consider the $34 million in cash J. Crew has on its balance sheet (on a pro forma basis, accounting for the use of the IPO proceeds), it still has about eight times more debt than cash. But despite the high ratio of debt to cash, using the proceeds from the IPO to reduce its debt will help investors sleep better at night. With reduced interest payments on a pro forma basis, J. Crew's interest coverage ratio increased from the uncomfortable 1.6 in 2005 to a much more palatable 5.8.
True, its latest results show a lot of heartening signs. Fiscal 2005 sales increased 18.5% to $953 million, and J. Crew made a profit of $3.8 million before the preferred dividend payment, as compared to its whopping loss of $100 million the year before (which was related to refinancing its debt -- not counting that refinancing, the net loss would have been $50.5 million). Same-store sales increased 13.4%, but if you look at same-store sales over the last five years, it had a few rough years where it reported declining same-store sales (fiscal 2002 through fiscal 2004, with two of those years showing double-digit decreases). One could argue it has had pretty easy comparisons for the last couple years, given the previous slowdown.
Bear in mind, though, that the latest fiscal year marks J. Crew's first profitable year since 2001, and this year's per-share profit is on a pro forma basis, adding in the effects from the IPO that relieved it of having to pay preferred stock dividends.
Meanwhile, with those tougher years behind it, J. Crew is planning some aggressive expansion. Although J. Crew only opened six stores last year, it plans to increase its store base by between 15 and 30 stores this year, and by between 25 and 35 stores per year in the near term. J. Crew revealed in its final prospectus that its net investment to open a new store is $844,000 for a new store and $511,000 for a factory store. So expect pretty heavy capital expenditures to come.
J. Crew is headed up by Millard ("Mickey") Drexler, well known for his fashion savvy and his stint as head honcho over at Gap
Drexler can't be blamed for J. Crew's debt load; it was part of the legacy he inherited when he came on board. However, given the pretty aggressive plans for growth outlined in the IPO filing, investors might feel a bit nervous about this retailer's future.
With only about 200 stores, J. Crew has plenty of room for growth, but does it have a sustainable competitive advantage, other than the high price tags on its preppy clothes? Its niche is unclear (although its brand is admittedly solid), and there are plenty of hungry competitors, such as Abercrombie & Fitch
Given that question, it's not too surprising that the company had to put the brakes on growth for a couple years by decreasing store expansions and the number of catalogs it circulated. Meanwhile, despite signs of strength last year -- including an increase in gross margin -- the company's first quarter seemed to indicate that it's not immune to some of the concerns that have afflicted other retailers lately. Its gross margin ticked down by 130 basis points to 45.5% (as it had increased markdowns), which was offset by a decrease in buying and occupying costs.
Initial public offerings are exciting when they sport a name that we all recognize, and J. Crew definitely fits the bill when it comes to "star power" in a strong and well-known brand name. However, the message behind the IPO is that the company in question is seeking funds for its business. At the moment, I worry that J. Crew's IPO is benefiting insiders and creditors more than investors, and wonder if the growth trajectory of this retailer can live up to investors' expectations, especially when the retail market is so shifty. Investors in J. Crew should be wary of the hefty risks.
Alyce Lomax owns shares of Urban Outfitters, but of none of the other companies mentioned.