Believe it or not, my passion for biotechnology does not blind me to the possibility that there might other good investments out there. Far from it. And because I spend a fair amount of time sharing my investment woes -- such as those in wireless companies Metricom, Globalstar, and Vari-L -- a guy can share one little teeny success far from the land of DNA, can't he? Please?
I've regaled -- or bored -- the Rule Breaker Team for months about the virtues of Hot Topic (Nasdaq: HOTT), a national retail chain of over 300 Hot Topic stores geared to 12-20 year olds and six new-concept Torrid stores for plus-sized women. The company has a clear, understandable, and fun business that's a break from the complexities, of, say, therapeutic protein and antibody discovery, testing, manufacture, approval and marketing, or optical networking. Not only that, but it shows up regularly in our monthly Small Cap Growth Stock Ideas spreadsheet of companies that meet the Foolish 8 investing strategy criteria.
It's easy to bend the Team's ears with tales of the company's solid business plan, excellent management, and increasingly powerful brand and consumer appeal. But is there any hope of convincing the Team that a company like Hot Topic, a music-based specialty retailer, fits our portfolio strategy and is worthy of purchase? Can a chain of clothing stores be in an important, emerging industry and ever have a sustainable competitive advantage?
I mean, look, is it possible for a specialty retailer to find happiness in our portfolio when it sells dark blue fairy wings, vinyl skirts, and t-shirts that say:
Carton of Eggs........................$3
Ski Mask..............................$14
Tickets to Britney Concert......$54
Egging the crap out of America's pop princess
...PRICELESS!!!!!!
Let's see.
Business criteria
The Rule Breaker strategy targets top dogs and first movers in important, emerging industries. When great innovation leads capital to move dramatically and violently to new places, we want to bet on the best and fastest horses: Firms who invent new products or services, reinvent products or services to create new demand, or adapt products or services to create new demand. For example, we've bought and sold stocks for this portfolio based on views that companies could use the history-changing advances of the Internet and in biotechnology to transform (reinvent, adapt) existing industries or create (invent) new ones.
Can retail ever be an important, emerging industry? Important enough to have lasting relevance, deep customer reach, expanding possibilities, and be sorely missed if it disappeared tomorrow? Sure. McDonald's (NYSE: MCD), Starbucks (Nasdaq: SBUX), The Gap (NYSE: GPS), Wal-Mart (NYSE: WMT) -- a host of retailers come to mind, each of which has made an enormous difference in people's lives.
But come on, a teen retailer?
The business model
Many investors simply can't get past that 12-20 year-old market segment, balking at the label teen retailer. A frequent rejoinder is, "The first season they miss a trend, they're toast. With all the good investments out there, so they say, who needs that bother?"
This is where Hot Topic becomes interesting.
Hot Topic licenses from the music groups popular with its target audience and then produces t-shirts, other related apparel, and gifts based on the music and the clothing worn by people who attend the groups' concerts. It follows the leading edge -- closely -- rather than trying to create it, by giving incentives to its employees to attend concerts and related events and observe carefully the popularity both of the music and various clothing. It also solicits and pays close attention to customer feedback, in the stores and through its website. Keeping its ears so close to the ground reduces the fad risk enormously.
This business model relies on a need that has grown phenomenally and enduringly since the 1950s, that of U.S. teens to use music and clothing to establish their own identities in transition to adulthood.
The results
This business model has posted consistently phenomenal financial results, as Dan Padavona showed superbly in his March 2001 community post of the day, and I did barely serviceably in this year's Valentine's Day special. The company's sales have grown from $44 million in FY 1997 to $257 million in FY 2001, a compound annual growth rate (CAGR) of 55%, with EPS in the same period growing from $0.17 to $1.09 for a 59% CAGR. Hot Topic has managed the feat of growing its brand appeal so that it rarely, if ever, runs a sale and then only on very limited items. In the cutthroat world of clothing retail, that's something. More astonishing: Have you ever met a Hot Topic ad on TV, in a magazine, or on the radio?
And even in the economic malaise of the last months, the company's sales have increased. Total revenues jumped 18% year-over-year for September, though same-store sales were up only 0.6%.
The challenge
It's fair to say that many, many retailers add stores and revenues rapidly, only to fail to sustain sales growth at that critical mass of stores. At one time, McDonald's, Starbucks, The Gap, Wal-Mart, and Home Depot (NYSE: HD) started on their extraordinary paths of wealth building, fighting that battle. Yet each of these companies either invented retailing concepts or reinvented and adapted existing ones to attack the status quo, moving from one to a few stores and then to hundreds and even thousands, moving mountains of consumer dollars to them.
For Hot Topic to enter those ranks -- or come anywhere close -- it must leverage its brand and business advantage to go beyond 300 Hot Topic stores to a bigger more powerful money machine. Torrid is a first step, a carefully-researched entry into the underserved market of coolwear for plus-sized women. The risks? The road is littered with the corpses of retailers who failed at this critical juncture.
Foolish frolic and detour
As of late September, we in metro D.C. are lucky to be one of the six places nationally where there's a Hot Topic store located near a new Torrid store. It's my goal to pack as much of the Rule Breaker Team as possible in a car and trundle on up for store visits to the Annapolis Mall in Annapolis, Maryland. Then we hope to be back with further analysis of the company, covering more of the Rule Breaker criteria, competition and the like.
In the meantime, why not check it out yourself? Enjoy the customer websites (www.hottopic.com and www.torrid.com) and the business website. Find and visit the Hot Topic nearest you through the store locator, and take a trip if you are close to one of the first Torrid stores. Decide if you think this company is worth more research, and share your views on the Rule Breaker -- Companies board.
And Fool on!
Tom Jacobs (TMF Tom9) wanted to buy an "Anticrombie" t-shirt at Hot Topic last year but feared spoiling the store's demographic. At press time, he owned shares in Hot Topic. To see his stock holdings, view his profile, and check out The Motley Fool's disclosure policy.
