“I’m returning to my first love, and to what I really understand,” Delta Galil CEO Isaac Dabah said Thursday, after the company announced its largest-ever acquisition.
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Delta will buy the jeans brand 7 For All Mankind, as well as the lifestyle clothing and accessories brands Ella Moss and Splendid, for $120 million cash from U.S. firm VF Corporation.
Delta, which specializes in the design, manufacture and sale of undergarments, socks, leisure wear, active wear and children’s clothing, expects the transaction to boost its per-share earnings from 2017.
“For four years we didn’t make any deals, we didn’t use the money on our books and didn’t take any chances. But prices have come down and we took advantage of the opportunity,” said Dabah.
“The operation we purchased completely suits Delta’s strategy, and its profit potential is great,” he added.
The capital market responded enthusiastically to the deal. Delta’s share price jumped 13.7% to 103.10 shekels ($26.80), the biggest one-day gain it has enjoyed in four years, on turnover of 31 million shekels – 12 times the share’s average daily volume.
On Sunday, Delta stock closed up a further 0.4% at 103.50 shekels.
The market’s reaction was presumably based on the deal’s potential to improve Delta Galil’s profit margins by shifting the weight of its operations toward higher-income customers, together with an analysis of the pricing of the transaction as presented by Dabah and Yossi Hajaj, the deputy CEO and head of global operations.
The sales volume of the brands Delta acquired was $344 million in 2015, which was down 14% from 2014. Earnings before interest, taxes, depreciation and amortization, or Ebitda, was $23 million in 2015, down 51% from 2014.
For 2016, sales and Ebitda are tipped to reach $300 million and $10 million, respectively.
“The denim market in the United States and the premium brands have declined in recent years, partly as a result of a decrease in foreign tourism to the United States,” said Hajaj. “But it’s a cyclical market, and it steadied in January to May 2016, and even showed a rise of 1%.”
Chief Financial Officer Jacob Heen noted that purchases by overseas tourists accounted for about one-third of 7 For All Mankind sales, which dropped by 30%.
The brands were also hit by the euro’s softening against the dollar – down to 1.10 dollars per euro from 1.35 – as well as by administrative problems in Europe.
The fall in profits and, to a lesser extent, the drop in sales, are the main risk in the deal. But both the market and analysts seem to think the risk was factored into the sale price.
The $120-million acquisition price also includes the $25-million property of the company headquarters in Los Angeles, raising the value of the operations it bought to $95 million.
Considering that the final price will be adjusted in accordance with changes to the working capital on the day the transaction is completed – that is, inventory and net customer debt, which was $72 million at the end of 2015 and is expected to be between $65 million and $75 million when the deal is finalized, before the end of the third quarter – the enterprise value to Ebitda ratio drops to 2.5.
Dabah noted that four years ago, Delta Galil acquired the German underwear manufacturer Schiesser for $12 million less than the fair value of the transaction.
“The profit opportunity for VF could be double,” he said, noting that VF Corp. had paid $885 million for the activity in July 2007.
For VF, whose brands include The North Face, Jansport, Eastpak, Timberland, Lee, Wrangler, Kipling and Nautica, and whose market value is $26 billion with annual sales of $12.4 billion and an Ebitda of $2 billion in the 12 months that ended in March, the deal is an opportunity to get rid of an activity that generated 2.8% of turnover and net profits of $5.8 million.
Dabah noted that VF was not focused on these brands, which accounted for 3% of revenue and 0.25% of operating profit. He thinks that’s why Delta Galil’s vice president for business development, Inbar Schwartz – who led the initial contacts over the deal two years ago – persuaded VF to make the sale in direct talks and at a relatively low price, rather than in a tender.
Even though the brands’ weak performances caused VF to record a $144-million pretax, noncash impairment charge at the end of 2015, Delta is nevertheless getting the premier jeans brand in the United States, with a 17% market share. The 7 For All Mankind brand accounted for 70% of the acquired activities, with jeans that sell for $200 a pair. Combined with Splendid and Ella Moss, Delta Galil can expect to increase the brand activity in its portfolio by between 53% and 65%.
As a result, Delta Galil is diluting its private-label manufacturing for chains such as Walmart and Victoria’s Secret to 35% from 47%, and could significantly improve its gross profitability.
The purchase will also increase Delta’s share in the premium market to 55%, from 41%, and boost the percentage of sales volume contributed by the United States by 4%, to 62%
Dabah and Hajaj said the gross profitability of the acquired activities exceeds 50%, compared to an average gross profitability of 30% in the previous 12 months for Delta Galil.
Dabah believes Delta can leverage the strength and pricing power of its new brands to increase sales by expanding the number of products marketed under them.
He said the profitability of the acquired activities can be increased and increase the Ebitda margin to 15%, compared to the 2016 forecast of 3.3%.
“That will only happen in 2019,” said Dabah, but pointed to measures the company plans to take – such as closing 20% of money-losing stores, reducing the share of retail in sales of the acquired activities to 20%, from 30%.
“Retail is tough. It’s better to increase the share of sales through chains such as Selfridges, Nordstrom, Saks Fifth Avenue and Bloomingdale’s,” said Dabah.
Additional steps to increase profitability include increasing the contribution of online sales to 6% of daily turnover; making better purchases of raw materials and manufacturing services; and unifying logistics in Europe and integrating the European activity of Schiesser.
“It’s an excellent strategic acquisition with a large potential and a low level of financial risk,” said Oz Levi, vice president for research at Apex Capital Markets.
He pointed out that the purchase significantly increases Delta Galil’s branded activity, to 65% of sales volume, while improving distribution and balance among the company’s profit units. All that for just $120 million, when the value of the real estate and working capital of the acquisition alone come to $95 million.
“One could say that Delta bought a leading, premium American brand with annual sales of $300 million for just $25 million – nearly for free,” added Levi.
He believes the price to earning ratio of the branded operations is substantially higher than the PE ratio the stock market assigned the private label.
Levi noted that the question is whether Delta can leverage its new brands while expanding the product lines and stopping the decline in sales, as a first step toward increasing them, by applying the managerial focus that VF presumably failed to do.
Levi said that Dabah’s experience is a valuable asset to Delta. Dabah bought the Gloria Vanderbilt jeans brand in 1993 for $5 million, and sold it to Jones Group in 2002 for $100 million in cash and shares.