This week, our focus turns towards the company behind London Fog®, Mossimo®, Ocean Pacific®, Fieldcrest®, Danskin®, Umbro®, Pony® and Peanuts® brands. While it is highly likely that you recognize at least one of these brands, what you may not know is that all of these brands are owned by Iconix Brand Group (ICON), which has a 2018 convertible bond currently offering a very attractive 16.5% yield. From its most recent quarterly and full year results, as well management’s discussion on its most recent earnings call, there have been several positive developments at Iconix that are definitely worth highlighting
Iconix appointed Peter Cuneo as interim CEO. Cuneo is well-known for his epic turnaround of Marvel Entertainment, among others.
The company increased free cash flow year-over-year by 14%, from $165.4 million in 2014 to $188.9 million in 2015.
Earler this month, Iconix successfully secured a $300 million term loan to cover its June 2016 notes.
Iconix’ Entertainment business segment was up 42% year-over-year in Q4.
The company more than doubled net income over 2014 levels ($248.6 million vs. $129.7 million).
These short 23-month bonds also have a convertibility feature that may provide investors with additional return via capital gains. Not only does this issue provide diversification into the consumer sector, it’s deeply discounted price of about 77 and low 1.5% coupon means that the majority of its high 16½% yield would be taxed as as long term capital gains rather as interest payments. Therefore we are targeting these (unrated) short 23-month bonds from Iconix Brand Group for addition to both our FX1 and FX2 global high yield income portfolios.
Last year, when former Iconix CEO Neil Cole stepped down, the market reacted with Iconix’ share price dropping by 24%. Cole’s resignation left Iconix without the person who had led the company since 2005, when he changed the company’s name from Candie’s Inc. and turned it into a clothing-brand manager and licenser instead of a manufacturer and seller. Iconix then appointed interim CEO Peter Cuneo. Cuneo has a fantastic track record of turning around troubled companies. In his professional career, Cuneo has engineered not just one, but seven turnarounds of entire companies or divisions at Clairol, Black & Decker, Remington and Marvel (creators of Spider Man and the X-Men). Cuneo took the reins at Marvel in 1999 after it had just emerged from bankruptcy and its shares were trading for under $1.00. Under Cuneo’s leadership, the company flourished and after ten years, Cuneo sold Marvel to Disney for $4.5 billion with shares then trading at $54.
Cuneo has continued to direct Iconix as interim CEO since Cole’s departure last August. In February, the company appointed John Haugh as CEO, effective April 1, 2016, with Cuneo also remaining with Iconix as Executive Chairman. Haugh has over 30 years of experience across global brands and retailers such as Luxottica Retail, Build-A-Bear Workshop and Mars Inc. Together, Haugh and Cuneo make a powerful management team that will provide excellent leadership for Iconix as it seeks to grow its existing brands.
Q4 2015 and Full Year Results
Iconix recently released its results for Q4 and full year 2015. For the full year 2015, net income more than doubled over 2014. In 2014, the company recorded net income of $118.8 million. 2015 net income came in at $248.6 million, an increase of 109% (omitting the one-time, non-cash impairment charges taken in Q4). Free cash flow saw a 14% increase over the previous year, going from $165.4 million to $188.9 million, even with the slight (3%) decrease in licensing revenues. Moving forward, company management is projecting free cash flow for 2016 to be between $150 million and $170 million, which it intends to use to pay down debt. Another bright spot for Iconix was its Entertainment business segment which was up 42% in Q4 and also increased 4% for the year. Most of the entertainment increase was driven by the company’s Peanuts brand, which experienced a significant increase due to the release of the Peanuts movie during Q4. In fact, the Peanuts brand actually grew by over 50% in the U.S. last year.
About the Issuer
Iconix Brand Group (ICON) is the world’s premier brand management company and owner of a diversified portfolio of strong global consumer brands across fashion, sports, entertainment, and home. Iconix specializes in marketing, merchandising and licensing its brand portfolio and has over 1,100 licenses with leading retailers and manufacturers worldwide that sell across various distribution channels from the mass tier to the luxury market, as well as through various media outlets. Iconix brands include well-known names such as MossimoÒ, London FogÒ, DanskinÒ, Ocean PacificÒ, and sports brand UmbroÒ. In addition, Iconix also owns interests in PeanutsÒ, Ed HardyÒ and sports brand PonyÒ.
Iconix’ business strategy is to acquire existing brands and then license the rights to third parties. Their strategy is considered “business-lite” because Iconix manages the marketing, merchandising and licensing of the brand while the licensee manages everything else (manufacturing, inventory and sales). The company has had success with its direct-to-retail (DTR) program where it licenses a brand exclusively to a single retailer. Examples of this are the DanskinÒ brand exclusively licensed to Wal-Mart, MuddÒ exclusively licensed to Kohl’s and Material GirlÒ exclusively licensed to Macy’s.
2015 brought some challenges for Iconix, including an SEC investigation into its accounting treatment of its joint ventures and a new management team. The company has already restated some of its quarterly results and submitted these to the SEC and is awaiting confirmation. In addition, the new management team is working to optimize and grow the company’s well-respected brands with its licensees.
Iconix stated in its most recent earnings call that “2016 will be a year for restaging the business”. The company projects its base business to be approximately flat for the year, but the company has increased its marketing and advertising budget for 2016, working more closely with its licensees and partners to identify areas where they can provide additional support and drive sales. This signals a shift in the company from growth by acquisition to more organic growth.
Revitalizing its relationships with the big box apparel retailers in the U.S. this year will continue to be a focus for Iconix. In 2015, the company renewed six large DTR licenses with some of the largest and best-known retailers: MossimoÒ at Target, CandiesÒ at Kohls, BongoÒ and Joe BoxerÒ at Kmart / Sears, and Ocean PacificÒ and StarterÒ at Wal-Mart. Iconix has over 50 DTR agreements globally. For certain brands, the company is already working to more effectively address online shopping trends by improving the overall e-commerce experience for the consumer while driving traffic to the licensees’ product websites for digitally and socially driven campaigns.
In addition to domestic growth, the company is also looking to growth in its international business. Last year, international business made up roughly a third of Iconix revenues and the company’s goal over the next four to five years is to increase this share to 50%. Indeed, international revenues performed well last year, with licensing revenues in Japan up 12% in 2015 over 2014 levels. And, in 2015, Iconix continued to expand its international platform by acquiring full ownership and control of Iconix China. In 2015, the company’s total international business revenues grew by 8% over 2014 and the company is predicting growth in this area for 2016 around 10%.
Interest Coverage and Cash Flow
In the absence of the company’s $438 million impairment charge for 2015, Iconix had operating income of $174.9 million. The company’s interest expense for 2015 totaled $86.2 million for an interest coverage of just over 2x.
For 2015, Iconix generated $188.9 million in free cash flow. For 2016, the company projects free cash flow to be between $155-$170 million. Moving forward, it expect to generate a base of $160 million of free cash flow in 2017 and beyond.
These short 23-month bonds are convertible to Iconix stock at a conversion price of $30.86. Since January, Iconix stock has shown impressive year-to-date gains. Since its low of $5.04/share in early January, the stock is now trading around $8.49 / share, an excellent YTD gain of over 60%. And, just one year ago, the stock was trading over $34/share. With the stock price showing signs of recovery, this convertible bond may provide investors with additional return via capital gains.
The default risk is Iconix’ ability to perform. While the company endured some bumps in 2015, it still generated healthy free cash flow of $188.9 million, with estimates to generate between $150 million and $170 million this year. In addition, the new management team of Cuneo and Haugh will provide effective leadership for Iconix in directing how to maximize the growth of its existing brands both domestically and internationally. The outstanding return on these relatively short-term convertible bonds appear to outweigh the risks identified here.
Inconix currently has $1.4 billion in long-term debt, which includes these 2018 convertible bonds (with $400 million outstanding). There was concern over the company being able to retire or refinance its June 2016 notes, but the company was recently able to secure a $300 million term loan with Fortress Investment Group, which it will use to repay the $300 million for these notes. The balance of its long-term debt is in senior secured notes and variable funding notes that do not mature until 2043, but the interest rate steps up after 2020. Iconix mentioned several times during its most recent earnings call that it intends to use available free cash flow to de-lever its balance sheet, also with intentions to satisfy between 40-50% of the 2018 bonds with free cash flow. In addition, the company expects to generate a free cash flow base beyond 2016 of approximately $160 million annually.
In late 2015, Iconix announced that the SEC was investigating the company’s accounting treatment of its joint ventures. Since that time, Iconix has fully cooperated with the SEC and has reviewed and restated its financial results from 2014 and the first half of 2015.
Summary and Conclusion
In spite of what the markets may think, Iconix had a good year in 2015. Free cash flow increased by 14%. Net income more than doubled as compared to 2014. The company gained a legendary leader on its management team who is renowned for his abilities to revive and redefine companies. It successfully secured financing for its June 2016 notes. And, the company has fully cooperated with the SEC in restating financial results where needed. In light of the SEC news and management changes in 2015, the markets drove down not only Iconix stock price, but its bond prices as well. For bond investors, Iconix has excellent free cash flow and solid interest coverage. And with the stock price beginning to recover, the convertibility feature on these bonds could also provide additional opportunity for investors to increase their returns. The outstanding yield on these relatively short-term bonds provides investors diversification into consumer brands while providing favorable returns for their portfolios. Considering these factors, we have also marked these bonds for addition to our managed income portfolios, FX1 and FX2.
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Issuer: Iconix Brand Group, Inc.
Ticker: ICON (NASDAQ)
Conversion Price: 30.86/share
Yield to Maturity: ~16.52%
Disclosure: Durig Capital and certain clients may have positions in Iconix Brands’ 2018 bonds.
Please note that all yield and price indications are shown from the time of our research. Our reports are never an offer to buy or sell any security. We are not a broker/dealer, and reports are intended for distribution to our clients. As a result of our institutional association, we frequently obtain better yield/price executions for our clients than is initially indicated in our reports. We welcome inquiries from other advisors that may also be interested in our work and the possibilities of achieving higher yields for retail clients.
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