This week’s bond review gives investors a second look at the world’s premier brand manager. Iconix Brand Group has a brand portfolio that encompasses many well-known brands throughout the retail industry – names like Ocean Pacific, Umbro, Mossimo, Waverly and London Fog. Earlier this year, Iconix gained an outstanding new CEO. John Haugh is a retail veteran with over 30 years experience in leading premier global brands. Under Mr. Haugh’s direction, Iconix has:
Continued its solid interest coverage of nearly 2x.
Posted a 46% year-over-year increase in Q3 operating income.
Begun to improve the company’s balance sheet by eliminating more than $100 million in debt.
In our review earlier this year, readers may remember Iconix’ interim CEO, Peter Cuneo, who is well-known for his epic turnaround of Marvel Comics. Investors will be thrilled to know that Cuneo has stayed on with Iconix as Chairman of the Board. The company’s 2018 bonds, which mature in a short 15 months, are currently selling at a discount, indicating a yield of about 7.25%. Although this yield is lower than many of our recent bond reviews, it still exceeds the 1 year U.S. Treasury yield by more than 5x. In consideration of these factors, these bonds have met our addition criteria for our FX1 and FX2 income portfolios.
Iconix recently released its results for the quarter ended September 30, 2016. Here are some notable items from its Q3 report.
Exceeding analyst’s expectations: Iconix beat analyst’s expectations in both earnings per share (EPS) as well as in revenue estimates. Analysts predicted EPS of $0.17 per share and revenues of $88.9 million. Actual results from Iconix were $0.19 per share and revenues of $90.9 million.
Solid free cash flow: Iconix maintained its 2016 free cash flow guidance of $169 million to $184 million.
Debt reduction: In Q2, Iconix began the repurchase of a portion of its 2018 notes. This process was concluded in July, with the company paying $35 million cash for the repurchase of $105 million in face value of its 2018 notes.
Operating Income growth: Q3 operating income grew by 46% compared to Q3 2015 ($40.7 million versus $27.8 million), driven primarily by growth in its Men’s segment as well as its Home segment.
Outstanding Operating Margins: Due to Iconix’ “asset-lite” business model, it has extremely attractive operating margins. For the nine months ending September 30, 2016, the company’s total operating income margin was 51%.
Increasing segment revenues: For the nine months ending September 30, 2016, revenue from Iconix Entertainment segment grew by 18% over 2015 and licensing revenues in Japan grew 49% year-over-year.
SEC conclusion: On November 4, 2016, the SEC concluded its review of Iconix accounting practices for 2013-2015.
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 has grown through its acquisition of existing brands followed by licensing the rights to third parties. This 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.
Positioning Iconix for Future Growth
In a recent Investor Day presentation, Iconix’ new CEO, John Haugh, outlined the current position of Iconix Brand Group as well as a comprehensive plan for primarily organic growth, complimented by strategic acquisitions. Iconix currently touts $13 billion in global retail sales over its 30+ brands through its various distribution channels. In the past, the company’s primary growth came through acquisitions. However, its business had become dependent on acquisitions for growth and once acquired, Iconix was not actively managing its brands, but leaving the management to its retail partners. Mr. Haugh, together with Iconix’ upper management team, has created a plan to more actively manage each Iconix brand with the goal of creating an additional $50 million in revenues by 2019 through organic growth. To do this, Haugh and his team have defined Iconix’ brands into three different categories – “Driver” brands (brands in categories that are growing above their respective indexes), “Maintain” brands (representing Iconix’ mainstay of revenues, strong direct-to-retail, or DTR relationships), and “Incubate” brands (brands that are underperforming, have prospect for growth within Iconix or possibly divest). This strategy is best illustrated by this graphic used in the Investor Day presentation.
Haugh’s strategy will be to aggressively pursue growth in those brands represented in the “Driver” category where there are ample opportunities to grow existing relationships as well as forge new relationships to increase revenues. In addition, Iconix will continue to actively manage its many DTR relationships, which provide roughly 60% of the company’s annual revenues. These DTR agreements are with large, well-known retailers such as Target, Wal-Mart, Kohls and JCPenny, just to name a few. Iconix goal is to create an additional $50 million in annual revenue by 2019 split between the three categories as well as add an additional $25 million in revenue from strategic acquisitions.
Improving the Balance Sheet
Haugh and Chief Financial Officer David Jones also indicated that a major goal for the company is to delever the balance sheet. This process began earlier this year with the repurchase of $105 million of face value of the company’s 2018 convertible notes. Jones has indicated that Iconix plans to pay down an additional $70 million of face value of the 2018 notes which would leave $225 million in face value to refinance in 2018. Overall, Iconix plans to reduce its overall debt from its current level of $1.35 billion to $1.0 billion by 2019.
Interest Coverage and Cash
Iconix continues to register excellent interest coverage. For the nine months ending September 30, 2016, the company had operating income of $142.7 million and interest expense of $74.5 million for an interest coverage ratio of 1.9x. The company also maintains robust cash reserves, most recently totaling $250 million.
These short 15-month bonds are convertible to Iconix stock at a conversion price of $30.86. Over the past year, Iconix stock has traded at a low of $4.67/ share and a high of $10.30 / share. It is currently trading around $9.30 / share. With the stock price trend increasing, this convertible bond may provide investors with additional return via capital gains.
The default risk is Iconix ability to perform. The company’s new CEO John Haugh, is definitely taking a more hands-on, active approach in managing the company’s well-known brands. The company has outstanding operating margins and is focused on significant debt reduction over the next few years. It has healthy cash levels that it can use for deleverage as well as for accretive acquisitions should the opportunity arise. The low 1.5% coupon on these 2018 bonds means that investors could realize capital gains as the bonds are currently trading at a discount, with a current yield around 7.25%. Based on this information, the returns on these short 15-month bonds from Iconix, appear to outweigh the risks identified here.
These 7.25% yielding, very short duration bonds (15 months) have similar yields and durations to other bonds reviewed on Bond-Yields.com, such as the 8% Commercial Vehicle Group and 28.5% ION Geophysical bonds.
Summary and Conclusion
Iconix owns some of the most recognizable brands in the retail sector – names like Dankso, Umbro, Waverly, Peanuts and Mossimo. The company has procured new management that looks to more actively manage its valuable brands over the spectrum of distribution channels. While management is focusing primarily on organic growth, it will also continue to consider accretive acquisitions to increase its bottom line revenue. The company is also committed to reducing its debt and has begun that process with its recent repurchase of $105 million of its 2018 notes. And while management views 2016 as a transition year for the company, Iconix posted excellent year-over-year growth in its Q3 operating income and continues to show solid interest coverage and robust free cash flow. Although these 2018 notes are only couponed at 1.5%, the currently discounted price gives investors the possibility for returns through capital gains. The yield to maturity of 7.25% makes these bonds an excellent consideration for addition to our Fixed-Income1.com and Fixed-Income2.com global high yield income portfolios.
Issuer: Iconix Brand Group, Inc.
Ticker: ICON (NASDAQ)
Conversion Price: 30.86/share
Yield to Maturity: ~7.25%
Disclosure: Durig Capital and certain clients may have positions in Iconix Brands’ 2018 bonds.
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