Is It Better To Own Those Calvin Kleins, Or Rent 'Em? Posted: Apr 01, 2008 10:08 AM by Will Ashworth The Calvin Klein brand was bought by Phillips-Van Heusen (NYSE:PVH) in 2003 for $400 million cash, $30 million in stock and a potential bonus of $300 million based on revenue over the next 15 years. Klein got the financial backing he was looking for and Phillips-Van Heusen acquired an internationally respected brand. It was a win-win situation for both companies. Phillips-Van Heusen then licensed the Calvin Klein brand to Warnaco Group (Nasdaq:WRNC). So, the question is, is it better to own the brand or is it better to rent it? History Lesson Warnaco Group is the owner of the Speedo swimsuit brand among others. Its licenses with Calvin Klein include underwear, jeans and intimate apparel. In 2006, Warnaco accounted for 37% of Phillips-Van Heusen's royalty revenue. It was once a frosty relationship; then in 2007, Warnaco paid $38.5 million to Phillips-Van Heusen for the right to operate Calvin Klein accessories stores in Europe and Latin America along with ecommerce rights for jeans in the Americas, Europe and Asia. Warnaco's CEO, Joe Gromek, estimates the deal will generate $150 million in annual revenues over the next five years. That's an excellent return on investment. Mirror Images On first impression it's difficult to say which company is out ahead. The two companies are almost identical in terms of 2007 revenues - $1.9 billion for Warnaco and $2.1 billion for Phillips-Van Heusen. The most recent quarter debt-to-equity ratios are also nearly identical, 42% for PVH and 40% for Warnaco. There's very little to tell the two businesses apart. Even their growth numbers (revenues and operating income) in the most recent fiscal year information are alike, all between 10% and 20%. Valuations Tell the Story When you examine their valuations, you begin to find your answer to which company is the better investment. Despite similar growth, Warnaco's current price-to-earnings ratio is 21, almost double Phillips-Van Heusen's at 12 times earnings. Another metric helpful untangling this mystery is to examine enterprise value (EV) in relation to EBITDA. Enterprise value is the theoretical takeover price of a company including its debt, cash, etc. Warnaco's EV is 8 times EBITDA while Phillips-Van Heusenâ€™s is 6 times EBITDA. Considering Phillips-Van Heusen's return on equity is much higher than Warnaco's (19% compared to 11%), it seems at the very least, EV-to-EBITDA should be equal. Therefore, either Warnaco's value is about $400 million on the high side or Phillips-Van Heusen is approximately $600 million too little. It really depends on your viewpoint. (For a crash course on these ratios, check out our Investment Valuation Ratios Tutorial.) Mutual fund manager Jonathan Vyorst, responsible for the five-star Paradigm Value Fund, believes there are some great deals out there currently including Phillips-Van Heusen. He feels the combination of the Calvin Klein growth engine attached to a stock trading at 10-times future earnings presents a great opportunity for investors willing to wade into retail. Warnaco's stock in the last year is up over 35% while Phillips-Van Heusen's is down 35%. Those with a tolerance for risk will likely be unable to pass on this fire sale. Bottom Line Both companies might make excellent long-term investments. Their 2007 deal ties them inexorably together. If your investment decision becomes one or the other, I'd lean towards Phillips-Van Heusen for two reasons: 1) Phillips-Van Heusen is clearly the cheaper stock 2) Phillips-Van Heusen has control of brands beyond Calvin Klein including Izod, Geoffrey Beene, G.H. Bass and Arrow Shirts. In this instance the owner is clearly more impressive than the renter.
For additional insight into brand management versus licensing, check out Getting To Know Business Models.