EganaGoldpfeil (“Egana”) is a vertically integrated company that manufactures, wholesales, and retails “affordable luxury” watches, jewelry, leather goods, and other lifestyle products.  Its primary market is Europe (85% of sales), but it also has a presence in both Asia (11%) and the U.S. (4%)  The company’s reach covers a diversified range of sales channels including department stores, co-operatives, franchises, chain stores, and mail order.  Egana’s business strategy of reviving older brands is similar to what Coach did so successfully after its spin-off from Sara Lee in 2000.

 

We believe that this relatively undiscovered company should trade at twice its current valuation.  The company is likely to grow organic revenue at 15%-20% and earnings of 20-30% (through margin improvement) annually over the next 4-5 years, yet trades only at 11.0x May 2007 EPS with a 3% dividend yield.  Growth visibility is good as a sizeable amount comes through guaranteed contracts.   By comparison, slower growing European competitors (LVMH, Richemont, Swatch, Hermes, and Burberry) trade at 15-20x NTM EPS. 

 

In addition to its cheap valuation, we like management (led by CEO Hans Seeberger) and believe that over the last few months they have started to put in place an important series of steps to build investor credibility.  These include buying and consolidating a majority owned subsidiary (Egana Jewellery - HK926), selling a 10% position to a strategic partner at a substantial premium to the current price, and implementing and communicating to investors a strategy that focuses on organic growth and margin improvement.  Also, they will likely list the stock on the Frankfurt exchange within the next 12 months.    

 

From 1998-2005, Egana built a brand portfolio through a series of acquisitions. Brands acquired included Goldpfeil, Madler, Pierre Cardin, Carrera, Junghans, Comtesse, JOOP, Sioux, and Salamander.  Although many of these brands are not familiar to most Americans, they are very well known in Germany, Eastern Europe, and to some extent Asia. Salamander, a widely recognized German retailer of dressy footwear, is the largest (30% of consolidated revenues) and most recent acquisition (completed in early 2005).   Since completing this acquisition, management switched its focus to organic sales growth and margin improvement.  Their strategy now is to cross sell Egana-owned brands into Salamander’s 172 retail locations, and expand all existing brands into new geographies (primarily in the Eastern Europe, United States and Asia). 

 

Roughly half of future revenue growth is expected to come from Western Europe driven by guaranteed sales contracts to its co-op customers and increasing sales of many of its other brands into its recently acquired Salamander chain.  The remaining half of the growth will stem from expansion into Eastern Europe, Asia (primarily China), and the United States.

 

Guaranteed contracts?  Surprisingly, Yes!  Egana has unique (and valuable) relationships with German retail entities called co-ops.  Co-ops enter into 3 to 10 year contracts with Egana that include ~8% annual purchase escalations.  In exchange, Egana supplies about 40% of each co-op’s merchandise and handles marketing, logistics, and in-store product displays. Co-ops are essentially buying groups made up of numerous mom-and-pop retailers.  Egana began working with co-ops 30 years ago and actually helped establish some of the largest in order to gain access to this crucial distribution channel. In exchange for Egana supplying co-ops with a good portion of their inventory, co-op’s deal with fewer suppliers and lower their inventory carrying requirements (Egana is in charge of the replenishment).  Egana will often work with co-ops to improve their business. For example, if a product is selling poorly at a co-op, Egana is able to swap the product with one of an equivalent value and sell the poor seller somewhere else (e.g., remove from Europe and sell to Asia). In China, Egana is establishing a similar co-op program which should help provide value to entrepreneurial retailers in China. This relationship with the co-ops gives Egana a competitive advantage in distribution and is partially what attracted Richemont to make a strategic investment.

 

We believe that (consistent with their 5 year plan) the company can achieve HK$10.5B of sales and 11% operating margins by FY May 2010 vs. an estimated HK $5.9B in sales and 8.4% margin in FY May 2006. This does not include any upside resulting from the Richemont strategic investment, which could potentially expand margins to as high as 15%.

 

Based on a more conservative HK$10.0B and 10% operating margin, the company would generate $0.58 in EPS in FY 2010. Applying a 15x LTM EPS multiple (a discount from competitor multiples), the stock would be valued at HK$9.30 by May 2010, over a 30% IRR from the current price of HK$3.40. This return does not include an estimated 3% annual dividend.

 

 

 

 

 

*Pro-forma for privatization of majority owned sub which will save them $0.015 pre-tax. Actual FY06 EPS should be closer to $0.23.

 

At a stock price of HK$3.40, the table below shows that at 11.0x FY07 and 8.7x FY08 EPS, Egana trades at almost a 50% discount to its competition on an EPS basis, as well as significant discounts based on EV/Sales or EV/EBITDA.

 

 

The primary uses of cash flow will be for growth in working capital (which represents roughly 25% of sales), capital expenditures (slightly in excess of depreciation), dividend payment (company targets dividend payout ratio at 30-35%), with the remaining cash flow going to debt paydown (company is targeting debt pay down of 10% per year).

 

We are comforted that there is downside protection stemming from the value of the company’s brands, estimated by a third party, to be HK$5.5B or HK$3.85 per share. By adding another $1.00 per share of net asset value (book value minus intangibles), we get to a of liquidation value of HK$4.85 for the company.  Furthermore, the CEO owns about 28% of the company, so his interests are aligned with shareholders. We also like that management’s incentives (organic growth, growth in operating income, ROIC) are aligned with shareholder value creation.

 

We believe the stock is undervalued for two reasons, neither of which should be related to fundamental value.

 

First, the stock trades on the Hong Kong Stock Exchange, but most sales are in Europe (and it is run by a German CEO). As a result, the stock is significantly undercovered by the sell side; European analysts are not interested in researching Hong Kong based stocks; Hong Kong analysts view the company as primarily European. Management is addressing this by listing on the Frankfurt exchange in the next 12 months.

 

Second, over the last several years, management did not make a significant effort to communicate with investors as they were focused on making and integrating acquisitions. As the organic growth and margin expansion story is only now becoming visible, management is more actively communicating its growth story to both the buy side and sell side.

 

Event #1: In August, 2006, as part of a business alliance with Egana, Richemont (a Swiss-based luxury goods firm) bought 10% of Egana at a price rumored to be at a significant premium to the current price (potentially at $4.00-$.4.40 per share). Because the sale of shares was a private transaction between CEO Hans Seeberger and Richemont, the company has not disclosed the actual price.   This alliance gives Egana access to Richemont’s brands and Richemont access to Egana’s retail distribution in China and Eastern Europe.  Note: Though potentially huge, we have not included any benefit from this strategic investment in our revenue and earnings estimates.

 

Event #2: In July, 2006 EganaGoldpfeil made a proposal to purchase the shares of its publicly traded majority owned subsidiary Egana Jewellery (926HK).  All said, this deal will save Egana HK$20M per year ($0.015/share pre tax).   More importantly, this simplifies the reporting structure and lifts some restrictions that had hindered the growth of Egana Jewellery.

 

Egana has a diversified mix of brands across a wide range of segments including luxury (Goldpfeil, Comtesse), affordable luxury (Salamander, Cerrutti, Puma, Joop, Dugena, Junghans), fashion and lifestyle (Carerra, Esprit, Mexx, Pierre Cardin), as well as private label. Out of the portfolio of 48 brands (36 owned and 12 licensed), about 75% of sales come from 12 key brands, with only Salamander representing more then 10% of consolidated sales.

 

Although many of these brands may not be familiar to most Americans, they are very well known in Germany, Eastern Europe, and to some extent Asia. An independent study (prepared by Outfit 5 and Spiegel-Verlag) listed Junghans, Dugena, and Esprit (licensed) among the top 10 fashion and core watch brands in Germany, outranking more well known brands such as Gucci and Bulgari. Additionally, Goldpfeil, Joop, and Comtesse rank #1, #5, and #10 in market perception in Germany, and rank favorably compared to Armani, Christian Dior, and Louis Vuitton in terms of brand awareness. In fact, Egana’s Goldpfeil brand has the highest market share in the luxury leather accessories. In Japan, Goldpfeil and Comtesse are ranked #15 and #7 in terms of brand awareness in the luxury goods segment.

 

Salamander (which represents almost 30% of consolidated sales) is Germany’s second largest footwear brand  and among the top 3 in other countries including Austria, Belgium, Czech Republic, France, Hungary, Poland, and Russia. In particular, the Salamander acquisition was quite accretive. Bought out of bankruptcy in March 2005 for HK$372M, the brand will generate roughly HK$1.6B in sales and HK$100M in operating income in FY May 2006 (to be reported in September). Egana has already improved the division’s operating margins from 4% at the time of acquisition to 6% as of May 2006, and expects to improve them further to 11% over the next three to four years due to centralized procurement, integration of in-house production, R&D leverage, extension of Salamander brand into higher margin categories, introduction of Salamander products into Asia, and cross selling other, higher margin Egana owned products into Salamander stores.

 

Our research indicated that management’s 15% organic growth target through 2010 is reasonable and that 20% is possible.  Margin improvement will primarily be driven by improving product mix, and SG&A leverage in the Salamander stores,  improved margins in the US and China as the geographies grow, and better leveraging of advertising dollars.

 

Timepieces (30% of sales): Although growth in the overall watch industry is relatively stagnant, the affordable luxury goods segment is growing at roughly 15% per year. More specifically, radio controlled watches, which currently account for only 2% of industry sales, are growing at a reasonably high rate. Overall, the company projects 10-15% organic growth in this segment, driven by growth in the Junghans and Ceruti brands.

 

Jewelry (17% of sales): The company is leveraging its distribution network for timepieces to expand its geographic coverage for jewelry by increasing its branded jewelry (Carerra, Pierre Cardin), fashion jewelry (Esprit, Mexx ) as well as its private label business. Egana has indicated that they have a special production process on their platinum jewelry which reduces the amount of platinum required in the jewelry, and as a result, has received interest from Tiffany’s, Monteblanc (Richemont), and Cartier (Richemont) as a potential supplier, and has earned the approval of the Platinum Guild, an organization funded by leading platinum producers and refiners dedicated to supply information, advice and expertise to jewelry buyers. Overall, the company believes they can grow this segment by 15% per year as the company increases distribution and gains share on the platinum side.

 

Leather: (50% of sales, includes footwear): Growth in this segment is driven by cross selling of Egana-owned brands into Salamander retail stores (specifically handbags and brief cases), and expansion of existing brands into new geographies. The company is targeting 15-20% revenue growth in the leather segment.

We expect Egana to grow revenues in Western Europe (75% of sales) by 10-12% per year driven by guaranteed sales contracts to its co-op customers, increasing sales of many of its other brands into its recently acquired Salamander chain, and strengthening of the German economy (which represents the majority of Western Europe sales). This should contribute roughly ½ of total organic growth. The remaining ½ of the organic growth is split between Eastern Europe (20% annual revenue growth), Japan (30% annual growth), China (40% annual growth), and the United States (25% annual revenue growth).

 

We have spoken with CEO Hans Seeberger and have confidence that he and his management team are focused on profitable organic growth.  We are comforted that bonuses are aligned with shareholder value creation.  Specifically, 5 factors drive bonus payouts: 1) Minimum of 15% organic growth, 2) 8% or better operating margin in every division in 2007 increasing to higher targets by 2010, 3) 25% annual pretax income, 4) 5% net margin in 2007 increasing to higher targets by 2010, 5) Minimum of 12% ROIC (goal is to get to 15% by 2010).

 

Additionally, CEO Seeberger effectively owns about 28% of the company (after 10% of sale to Richemont) so his interests are clearly aligned with shareholders.