Description

FOSL is a $700mm market cap, $900mm EV company that designs, develops and sells company owned and branded watches, jewelry, and leather goods globally.   The company owns the Fossil, Skagen and Misfit brands and it is the largest licensor of watches and jewelry for global brands including Michael Kors, Armani, Kate Spade, DKNY, Marc Jacobs, adidas, Diesel, etc.  The stock and business model have come under tremendous pressure in recent years after a shift in consumer preferences towards smart watches and pressure on the overall US retail environment.  Shares are down 85% over the past 3 years as the company endured a perfect storm of headwinds including:  1)  brick & mortar retail environment contracting which hurt wholesale sales and is causing FOSL to close now unprofitable owned retail stores, 2) slowdown in sales of its most successful branded watches (Michael Kors) which enjoyed hypergrowth / over-distribution, 3) loss of share to new product category, smartwatches, in which FOSL is now playing catch-up, and 4) fx impact on european /Asian business.     

In 2017, to address some of the structural changes in both product and sales channel, FOSL embarked on a plan to improve profitability of the downsized watch business while innovating across owned and licensed brands (alongside partner Google).  The thesis is that over the next couple years FOSL will be able to improve profitability by stabilizing its mid-priced fashion watch sales and growing connected smartwatch sales.  This would including recapturing some of the operating margin erosion that occurred from 2011-2014 when margins averaged around 17% versus 2017 margins of ~1%.  The average operating margin from 2000 to 2017 was 13%.  This won’t occur overnight as FOSL must close unprofitable retail stores, right size its wholesale business’ cost structure, and invest to effectively innovate and commercialize fashionable smartwatches (currently ~$300mm or ~20% of total watch sales) and roughly doubled in 2017).   That said, as revenues stabilize and grow around 2019-2020, we believe that revenue base of ~$2.5Bn to $2.7Bn should enjoy profit margins closer to the average of todays depressed margin of 1% and the last time the business had a $2.5bn rev base when margins were 19%. 

FOSL has embarked on a New World Fossil plan, whereby they expect to achieve $200mm in cost savings by 2020.  If FOSL recaptures some of its margin—resulting from the cost savings plan, in conjunction with fashion watch stabilization and continued healthy dd growth on its smart watch collections—the shares present attractive upside:

Market & Growth Opportunity

The watch market globally is a $65bn market globally comprised 50% of high priced swiss watches and 50% fashion watches, making FOSL’s fashion watch tam ~$32bn at retail.  The wearables market in half a decade grew to a $17Bn market and is expected to double to $32bn by 2020.  Interestingly, according to analytics by FOSL, these markets are comprised mainly of women who are aspirational fashion consumers.  This has been FOSL’s core customer for decades so one may assume they should be able to figure out how to market new innovative products to this consumer and acquire some share of this market. 

FOSL was the dominant global player in fashion watches priced $100-$200, attracting many of the most iconic global brands as licensors who partnered with FOSL to design and distribute branded fashion watches across their global distribution channel.  There are few other companies who can provide the breadth of design, data and marketing expertise as well as the global points of distribution as FOSL.

FOSL’s sales of “connected products” doubled in 2017, reaching ~$300mm or just 1.7% of the wearables market.   If they can continue to grow branded smartwatch sales, with google as their platform & tech partner, there would be material upside potential. 

Mgmt & Ownership

The CEO started the business with his brother in the 80s and had run the business for decades.  Kosta (CEO) takes $0 in salary and owns 8% of the company.

Over the past 5 months there have been many insiders purchases, most notably by the individual who runs their connected watch business, who purchased close to $1mm in shares.

Valuation:

While FOSL faces near term disruption as they transition the business, they generate attractive cash flows.   In 2017, despite revenue declines of 8% and EBITDA decline of ~15% the co generated ~$155mm or 20% LFCF yield, and 17% LFCF yield.  I expect the next two years FOSL will generate $70mm to $120mm in FCF each year, representing a LFCF yield of 10% to 17% (UFCF yield of 9% to 15%).

Risks:

·       Brands that currently contract with FOSL to leverage their distribution capabilities could choose not to renew when licenses come up.  FOSL has had a good track record of brand renewals until recently when Burberry decided not to renew its watch business with FOSL.  It is unclear if/how Burberry will continue its swiss watch business.  Adidas partnered with Nixon (a much smaller watch brand) to design its new line of watches.  Nixon does not have the scale of distribution that FOSL enjoys, however adidas has >2,000 stores globally to distribute its watches.

·       Fosl could be unsuccessful marketing its smart watches

·       Retail store closures (at Fossil retail and wholesale, ie department stores) could accelerate and further pressure sales without offset from online dtc

·       FOSL could not be successful capturing the incremental $100-$120mm in cost saves as part of their plan

Catalyst

As revenues stabilize and profit margins improve the stock will become too cheap to ignore.  Also, ~40% of the float was short as of the last reporting data, creating for a squeeze like conditon, which we may have seen the first of this week after they reported better than expected results and guided slightly better than feared.