Authentic Brands Inc. - IPO Review

What do Marilyn Monroe, Elvis, Muhammad Ali and Shaq have in common? 

Authentic Brands… the founder-led, 3rd biggest global licensor, which is soon to come public. 

When you open the S-1, all you see are pictures of celebrities. It piqued my interest when I saw it. And then, a couple of weeks ago there was a news article saying they’d bought Reebok from Adidas for $2.5B. Now, I really wanted to see what was going on. 

Here are my notes on Authentic Brands Group Inc (ABG Inc), after my review of the S-1 which was filed in July 2021. The proposed ticker symbol is “AUTH” and WeBull seems to be brokerage of choice.

What I like:

• Great Management

• Decent Growth, Margins and Strategy

• Making Profits and

• Solid Partnership with SPG (Simon Property Group)

What I will keep an eye on:

• High level of debt from the fast pace of acquisitions

• Deal details on Reebok acquisition (the reported number of $2.5B is massive)

• Whether the company uses the IPO proceeds to delever significantly

Read on for more…

Business

Authentic Brands LLC was established in 2010. It has an interesting approach to the brand business. Instead of actually owning the product, they own only the intellectual property, or the “Brand”. 

Here’s how their founder and CEO, Jamie Salter describes it:

You have to love a founder who can break down his business in such simple terms. Personally, I think it’s a fantastic concept. The business remains asset-light, while the company concentrates on digital marketing and, earning a royalty from the brands they license. 

A few highlights… the Company has 

• Acquired 32+ brands

• Gross Merchandise Value (GMV) of ~$14B of which 18% comes from e-commerce

• A network of 800 licensees in 136 countries

• Revenue CAGR of 30% since 2016

• Operating Margins of 76% as of Q1 2021

• A Global Business with 79% in the US, 6% in EMEA, 6% in LatAm and 9% in APAC

• Strong social media presence of 230 accounts, 9B impressions per year, 269M followers

Business Model:

“Retain brand ownership and approval rights over marketing strategies, product development and use of data” - this is how they put it. 

So how do they make money? 

ABG is a licensor who licenses the use of their brands to licensees who manufacture the actual product, stock inventory and run the traditional business. (I wrote this down just to keep things straight). The licensee has the right to use the brand or the logo in exchange for a royalty payment, usually 3% to 5%. 

The revenue for ABG is calculated based on the percentage of the wholesale or retail product sales by the licensee, i.e, [% royalty x product sales]

Revenue Streams:

• Guaranteed Minimum Royalty (GMR) - this is a guaranteed base amount that the licensee pays. This is what the Company receives regardless of whether the specified sales target is met. This sets up a good minimum income base for the Company. First year GMRs are usually due in full upon signing which means ABG gets a good lump sum amount up front. 

• Overages - If the [% royalty x product sales], is greater than the GMR, then the excess amount is considered the overage. So, the more products sold, the more ABG earns.

• NIL - Royalty from the Entertainment Brands through Name, Image and Likeness (NIL) associated with the relevant celebrities, as well as other IP rights, such as trademarks and copyrighted works, including videos and photos of certain of these brands and certain music publishing rights. These royalty fees, which are typically structured as one-time fees, are negotiated on a case by case basis.

As of March 31, 2021, minimums contractually payable to ABG totaled more than $2.6 billion, of which more than $1.7 billion is payable in the years 2021 through 2025. This gives us an indication of at least the minimum the company will earn in the next 5 years - ~$340M/year.

The revenue model is typical to royalty and management agreements, which is usually a lucrative setup. What makes a different is the rate of royalty and the overage thresholds. As I said earlier, the Company suggests a 3% to 5% rate but we don’t how many contracts are at 3 and how may are at 5. We also don’t know whether there are contracts at much lower rates.

Lines of Business:

The company has 2 lines of business:

• Lifestyle Brands - e.g. Juicy Couture, Barneys - As of 31 Mar 2021, this made up 85% of revenue through 420 licensees

• Entertainment Brands - e.g., Marilyn Monroe, Mohammed Ali, Elvis Presley, Shaq - this made up the remaining 15% of revenue

Acquisitions

Here’s a summary of the recent brand acquisitions followed by a history of their acquisitions since inception (the image is a bit small).

• August 2021, ABG announced the acquisition of Reebok from Adidas for a whopping $2.5B.

• June 2021, Eddie Bauer brand for a total cash purchase price of $205.8 million (excluding acquisition costs)

• Lucky Brands and Brooks Brothers brands in 2020 for a total cash purchase price of $179.3 million (excluding acquisition costs). 

• 50% in F21 Ipco, the entity that acquired the intellectual property assets associated with the Forever 21 brand. The acquisition price was initially $20m for for 37.5% and this was later increased to 50% in Feb 2021, under SPARC. (SPARC is jointly owned by ABG & Simon Property Group, see Customer Base below)

• 16.7% interest in Copper Retail a company that acquired substantially all of the retail and operating assets, other than certain retail properties, of JCP, for an initial investment of $50.1M

• Increased ownership interest in SPARC to 50%, which represents a non-controlling interest

Management

ABG has very solid top management and is founder-led. These people staying on will be crucial to the success of the company.

• Jamie Salter (58), founder & CEO, is a 30-year veteran in the marketing industry and he’s led the company to where it is today. He is crucial to the success of this company.

• Nick Woodhouse (52), President & Chief Marketing Officer, has over 30 years of experience as well within the retail and brand management industry.

• Kevin Clarke (61), CFO, also has over 30 years of investment banking and senior level corporate management experience.

30 years of experience seems to be the sweet spot for this company. However, Jamie Salter has also brought his son, Corey Salter (32) , into the business as Chief Operating Officer. This is clearly noted in the S-1.

Here’s a look at the key compensation numbers for the top management.

A note on the Options Awards (some assurances of performance):

• The Options Awards were given to the named Executives (above).

• They are equally divided between service-based and performance-based units.

• The Service-based units will be 50% vested if the person leaves before 9 Aug 2024 and 100% thereafter. So, we have some assurance that the management will likely stay in place till 2024.

• The Performance-based units are being modified so that 50% will be counted as vested upon the IPO and the remaining 50% will be divided into two tranches that will vest if (a) the stock price reaches $95 (b) if the stock price reaches $105

Customer Base

The largest Customer is SPARC Group Holdings II representing 11% of ABG’s revenue as of 31 Mar 2021. ABG owns 50% of SPARC while Simon Property Group ($SPG) , the mall REIT, owns the remaining 50%. SPG also has beneficial ownership of over 5% of ABG’s stock. 

According to the S-1, SPARC is a multi-brand operator of the Nautica, Forever 21, Aéropostale, Lucky Brand and Brooks Brothers brands. SPARC designs, sources, manufactures and distributes apparel and accessories through over 1,300 owned and operated branded retail stores, digital channels and leading wholesale accounts, generating $2.6 billion in global retail sales in 2020 and over $850.0 million in global retail sales in the three months ended March 31, 2021.

So it turns out that the company may not be purely involved in “intellectual property”. They do have some manufacturing, even if it is through an affiliate. ABG accounts for their ownership in SPARC as a minority interest because they don’t exercise control and therefore, calls them a customer.

Industry and Competition

The Global Licensed Merchandise Market size is projected to reach USD 376.86B by 2026, from USD 127.28B in 2020, at a CAGR of 19.8% during 2021-2026. - 360researchreports

I do think that the definitions are different here from how ABG looks at their TAM.

According to the S-1, ABG sees their TAM at ~$13T of GMV. This looks like they’ve included all kinds of merchandise that can possibly be licensed. Based on a simplistic calculation of between 3% to 5% of royalties, they calculate their market opportunity to be between ~$390B and ~$650B. If you take into account the entire universe of consumer spending and if they keep acquiring brands, they can potentially add more and more licensees. I think this number is too high. The GMV for the top 10 licensors add up to roughly $135B (see below) so, $13T as plausible TAM is out there.

Competition:

[Source: Licence Global; I added in the numbers]

ABG ranks third among the competition which is impressive given that the company has been around for only 11 years and is competing with legacy brand owners. I didn’t do a comparison to competitors because none of these companies are purely licensors like ABG. But, it’s certainly something to explore further.

Are you even surprised that Disney is number 1? 😊

Use of Proceeds & The Transaction

The Company being listed is Authentic Brands Inc. (ABG Inc), while the operating company all this while has been Authentic Brands LLC (ABG LLC).

The proceeds will be used to ultimately repay Term Debt, to pay fees and expenses and general corporate purposes. The transaction will be structured such that the proceeds are first used to purchase the newly issued LLC Common Interests from ABG LLC. Then ABG LLC will use the proceeds to pay the existing debt. (We’ll look at this under the Financial Analysis section below).

No Dividends will be Paid… for the foreseeable future. [Although the company has been making distributions to shareholders].

ABG Inc was formed in Feb 2016 as a Delaware-based company and has not had any operations. The offering is being conducted through an “Up-C” Structure. [Resources to learn more about Up-C from Deloitte & Mayer Brown]

The S-1 lays out the basic structure of the deal but, I’m not going to get into this because (a) it’s long (b) the exact number of shares and amounts have been left blank. So this will change and then we’ll know more about the structure. Here’s what they say about the accounting:

The % of non-controlling interest has also been left blank. Suffice to say, the majority of the result of ABG LLC will be consolidated and there will be adjustments to the equity portion. But, since we don’t know what the recapitalization will look like for sure right now, let’s just look at the financial results of ABG LLC instead.

Financial Analysis

The Company’s presented 5 years of historical financials for ABG LLC and 2 Q1 financials for 2020 and 2021, to compare. I’ve reproduced the highlights below.

Their Adj. EBITDA calculation looked fine to me because it takes out all the one-off transactions and unrealized amounts. It also takes out the share income (loss) from associates where they have no control. Although they made a profit of $200M in Q1, 2021, this could have easily been a loss. However, they don’t have to fund this loss since they don’t have a controlling stake.

I’ve just taken out the stock compensation that they added back to arrive at a Final EBITDA. This is a better representation of the cash earnings, if you’d like particularly since they don’t really have significant Capex spending.

The Company’s results look quite decent. They have solid margins and have been growing every year. 2020 was a tough year for them, obviously because of the pandemic which affected product sales, not to mention entertainment events.

A few additional items to note in the financial statements:

Income Statement:

• During 2020, the company had a one-time impairment of $43M attributed to their Trademarks. It doesn’t say why.

• Their largest operating cost is payroll at 16.9% followed by General & Admin at 7.1% for 2020. Their costs are obviously not alarming seeing as they have an operating margin of 62% in 2020 and 76% in the Q1, 2021.

• Interest expense remains their biggest issue at almost 19.8% of Revenue. Their interest coverage for 2020 is about 3.2x (I’ve used: Interest Coverage = Operating Income / Interest Expense). This could be better given the company is not in manufacturing.

• Another important consideration is that 97.6% of the debt, from Bank of America, is floating rate debt at [3.5%p.a. + LIBOR]. This presents a significant risk when interest rates begin to rise (possibly in late 2022 and onwards) as the interest expense will increase as the LIBOR increases. 

• Distributions made were $74M in 2020 and another $16M in Q1, 2021. This is a payout ratio of 32% for 2020. I’d much rather have this at 20% or below.

• The amount booked from associates of $200M is an extraordinary amount booked in Q1, 2021. If we take this out from the Net Income, ABG made $78M in the first quarter which is still a 44% increase YoY and a net margin of ~50%.

Balance Sheet:

• The largest asset item is obviously Trademarks at $2.15B as of 31 Mar 2021, followed by cash at $457M and investments of $417M. The investments increased from 31 Dec 2020 by $216M because of Copper Retail. This is because Copper Retail’s year-end if 31 Jan, and the financial results are then consolidated into ABG as of March. I’d be happier if the cash balance was higher.

• On the liability side the biggest concern is the debt at $1.83B as of 31 Dec 2020 reducing to $1.81B as of Q1, 2021. The Company has obviously been on an acquisition spree and debt has been their major funding source.

• The debt is long-term. 97.6% of the credit facilities as of 31 Mar 2021 is from Bank of America and the rest a SPV Term loan attached to Brooks Brothers. They also have a $100M revolver that remains undrawn.

• According to the S-1, the Bank of America Debt (97.6%) is “secured by security interests in substantially all of the Company’s existing and future property and assets”. So the bank has a right to practically the entire company. Scary!

• Their Debt-to-Equity is about 3.6x, if the minority equity is included. I never adjust debt for cash. The level isn’t sky high but, it still makes me uncomfortable in the absence of hard assets.

• Their Debt-to-EBITDA ratio for 31 Dec 2020 is about 5.3x which means without any growth it will take the company over 5 years to service their debt.

• While I don’t think the company will default, this level of debt could potentially be troubling. Their debt payment obligations over the next 5 years:

• Deferred Revenue amounted to $95.3M as of 31 March 2021. I would want to look into this number further. Earlier (under Revenue Streams), I noted that the company takes first year royalties upfront. We also saw that the company potentially has minimum revenues of $340M/year. So, I will dig into this a little bit to see why the deferred revenue is low compared to the number we’re estimating.

• The Company also has a Deferred Tax Liability of $87M which is a future cash outflow. [I’d keep an eye on this…]

Valuation

Normally, I’d do my own valuation for a company. But, I don’t want to do one this time because there are still a few variables that need to be cleared up before we can see a real pro-forma. I note some of these in my concluding remarks.

Key Risks

Structure 

The Company’s structure and it’s proposed structure is complicated. They have a number of subsidiaries and partners and all of this makes it challenging to completely review the results every quarter. So, we’re just going to have to rely on more topline and consolidated numbers. 

The partnerships also run the risk of conflict. While partnering with SPG is awesome, there is always the potential for a falling out and the company runs the risk of losing some of its popular brands. 

Management 

I’ve already noted that the Company’s management is key to any kind of sustainable success. I’m glad that they have some form of performance and time-based restrictions for their stock options. Nevertheless, Jamie Salter comes across as a person who is committed to this business but he remains a Key Man Risk.

Market

Global Spending remains a key driver for the company’s well-being and so does the popularity of their brands. While ABG has had a fantastic record, brands do fall out of favor and as they say, there’s no accounting for taste. With the pandemic, people will curb their spending and more so on branded items. The effect of this is clear in the financial results for Y2020, with a growth of only 2% in their top line revenue.

Concluding Remarks

As I said in the beginning, I like this company, particularly the business model.

But, the structure is complicated and I don’t know what it will look like once the ABG Inc Consolidation is done.

The debt remains a concern and I also want to see how this new deal with Reebok will be tackled. The company had $457M in cash as of the Q1, 2021 and the Eddie Bauer acquisition took place for a cash purchase price of $205.8M afterwards in June. That leaves them with roughly $250M in cash + maybe $150M from operations. They’re buying Reebok for $2.5B, so it remains to be see how the purchase will be funded. I assume it will be through debt and quite possibly, SPG may back them with a stake.

I believe the IPO is delayed because of the Reebok acquisition and an amended S-1 just may look very different, once the company is ready to go. Once that comes out, I’ll take another look.

This was by no means a full review or deep dive. ABG’s structure is complicated with subsidiaries and the S-1 presents a comprehensive discussion in their 446 pages. I hope I’ve given you some points to consider though, when you do your own research.

I’d be really happy to learn of anything you find during your research so, I’d be grateful if you do a leave a comment.

Sincerely,

Ayesha Tariq, CFA

There’s always a story behind the numbers… (and the pretty pictures)!