The group has launched a vast reorganization effort to unload Victoria's Secret, its ailing lingerie brand, while making the most of Bath & Body Works, its fast-growing chain of body care and home fragrances.
That being said, with $5.4bn in sales and a neat pulse in profitability last year, Victoria's Secret, once thought to be heading for the fashion graveyards — replete of fallen angels and defunct icons — is giving new signs of life.
All hope may not be lost. The brand's sales have halved over the past five years, while its bottom line kept printing red ink, but the recent reshaping — which involves agressive cost-cutting, the launch of new collections and a focus on e-commerce — goes in the right direction.
The path to resurrection remains strewn with pitfalls, in particular because Victoria's Secret still maintains a hefty physical footprint at a time when e-commerce is literally eating the world. Competition online is fierce and margins are small — so there's no easy way out.
This is why L Brands decided to part ways with its flagship franchise. After an aborted sale attempt to private equity fund Sycamore that valued Victoria's Secret for $1.1bn, the group finally opted for a spin-off.
Buoyant public markets could offer a sexier exit than private equity. According to Citi, the new corporate entity, once separated and independent, could fetch a valuation north of $6bn — that is, a multiple of x5 to x6 forward EBITDA if everything turns out as expected — the wide disparity with Sycamore's offer notwithstanding.
On the other hand, L Brands's second pillar, Bath & Body Works, is topping $6.5bn in sales and has been experiencing exponential growth. Over the past five years, sales have doubled and operating profitability quadrupled. With 1,750 stores in North America, the chain has yet to venture beyond its domestic market, so a breakthrough abroad looks like a nice call option.
At the consolidated level, the expansion of Bath & Body Works made up for the decline of Victoria's Secret. This game of communicating vessels — with cost reductions on one pillar allowing for high-return investments on the other — enabled the group's free cash-flow to stay solidly anchored around $1bn per year over the last decade.
Said free cash-flows were distributed in full via regular and occasional special dividends. Returns of capital to shareholders also include up to $4bn spent on share buybacks, alas funded — because that is never good to see — by additional indebtedness.
However, following an advantageous refinancing last year, management should adopt a more conservative approach to capital allocation. In addition, founder and retail legend Les Wexner is progressively withdrawing.
It is true that the mistakes of the past — obsolete positioning of Victoria's Secret, excessive focus on returns of capital to shareholders, etc. — are typical signals of ends of reign. Mr. Wexner's time had come. His embarrassing relationship with late Jeffrey Epstein was an another nail in the coffin.
Basic sum-of-the-parts: if indeed Victoria's Secret is indeed worth $6bn at x5 operating earnings before amortization, then Bath & Body Works should command at least a $20bn price tag at say x10 EBTIDA.
In that respect, the two franchises would jointly be worth $26bn.
Subtract $3bn in net debt and "fair value" comes at $23bn, for a market capitalization of about $18bn. Should Victoria Secret be worth "only" $3bn — a middle ground between Sycamore's failed takeover and Citi's upbeat expectations following the spin-off — the group's "fair" value would still reach $20bn.
The upcoming listing of Victoria's Secret will settle the debate. As about Bath & Body Works, a x10 EBITBA may be unusually conservative. Despite excellent results so far, with a North American market that is now saturated, its domestic growth potential seems exhausted. So it is up to every investor to work with his own hypotheses.
The market, for its part, has chosen its own, as evidenced by the recent surge of the share price — and therefore the buoyant momentum that MarketScreener intends to profit from.