XELB - Xcel Brands A Buy After Restructuring

2023-08-07 06:46:03 ET

Summary

• Xcel Brands is a consumer products and social commerce microcap that is expected to capitalize on the blending of e-commerce, live streaming, and social media.
• The company has completed a transformation into a working-capital-light operating and technology platform, driving sales through live streaming and social commerce.
• Xcel Brands has a new 25-year license agreement with G-III Apparel Group, which could generate significant revenue and has a net present value bigger than the company's current enterprise value.

Today I want to introduce Seeking Alpha members to my newest pick. This company is a consumer products and social commerce microcap who I believe will be capitalizing on the blending of e-commerce, live streaming, and social media. By the end of June, the company was set to have completed a transformation into a working-capital-light operating and technology platform, driving sales through live streaming and social commerce. At the end of 1Q23, the company maintained $6M in cash and had zero debt. They currently have a roughly $20M enterprise value ("EV"). And yet they have a new, 25-year license agreement with a titan in the retail space; an agreement that I believe could net them $8M of revenue annually, meaning the net present value of those payments alone is bigger than their current EV. Moreover, management is currently projecting to be cash flow positive in 2H23 and beyond, and to show at least $5M in adjusted EBITDA ("AEBITDA") for FY24, with no upside baked in that guidance for a soon-to-be-released social commerce platform, nor for any license payments to be received beyond contractual minimums .

All of these facts lead me to believe the stock could quite feasibly double once the market becomes aware of all details, likely on their upcoming 2Q23 earnings call (presumably in August). Further, if the company’s new platform has even a modicum of success, I think the stock could be a triple. Of course, if the platform—which I believe has the possibility to be a smashing hit—gets major traction, the stock could do even better. To understand how the company got to where they are today, I’ll provide a brief overview of the company’s history and then dive into why I think the company’s future is so bright.

Xcel Brands, Inc. ( XELB ) was founded in 2011. In their latest investor presentation the company breaks its history into three distinct phases:

• 2011 – 2016: Building the Foundation
• 2017 – 2022: Expanding Infrastructure
• 2023 & Forward: Leading Social Commerce Platform

During its first phase, XELB acquired the brands Isaac Mizrahi, Judith Ripka, Halston, and C. Wonder, and experienced growth in Direct-Response TV and licensing. In the second phase, XELB acquired the Longaberger and Lori Goldstein brands and was named QVC’s Apparel Vendor of the Year. In addition, the company invested over $5M into the infrastructure for wholesale, direct-to-consumer ("DTC"), and social commerce.

During these first two phases of the company’s history, XELB operated in both the wholesaling and licensing spaces. While the wholesaling business certainly provided some potential upside for the company, it also came with extra risk. Some of these risks were certainly exposed—as they were with thousands of companies globally—during the Covid-19 pandemic. Specifically, as a wholesaler, XELB was subject to normal risks of apparel companies such as the whims of consumers and inventory risks. This was especially difficult for a company like XELB given their lack of scale to help offset these corresponding risks. Thankfully, even prior to the Covid-19 pandemic, the company had been preparing for its third phase, which is the one that piqued my interest in XELB’s story.

XELB’s Restructuring and De-Risking

Prior to 2023 XELB operated as a hybrid company focused on both wholesale operations and the licensing of its multiple brands. Beginning in 2023, and essentially now completed by EOQ2, XELB restructured, transforming into a high-touch licensing and live stream DTC business. This change in the business model is allowing the company to save $13M in annualized operating expenses—$6M in reduced payroll and $7M in lower operating costs. The restructuring should allow the company to return to profitability and cash flow generation later this year.

In addition, this restructuring helped to eliminate the company’s debt of $25M and provide them with $6M of cash-on-hand as of March 31, 2023. Moreover, by now, the company should have absolutely no inventory—and thus no inventory risk in the current highly competitive and tight environment. Nevertheless, the company’s licensing agreements allow the company to enjoy, at the least, a reliable source of revenue, while also some benefits to the upside from strong sales of their licensed products.

The most notable of these licenses is XELB’s recent, 25-year master license agreement with G-III Apparel Group ( GIII ). As XELB’s press release announcing this new deal indicates: “G-III is known for unlocking the potential of brands and is a vendor of choice for global retailers, having successfully grown DKNY globally, launched Karl Lagerfeld Paris, and built the Calvin Klein and Tommy Hilfiger women’s businesses in North America.” As part of the 25-year agreement with GIII, XELB received an upfront advance payment in May 2023.

GIII has now taken over the Halston brand and assumed all of the apparel wholesale operations and distribution in department stores, e-commerce and other retailers. It should also be noted the agreement with GIII includes escalating guaranteed minimum sales requirements and certain guaranteed payments. XELB will recognize revenue from the agreement in 2Q23 and expects to realize even greater revenues in 2024 and beyond.

Part of the reason XELB is optimistic about this deal in 2024 is because another, premium Halston licensee, JS Group , plans to launch new products under the Halston brand in spring 2024 in premium distribution (e.g., Neiman Marcus, Saks). Following that, GIII plans to leverage this Halston brand promotion/awareness by JS Group in the premium space by then taking Halston into stores like Dillard’s and Macy’s in Fall 2024. Future plans for Halston also include significant expansion in DTC and social commerce for the men’s collection in 2025.

GIII’s Excitement

I have not taken XELB’s word on GIII’s excitement. Instead, I reviewed GIII’s own 1Q24 conference call on which they announced and discussed the new deal with XELB. In introducing the new agreement, GIII CEO, Morris Goldfarb stated:

“Halston is an American heritage brand with a rich legacy of glamorous designs across a range of price points. Currently, the brand is sold through a number of distribution channels, with a focus on top-tier department stores and live streaming. With our best-in-class design and merchandising teams, retail relationship and distribution expertise across stores and digital platforms, we will make the brand more widely available to consumers across a broad range of touch points . At G-III, we are known for our success with American heritage brands and believe there is tremendous opportunity to grow Halston by leveraging our proven model to unlock its potential.” (emphases mine)

Later, in response to an analyst question, the CEO elaborated:

“Halston, for us, is a brand that we will have full control of and basically servicing the demands of where the consumer wants to be. We’re developing a collection of a little bit more glamorous than we historically have done product. We’ve staffed it with talent that is premier in our organization . W e’re excited about the opportunity of building a global initiative with Halston . It’s a brand that very much is classified as an owned brand. And as such we will share some licensing royalty with Xcel. They seem to be great partners, and we’ve got a strong plan for this in the coming years . (emphases mine)

What exactly does that mean to GIII in dollars and cents? Thankfully, the CEO issued some initial guidance:

“If I were to put a target on it, I would tell you within 4 years, it’s a $250 million business. It is global. It is in demand. We didn’t just pick the brand without doing our diligence. We have customer support for it globally. Quite honestly, I was a little surprised after the fact that it has the global appeal, particularly in Europe. ” (emphasis mine)

One key component XELB investors should keep in mind: this Halston/XELB licensing deal with GIII is beneficial to GIII as they are losing the Calvin Klein and Tommy Hilfiger brand licenses. In relation to that and the Halston deal, the CEO pointed out on the call: “As most of you do know, we’re in a process of exiting both Tommy and Calvin. So this (the Halston/XELB deal) is a shore up to our assets.” To put this in financial perspective, I believe the Calvin Klein brand was responsible for well over $1B of annual GIII revenue. That, together with my own conversations with people familiar with GIII’s thinking, leads me to believe that their initially-stated guidance of Halston being a $250M annual brand within four years is conservative.

XELB’s restructuring, their de-risking of the company, and their deal with GIII have me excited about the stock. I believe once the market figures out what is happening at XELB with GIII, the stock could double from current levels (more on that in the “Valuation” section below). Of course, that potential double catches my interest, especially given the fact that I believe XELB has drastically de-risked the company by no longer carrying inventory and by closing out all debt. But what has me even more excited about XELB is its planned launch of its own proprietary social commerce technology platform.

Social Commerce Technology Platform

Over the past few years, and in preparation for a pre-holiday shopping season 2023 official launch, XELB created a multi-brand, short-form video content platform with the ability for shoppers, creators, and influencers to earn fees based on sales conversions from an embedded SKU. As mentioned in the intro, this platform blends social media, e-commerce, and live streaming. To my knowledge, no company has brought such a platform to market in the United States. While it would, at first blush, seem logical for a large social media platform to enter this type of business, doing so would undermine their current model of being funded not by users, but by the ad revenue of big brands. Hence, this market in the US has been left open to a small player like XELB.

At present, XELB is preparing for the launch of its new platform by signing retailers they know will promote the platform and leverage it with consumers who can sell to other consumers. Management believes this planning will provide them with a low-cost entry into the marketplace. In addition to signing retailers, XELB is currently developing new brands in collaboration with designers and social media influencers. In fact, they expect to launch 2-4 new brands within the first 12-18 months of the platform launch, while also keeping their eye on low-cost brands for acquisitions that management believes XELB can grow through social commerce.

My understanding is that XELB is extremely optimistic and excited about how the platform is performing in beta testing with its Longaberger brand. Moreover, the company seems to believe the platform will require minimal additional expense to bring to market and to operate. Based upon my conversations with people familiar with XELB’s thinking, the company intends to use a reactive approach to investing additional marketing dollars into the platform’s success. By that, I mean that the company has a conservative marketing budget, but will consider investing additional dollars if the platform starts to see rapid adoption. On the other hand, if the platform does not progress as expected, the company will not sacrifice its ability to be a (relative to their size) cash cow, collecting and profiting off its current licensing arrangements. I believe this prudent approach follows the current overall thinking at XELB: keep the business de-risked, limiting the downside, while taking advantage of any opportunities that might provide additional upside for shareholders.

Risks

As I have been emphasizing, XELB’s recent restructuring was undertaken, in large part, to drastically reduce their overall risks. Regardless, as with any company, risks still exist. I will highlight a few.

In apparel and fashion, consumer attitudes frequently shift and the market is full of competition. While XELB’s license arrangements help to mitigate these risks, XELB’s reliance on a small number of licensees presents its own risk since they themselves are subject to consumer mood changes and competition. For example, about 50% of XELB’s current licensing revenue is derived from TV. While the market is moving away from TV, so is XELB, so that risk is being mitigated through the coming years. This is especially true of the company’s upcoming social commerce platform. In addition, it should be noted that the GIII partnership includes a kick-out clause after five years, meaning that if the brand is not successful, GIII could end the partnership. This specific risk seems small given not only GIII’s current excitement about the brand, but also their financial motivation to replace the Calvin Klein and Tommy Hilfiger revenue they are losing.

Another risk is that XELB could make a bad acquisition or could sink an excessive amount of money into its new social commerce platform in an effort for the platform to be a massive hit. This risk seems minimal as any acquisitions would likely be for relatively small dollar amounts and I do not envision management going below cash flow neutral in an effort for the platform to succeed. As noted earlier, I believe XELB will take a reactive approach to their social commerce platform, only investing additional marketing dollars in the platform if it is gaining traction in the marketplace. And, of course, if the platform gains traction, then XELB’s stock price is likely to be significantly higher than current levels and the market would likely cheer the additional spend.

Yet another risk is the lack of liquidity in XELB’s stock at this time. The shares can be volatile due to the low volume of trading. XELB investors should be aware of this phenomenon and those entering the stock should consider scaling in so as not to run up the price on themselves.

The final risk worth mentioning—although many investors may view this as a strength—is the high concentration of insider ownership. According to Yahoo Finance, 56% of shares are held by insiders. The CEO alone owns over 11% of the company and one director owns over 5%. The downside of this concentration, of course, is that insiders have a high amount of control over the company. The positive side is they also clearly have “skin in the game.” If XELB were ever again to tap the capital markets to acquire a company or bolster its platform, insiders would be diluting themselves more than other stockholders.

Valuation

What makes XELB so attractive to me is the risk/reward scenario. Following the recent restructuring, XELB has removed its inventory risk and closed all its prior debt (besides lease obligations). As of March 31, they carried $6M of cash-on-hand, meaning the Enterprise Value (EV) is roughly $20M. After the May 2023 upfront payment by GIII, it is quite possible the EV is now closer to $15-17M. We will not know those details until the company releases its 2Q23 results, most likely in August. In any case, for my purposes, I am assuming a current $20M EV.

In terms of guidance, the company is currently not including any upside from the upcoming platform release, nor are they assuming anything beyond license contract minimums for their royalties. XELB expects to be cash flow positive in 2H23 and they are guiding for $5M in AEBITDA for FY24. Again, this should be set against the stock trading currently at an EV of approximately $20M. In other words, the stock trades for 4x EV/FY24 AEBITDA. For a company with its main brand under a 25-year license agreement with an industry titan, and with set minimum payments and potential upside as well, I would expect them to trade at double this level or 8x EV/AEBITDA (it should be noted also that in May 2022, XELB sold part of its Isaac Mizrahi brand for 8x AEBITDA). That equates to roughly $2.70/share. Of course, management guiding for these 2024 AEBITDA results does not guarantee the results, so the company still must perform. Regardless, to me, the risks seem minimal at current prices, especially with no platform or royalty upside included in the stated guidance.

However, regarding the social commerce platform, I believe XELB has a potentially huge hit on their hands. Short-form video content is currently king, with no apparent end in sight. Moreover, the “many-to-many” approach of the social commerce platform, whereby users are promoting products to other users (instead of the “one-to-many” traditional marketing, whereby one celebrity promotes to the masses), fits well with the predominant “gig economy” mindset of our culture.

While it is exceedingly difficult for me to bake in any reasonable expectations for the social commerce platform, I see very little downside based on my understanding of management’s reactive approach that I outlined previously. In any case, I cannot envision XELB’s platform falling totally on its face. Therefore, my base case is that XELB’s platform sees some modicum of success and is able to contribute in some fashion to AEBITDA in 2024. If that happens, I believe the future is looking exceedingly bright for XELB and the stock likely triples or more from the current $20M EV base. That would equate to a share price of around $4.00/share.

However, it should be noted this assessment with respect to valuing the company’s new platform is entirely qualitative as I cannot possibly put together a quantitative analysis of the platform at this time. Regardless, my experience leads me to believe the market will respond quite favorably to XELB if a new, short-form video content platform gains traction. Once the platform is released and XELB is able to report results, we should start gaining a better insight into the possible upside.

Conclusion

I view XELB as a stock that could quickly double. I believe the market has not yet realized the full implications of the GIII partnership. Specifically, I think the market has yet to notice that the net present value of the 25-year payments from GIII is likely higher than the company’s EV at the time of this publication. I expect XELB’s next quarterly conference call will be a “wake up call” to the market in this respect. On the May call, management was apparently not at liberty to speak in depth about the partnership since GIII was waiting to announce it on their early June conference call. I would expect more details on the August call.

But more importantly than its possibility of doubling, I view XELB as being low risk at an EV of approximately $20M . The company seems to have a reliable source of revenue and the restructuring of its business should lead XELB back to profitability and cash flow generation. Moreover, the company no longer bears the dreaded inventory risk associated with being a wholesale operation since they have now exited that portion of their business.

Finally, given the current XELB valuation and the revenue and earnings potential from the licensing business alone, I view the upcoming social commerce platform release like a “free call option.” By that, I mean that my assessment of the social commerce platform leads me to believe its release provides limited downside for the company, but simultaneously provides significant upside potential. For all of these reasons, I am now instituting coverage of XELB stock and making it one of my official picks.

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