NAKD – Speculative play
Last Friday, January 13, 2017, we issued a premium tweet that we were taking a small speculative bet in shares of microcap NAKD at around $1.70.
Naked Brand Group, North American designer and manufacturer of underwear, intimate apparel, and sleep ware, announced a letter of intent to merger with New Zealand based private industry peer Bendon Group.
Naked trades under the symbol NAKD on the NASDAQ with roughly 6 million shares outstanding and 2 million shares potential dilution from warrants, but the average strike price of the warrants is above $4 and therefore these securities are antidilutive. Its products are sold in premium department and specialty stores and internet retailers in North America, including accounts such as Nordstrom, Dillard’s, Bloomingdale’s, Amazon.com, Soma, Saksfifthavenue.com, barenecessities.com and others.
NAKD is not appealing to us on its own merits. At an annual revenue run-rate of around $2 million, the company is losing a good deal of money and has stated that it will have to keep raising money to maintain operations. We have also not been a big fan of investing in stocks that are tied to brick and mortar retailers. But sometimes changes in perception are drivers of big short-term moves in stock prices (even if they don’t stick). We thought premium members who consider themselves traders to some degree may want to follow NAKD over the news few days.
Last Friday morning the company announced:
Naked Brand Group Inc. (NASDAQ:NAKD) ("Naked" or the "Company"), an innovative innerwear fashion and lifestyle brand, and Bendon Limited ("Bendon"), a global leader in intimate apparel and swimwear renowned for best in category technology and design throughout its 70 year history, announced today that they have entered into a Letter of Intent (the "LOI") for a proposed merger of the companies (the "Merger").
The stocks prior day closing price was $1.04 and opened at $2.65 before popping to hit a high of $3.50. The stock then pulled back to close at $1.70 after the company announced later in the day that it would be selling 1.9 million shares of stock at $1.04 to raise $1.95 million. NAKD will need the money needed to cover costs (and we believe to stay afloat) while it attempts consummate the merger.
NAKD is calling the potential acquisition transformative. The CEO of NAKD and of Executive Chairman of Bendon spoke very glowingly about the merger. So, we think the pull back in shares could be gift as traders realize that the raise is really a non-event when you consider that 1.9 million shares is peanuts compared to the 118 million shares that will be issued to Bendon to close the deal. If the positive perception of the merger takes center stage again we think NAKD could see another pop.
Perception Is That Merger Could Breath Life Into NAKD
The merger calls for NAKD to issue a ton of common stock (118,812,163 shares) to Bendon. But Bendon will dramatically increase the combined revenue of the merged company and provide NAKD with much more distribution to grow its current product lines, something it looks like has been a challenging task. So, there is an outside chance that NAKD shareholders are getting a sweet deal
Here is a back of the envelope calculation that indicates there might be an opportunity at hand.
According to Friday’s press release Bendon generated roughly $100m (USD) in revenue during fiscal 2016. If we assume that Bendon has a similar margin profile as NAKD, which seems reasonable since they are operating in the same industry, then NAKD’s and Bendon’s share of the combined company should be roughly proportional to the revenue they contribute to the combined entity. Assuming that Bendon generated $100m revenue in the trailing twelve months (ttm) and NAKD roughly $1.7m, then NAKD shareholders should not even get 2% of the company (1.7/101.7=1.67%). The initial letter of intent outlined how NAKD shareholders would be left with 6.7% of the combined entity, indicating a sweet deal for NAKD shareholders that is not proportionate to revenue.
Why do NAKD shareholders apparently get a better deal then they are supposed to, based on economic reasoning? A thesis that could explain the deal terms is that Bendon is less interested in the operating capacities of NAKD, but really interested in accessing the US capital markets. NAKD with $1.7m in ttm revenue is not significant to Bendon, so Bendon might view this transaction as a reverse-merger to go public in the US, with a small operating business, and managers (NAKD CEO Carole Hochman will become Bendon’s Chief Creative Officer) thrown in as an extra.
Caveats
There are many caveats to the thesis, and a lot of uncertainty surrounding the current situation:
- The letter of intent is not binding and does not guarantee a transaction will consummate
- Until the definitive merger agreement is issued we will not fully understand the details of the transaction
- The full financials of Bendon have not yet been disclosed
- We are afraid that Bendon wants to access the capital markets to improve an overleveraged balance sheet.
- According to TheAustralian, Bendon generated roughly $115m (USD) revenue in 2014. The same article explains how Bendon aimed at doubling this revenue run-rate with their Heidi Klum brands. With $100m revenue in 2016, Bendon apparently has been underperforming in the recent past (although we don’t know if Bendon divested of any of its business).
- We view this as only a short-term potential opportunity.
- NAKD is dealing with delisting risk from the NASDAQ
Disclosure: Long Specualtive Trade in NAKD
