Spruce Point Capital Management Announces Investment Opinion: Releases Report and Strong Sell Research Opinion on Skechers U.S.A. Inc. (NYSE: SKX)
Spruce Point Capital Management, LLC ("Spruce Point" or "we" or "us"), a New York-based investment management firm that focuses on forensic research and short-selling, today issued a detailed report entitled "A Skechy Investment" that outlines why we believe shares of Skechers U.S.A. Inc. (NYSE: SKX) ("Skechers" or the "Company") face up to 30% to 50% downside risk, or $18.60 ? $26.00 per share. Download or view the report by visiting www.SprucePointCap.com and follow us on Twitter @SprucePointCap for additional information and important updates.
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Spruce Point Report Overview
Founded in 1992 and headquartered in southern California, Skechers designs and sells branded footwear, apparel and accessories for men, women and children in the contemporary casual, active, rugged and lifestyle markets. Founded and long run by Robert Greenberg and his family, the Company is focused on offering comfort technologies at a reasonable price.
Spruce Point believes Skechers' stock price has been largely propelled by the Company's outsized growth in China. In recent years, Skechers has focused on expanding its reach outside the U.S., generating 20% of its 2021 revenues in China. Absent the China story, we believe Skechers is only a moderate growth, "fast follower" shoe company that will likely never be able to compete with the performance athletic shoe companies which possess vastly larger markets and stronger brands. After conducting a forensic financial evaluation of Skechers, we also find evidence that the Company's business is deteriorating and that financial pressures are mounting. Key findings of our report on Skechers include:
- We Believe Skechers Will Experience a Material Revenue Slowdown. We believe that Skechers' revenue growth over the past five years has largely been the result of two transitory catalysts: the sudden popularity of a single product line, D'Lites, in Asia beginning in 2015 and the Company's long-overdue efforts to step up its ecommerce presence. However, we believe these two factors have largely played out and future revenue gains will be harder to come by now that Skechers has caught up with other leading consumer products companies. Based on our research, we believe Skechers' China revenues experienced a year-over-year decline of approximately 25% in Q2 2022 and we contend that persistent regional COVID-related restrictions and economic headwinds make it likely that the entire Asia-Pacific region is down an equivalent amount.
- Skechers' China Sales Have Significantly Weakened and We Believe Its Market Position in Asia-Pacific Is Under Threat Due to Its Limited Brand Appeal. Accounting for 20% of the Company's 2021 revenues and acting as a major contributor to growth, Skechers' China business is vital to its investment story. However, following our field research with a broad range of stores and distributors throughout the country, we believe the Company's sales in China are now well below Wall Street's expectations. According to a recent report, Skechers' online sales during the mid-June Chinese Dragon Boat Festival promotional period were down 28% year-over-year, making it the second-worst performer among similar brands despite having higher discounting activity. Over the long-term, we believe Skechers' brand positioning is under serious duress ? especially in the Asia-Pacific region. Given that Skechers' primary market offering is comfort at a reasonable price and that the Company does not invest heavily in innovation or variety, we contend that Skechers may face struggles to grow further in Asia, where fashion plays a more important role in driving consumer purchase decisions.
- We Contend Skechers Will Suffer Another Inventory Episode. Skechers has faced several instances of excess inventory, most recently in Q3 2015 and Q2 2018. During these periods, Skechers' share price dropped by 30% - 50% and shareholder lawsuits were filed. We believe that Skechers is experiencing inventory issues that will worsen in the future as new purchases lag inventory growth. An analysis of Skechers' quarterly inventory data shows a rising level of inventory and a growing average number of days of inventory outstanding. Further, despite slowing revenue growth, Skechers has dramatically increased its purchase commitments. Skechers' purchase commitments relative to its last twelve months' revenue are approximately 64% higher than its peers as of their most recent fiscal year end.
- The Company's Deteriorating Profitability Is Compounded by Poor Investor Disclosure. We believe the Company's recent performance and current cash flow profile is highly troubling, with declining adjusted operating cash flow and free cash flow margins despite recent revenue growth. In fact, we believe Skechers' operating cash flow is materially worse than most analysts and investors realize. Adjusting for onerous capital distributions to partners and cash payments to settle employee compensation programs, we estimate the last twelve months' operating cash flow to be -62% lower than the headline result. Further, we also see a sustained effort by the Company to reduce its reporting transparency over the past two years, including eliminating a significant volume of key business and financial disclosures, particularly about the operations of its joint venture partners. The Company has also made recent changes in its communications that we believe serve to further complicate comparisons and financial analysis.
- We Believe Skechers' Management Team and Board Have Fostered Poor Corporate Governance. We believe Skechers has long embodied many of the stereotypical attributes of a founder-led company, including nepotism, self-enrichment, rampant related-party transactions and a reluctance to adopt best practices in corporate governance. An analysis of the Company finds that many people associated with Skechers have troubling track records, including Company advisor Gil Schwartzberg who was charged with fraud by the U.S. Securities and Exchange Commission for his role at LA Gear, and who has been associated with U.S.-listed Chinese stocks that have had their registrations revoked. Despite recent changes to the composition of the Board in response to shareholder involvement, we doubt that the Board still possesses the requisite independence, skills and public company director experience to effectively oversee management.
- We Estimate Between 30% ? 50% Downside Risk to Skechers' Share Price as its Premium Multiple Contracts and Lofty Expectations Are Missed. Despite the Company's serious financial and governance headwinds, sell-side analysts are resoundingly bullish on Skechers, seeing 58% upside with no analyst saying "Sell." However, we believe Skechers is just a moderate growth shoe company that will likely never be able to compete with the likes of Nike, Adidas or Puma. Given that we believe Skechers' growth rate will compress, its multiple will contract and its free cash flow generation will remain below average, we find many reasons for Skechers to trade at a discount to its broader shoe peers. As such, we see 30% - 50% downside risk ($18.60 - $26.00 per share).
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Please note that the items summarized in this press release are expanded upon and supported with data, public filings and records, and images in Spruce Point's full report. As a reminder, our full report, along with its investment disclaimers, can be downloaded and viewed at www.SprucePointCap.com.
As disclosed, Spruce Point has a short position in Skechers U.S.A. Inc. and owns derivative securities that stand to net benefit if its share price falls.
About Spruce Point
Spruce Point Capital Management, LLC is a forensic fundamentally-oriented investment manager that focuses on short-selling, value and special situation investment opportunities. Spruce Point Capital Management, LLC is a member of the Financial Industry Regulatory Authority, CRD number 288248.
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