VF to Spin Off Denim Business as Separate Public Company

Yesterday, VF Corporation, owner of Vans, Reef, The North Face and a lot of other brands announced that it was spinning off its jean business (it owns Lee and Wranglers) into a separate public company with 100% of shares to be distributed to existing VF shareholders.  It also announced that VF would be moving its headquarters to Denver.

The stock market, which never likes surprises it doesn’t understand, took the stock down 3.3%.  It’s back up 1.55% so far this morning (Tuesday).

To give you perspective, VF’s total revenues for the year ended December 31, 2017 were $11.8 billion.  Of that total, the jeans wear segment contributed $2.65 billion, or 14.0% of the total.  The company’s total operating profit during the year was $1.91 billion and jeans contributed $421.9 million, down from $491.1 million the previous year and $535.4 million the year before that.  Revenues in jeans have been down as well.

Why Are They Doing This?

If I were to sum up the press release, presentation and conference call, I’d say that the jeans business is great at generating cash flow, but not so great at generating growth.  So, it holds back the overall results of VF.  They didn’t exactly put it that way.  They said that:

• Jean and the rest of VF now have “diverging path to long term value creation.”
• “The separation will provide greater strategic focus, operating model alignment, and greater management capacity to invest in new growth vectors and capabilities to accelerate growth.”
• “The separation creates an opportunity to unlock long term value creation through streamlined operations, scale and cost efficiencies and the flexibility to pursue and invest in strategic priorities and growth initiatives not easily accessible inside the VF portfolio today.”
• They will be separate companies with “…a separate management team focused actively on its own unique opportunities.”

VF, as you know, has always trumpeted the synergies and efficiencies between its businesses, but we learn in the conference call that the synergies between jeans and the other business are less clear than they used to be and that the jeans business is more independent than the rest of the portfolio.

This, then, as they describe it is good for shareholders, good for the jeans business and good for VF.  Everybody should be happy.

Why Not Just Sell the Jeans Business?

Good question.  They’ve sold, as well as bought, businesses before after all.  It’s kind of what they do.  The answer they gave is that they’ve held the jeans business so long that it’s fully depreciated.  A sale would result in a big reported profit and tax hit.

Fair enough, but the devil is in the details and it’s a long-term capital gain (I assume- I’m not a tax guy).  Whatever the tax hit would be, let’s phrase the decision to spin it off, instead of selling it, differently.  Would it be unreasonable to say, ‘It’s a declining business and we didn’t think we could sell it for enough to justify the tax hit.’

From the language they used in the conference call, it sounds like they didn’t shop it before deciding to spin it off.  That suggests that they were quite certain that it couldn’t possibly be worth the price they needed to get.  They did acknowledge that if a potential buyer came along they were obligated to consider an offer.

A Complicated Deal

This deal is going to take one to two years to get completely done.  There are a lot of moving parts.  Assets to be allocated between VF and the new company (which doesn’t have a name yet), people to be moved, supply contracts to be managed, debtholders to be satisfied, real estate to be bought and sold or leased.  If the presentation and conference call were a little short on specifics, I’m giving VF a break on that one.  They have a responsibility to announce the deal, but the early stage, given the scale and timeline, makes it reasonable that specifics were largely unavailable.

There’s not yet a proforma balance sheet for either company after the transaction is done.  We did learn that, “There’s no change to VF’s capital structure or capital allocation priorities as a result of this separation.”  They also told us that the new company, whatever its name is, would have around $1 billion of new debt and leverage at the time of separation of around three times debt to EBITDA.  They assured us the new company would pay that down to close to two times within “a couple of years.”  Some or all of that new debt comes back to VF as cash and will replace the lost EBITDA from the jeans business.

They were not specific about how that will work.  You can understand why I’d really, really, really, like to be looking at a proforma balance sheet to figure this out.  They also noted that the costs of doing the deal weren’t quantified yet.

I’m cautious in my conclusions because of the lack of solid information.  Certainly the jeans business qualifies as the kind of business VF has divested before.  Strategically, I understand why they’d want to move on from jeans.  Perhaps they waited this long because of the size of the business and the fact that it was a foundational and critical piece of VF back when it was known as Vanity Fair.  As they acknowledge, they used to need it for its cash flow.  Now they don’t.

Some of the advertised benefits of the spin off are a bit too touchy feely for me.  That doesn’t mean they aren’t real, but it’s very hard to evaluate them.  I guess I’ve always thought of VF as a company where businesses could realize those benefits from inside the company anyway.

We’ll all know more in the months to come as the process moves forward and solid information is released.  This is a public offering and there will be a prospectus and a road show.  In the meantime, whatever the benefits of the spinoff are or are not, VF is getting rid of a business that’s declining and doesn’t meet its growth/specialty criteria.