Movado Group: "Buying" in Oct. 2015
Traveling Through Time | 15 min read | What I learned from "buying" Movado in Oct. 2015
Originally published on midstoryventures.com in February 2021.
This is part one in a ten-part series. Before reading this segment in the Traveling Through Time case study series — please read the Introduction post here.
Essentially, I simulated an investment opportunity from many years ago based on Geoff Gannon’s Singular Diligence newsletter. The write-up below is a record of my thought process and a reflection on what happened.
Navigation:
Simulating the Past: Arriving to a decision
WOULD I HAVE INVESTED 20% OF MY CAPITAL INTO MOVADO ON OCTOBER 8, 2015?
Movado is a Swiss watchmaker focused on the U.S. accessible luxury market.
Movado generates 50% of its revenue from company-owned brands (Movado / Ebel & Concord) and 50% from licensed watches (Coach, Hugo Boss, Ferrari, Tommy Hilfiger). It generates about $500M in sales per year at a 10% profit margin.
Movado is optically cheap.
Movado is cheap compared to its historical multiple, compared to its peers, and compared to the average business in the stock market. Movado’s peer group trades at a median multiple of 10x owners earnings. Its closest peer is Fossil because it has a large market share in the U.S. accessible luxury market and generates a significant amount of its revenue through licenses. Fossil trades at 8x owners earnings. Movado, on the other hand, trades at 6x owners earnings.
The best way to think about Movado is through the lens of a private buyer.
Movado has net cash of $200M, so the company should be valued on an enterprise value basis. Over the 20+ years since the company has been public, management has never pursued any reckless, value-destroying opportunities, so it only makes sense to value every $1 of cash as $1.
With $71M in owners earnings, Movado could be worth as much as $936M in enterprise value.
The company-owned brands could be worth 2.5x sales and licensed brands could be worth 1.5x sales. This analysis is based on multiples from Swatch (company-owned brands) and Fossil (primarily licensed brands). There is additional upside to using these multiples, since Swatch and Movado are undervalued compared to the stock market. This analysis also does not consider any cost synergies that a strategic buyer would have. Movado has relatively high overhead compared to its peers, so a buyer could possibly pay more for the low-hanging cost synergies.
Movado is a business with above-average ROIC and above-average safety compared to companies in other industries.
The average business should trade at 10x owners earnings. Movado is trading at 30-40% discount to the average business in today’s stock market, despite being of higher quality.
Movado is not the highest quality publicly-traded watch-maker, but it is still a high-quality company compared to other industries.
Movado has 10% operating margins. This is slightly below its target of 15%. Fossil generates 15% margins and Swatch generates 20% margins, so considerably lower.
Movado also doesn’t have the highest ROIC in the industry. Historically, Movado has only generated about 15% pre-tax ROIC. There’s a few reasons for this. Movado lacks economies of scale. Movado’s company-owned watches are made in Switzerland, while their branded watches are made in Asia. Movado also doesn’t own its production facility in Asia for its licensed watches, whereas Fossil does.
Movado has also opted to maintain its prices when the rest of the U.S. market has increased theirs. Before the Great Recession, the company’s gross margin was as high as 60%. In 2015, their gross margin was 53%.
In terms of size and opportunity, Movado is weaker compared to Fossil and Swatch. Fossil’s average revenue per licensing brand is $100M while Movado’s is $50M. Fossil also has more brands in its licensing portfolio. Fossil and Swatch have a strong international presence, whereas Movado is generally limited to Americans due to its poor brand presence overseas.
Every downside has an upside though.
Despite Movado having lower gross margins, they have been able to achieve higher profits. This is mainly due to high sales volume. Movado has been able to grow their market share post-recession by maintaining their price points in a time where the average income in the U.S. stayed flat as well. As income once again rises among Americans, Movado will be able to complement its volume growth with price increases.
From the years 2012 to 2015, Movado has generated 30% pre-tax ROIC, which is substantially higher than the average publicly-traded company in the market. They have done this on 10% growth in sales since 2010. Operating profit in 2015 is nearly double what it was pre-recession, despite having similar sales in both periods.
While Movado doesn’t have unlimited upside, the company’s safety makes up for it.
Movado is safe from a competition standpoint, leverage standpoint, and capital allocation standpoint.
The watchmaking industry doesn’t compete on the basis of price; rather, they compete on brand positioning. In the watch industry, brands compete within segments that are typically based on certain price ranges: casual watches, accessible luxury, and luxury. Movado has an extremely strong position in the U.S. accessible luxury segment. In fact, it is probably the second-leading U.S. brand. Rollex is the first.
Movado’s company-owned business is safe for two reasons. First, it takes decades to build up a brand. For Movado and Omega, it took almost three decades to become the leaders in their respective regions. Second, there is very little incentive for other well-known Swiss watchmakers to enter the U.S. market. It is the least appealing market for them, since most retailers don’t know how to represent their brands and sell their watches. Movado was uniquely positioned because their founder, Gedalio Grinerg, built his career as a U.S. distributor for Piaget before acquiring Movado and growing its reach. A company is also required to make massive investments in concessions, distribution, location, so watchmakers find the U.S. market the least appealing.
On the licensing side, there is much less competition. Fossil and Movado make up 80% of the entire industry. Each player is more focused on growing sales per account rather than stealing licensing deals from the other. Most players switch if they want to have higher volumes. Fossil is best suited for the largest volumes. Movado is able to take on large and small accounts. Licensors almost never switch due to price or technical appeal. Guess also tried to switch from a smaller watchmaker to Fossil in 2005, but there were antitrust issues since Fossil has the largest market share in this part of the industry. So 50% of their revenue is virtually locked-in. Unless these brands completely flop or make a massive mistake, Movado should be able to retain and renew its licensing deals and grow those accounts. Since Movado’s entrance into licensed watches in 2005, they have never lost a licensing deal.
Management is more conservative in their growth strategy. They miss out on many growth opportunities, especially abroad, but the growth opportunities they do pursue are near sure bets. Instead of entering multiple markets, management opted to solely focus on the UK to ensure their success. Management is also not reckless with their money. The two acquisitions since their inception have been successful. One was an unprofitable company bought at a net-net price that generated a profit in their first year of ownership. While they have a lot of cash on the books, it is clear that value won’t be destroyed with it.
Among the other investment opportunities in my “investment universe,” I would consider Movado to be the safest, no-brainer investment with uncertain upside through multiple expansion, pricing increases, financial leverage, and opportunities for continued efficiency.
Back to the Present: What actually happened
HOW WOULD HAVE THE DECISION PLAYED OUT ON FEBRUARY 28, 2021?
First, let’s talk about how the business has performed.
From 2015 to 2020, Movado’s revenue grew by 4% and operating income shrunk by 10%. The wholesale business, making up 90% of revenues in 2015, only grew by 3% over the period.
Most of this growth was inorganic, as Movado added Olivia Burton (a 5-year old UK brand) in 2017 and MVMT (a 5-year old millennial brand) in 2018. In 2015, the wholesale business contributed 85% of the profit at a 10% margin. The acquisition of these two start-ups reduced the segment’s margin to 5% and cut overall profits by half.
The retail segment grew its revenue by 6% over the 5-year period, but its profits remained flat, despite growing assets by 25%.
Movado’s strong market position, the United States, became weaker and less profitable over time. Since 2018, it has become an unprofitable market.
For the licensing business, Juicy Couture did not renew its license with Movado and discontinued their watch business altogether. Ferrari, Hugo Boss, and Coach renewed a 5-year term. Tommy Hilfiger also used the option to extend the contract for 5 years, and Movado gained another 5-year option to renew with them. The company landed a new license in 2015 with Rebecca Minkoff, a 15-year old accessible luxury women's brand.
Movado bought back $68M in shares from 2016 to 2020, $50M of which was bought in 2016 at an average yield of 8.5%. Management also paid $14M in dividends across the 5 years. In 2019, management issued $5M in equity. The company issued debt in the same year. By 2020, Movado had $52M in long-term debt. Management continues to hold a significant cash pile of $185M.
Now, let’s see how much value was created through management’s strategic capital allocation decisions.
When the Singular Diligence Report was published in October 2015, the market cap was about $598M. With $77M in net payout and a market cap of $528M, total shareholder return (in dollars) has been $7M, or a 0.23% compounded return over a 5-year period.
Reflecting for the Future: On getting better
HOW WOULD I HAVE CHANGED MY PROCESS, GIVEN THE RESULTS?
The critical pieces of information that I really needed to make a no-brainer decision was:
The 6x owners earnings multiple: An average player trading at the lowest multiple in the industry; an above-average company trading at a below-average market price
The 30% ROIC: A high-quality business with clear volumetric growth and opportunity to increase its prices due to its strong brand position
15-year retention: A business that has never lost a licensing deal
Antitrust issues: A licensing industry with strong switching costs, to the point where there may be antitrust issues
Slow, precise growth record: A management team that is more cautious of losing capital than gaining capital
Given the results, I would have not grown my capital, assuming a 5-year holding period. However, I also would not have lost any money.
At one point, the market valued the company at $1.1B in May 2018. This implied a 1.7x EV/S and 15.1x EV/Owners Earnings. Selling at this point would have generated a 30% compounded return (multiple expansion and payouts).
To get to this, you would have had to have held the stock when it dropped to $496M in market cap just 2 years earlier, a 20% decline since the initial purchase. This implied a multiple contraction to 0.55x EV/S and 4.4x EV/Owners Earnings.
Even though I didn’t lose any money, I discovered some areas of improvement through this case study. If fixed, I believe I can significantly improve my results. Below is a re-evaluation of the (a) speed of my process (b) effectiveness of my process and (c) conviction throughout the holding period.
As mentioned in the last newsletter, my main area of weakness has been the time it takes to make a decision. In other words, I had a hard time figuring out the minimum amount of information I needed to make a no-brainer investment decision.
In this case study, I believe I really improved the speed at which I gained conviction. I found five pieces of evidence to answer five critical questions. These questions were absolutely essential to make the investment.
While I correctly picked essential questions, I did not pick all essential questions. In other words, I missed a critical question. In an effort to focus on efficiency, I sacrificed effectiveness. I did not focus on the durability of the Swiss watchmaking industry, generally, and the accessible luxury segment, specifically.
The business was extremely safe on the licensing side. The licenses had a very high probability of being renewed. I was comfortable in making that bet. But to the extent that Swiss watch industry was becoming increasingly weaker was something I overlooked.
The Swiss watch industry experienced three consecutive years of declining exports since 2015. In 2020, it was estimated the Apple watch outsold the entire Swiss watchmaking industry. The design and mechanics of Swiss watches were becoming less and less important to the average consumer.
At the same time, accessible luxury Swiss brands faced immense pressure. Upstart watch brands entered the scene by using social media to build a brand in a matter of years, eCommerce to sidestep the barriers to entry in retail distribution, and Asian labor to offer extremely cheap ($100-$200) but appealing watches.
I also misjudged capital allocation. I did not foresee that management would pay high EV/S multiples for unprofitable startups like MVMT and Olivia Burton. These unprofitable, marketing-heavy brands were the reason for the poor operating margin in the wholesale segment.
Lastly, I can be honest and say that I don’t think I would have had the stomach or conviction to hold the stock when Movado’s US market share declined and the wholesale segment flattened / shrunk. I did not have an intimate familiarity with the customer behavior of these markets / segments, so I would have not had any rationale to stay rooted in my conviction if the stock declined. I also do not think I would have understood the reason for the multiple expansion during the company’s poor performance.
Learning from this experience, there’s three specific areas of my process that I want to improve.
First, I want to get back to my natural focus on durability. Having started my career in venture capital, I have a natural inclination to ask: “How durable is this price segment, this distribution channel, this specific customer interaction / experience?” The question of obsolescence or segment pressure has always been my #1 concern — the one I spend the most time on.
On the other hand, Geoff’s #1 concern is competitive risk. By reading Geoff’s Singular Diligence report, I disregarded my own unique way of looking at investments, if I’m being honest. Durability is a critical component of safety.
I want to re-emphasize durability-based questions in my checklist:
Is there a will or a way for new entrants to steal my business?
Is the industry getting better (safer from competition) or worse? How have the industry dynamics changed over time?
Second, I want to be a better judge of capital allocation. While it would have been understandable to say that management was conservative and wouldn’t have pursued any value-destroying opportunities, there were certainly signs.
For example, Movado had included this line in their 10-K since 2010: “Strategic acquisitions of watch brands and their subsequent growth, along with license agreements, have played an important role in the expansion of the Company’s brand portfolio.” The founder of the company, Gedalio Grinberg passed away in 2009, so there were no guarantees that the founder’s capital allocation philosophies, especially around acquisitions, were passed down and embodied by the founder’s son.
In fact, I had this line of thinking, but neglected it during my process: “Our founder / father Gedalio Grinberg started this company through transformational acquisitions, and since we are in a rapidly changing environment, we have to take similar measures to replicate his success.” To improve in this area, I will add to my checklist the following questions:
Are there any subtle signs that management would bend their capita allocation philosophy in the face of hard, uncertain, or changing times?
Lastly, I want to know the business well-enough to have a clear pre-mortem. In an effort to be efficient, I neglected this step in this case study, despite the level of importance in my process.
To make a no-brainer, high-conviction bet, I will have to sketch out a detailed pre-mortem for every investment. And that will require deeper understanding of consumer behavior, business segments, and management philosophies. If I feel like I do not have a firm grasp on those things, I should not be afraid to put it in the “Too Hard” pile, even if it’s just a case study. This is the only way to improve my process.
Movado was the perfect case study for situations that look obviously cheap and fairly good and traditionally safe.
It is important to question whether or not past performance and past behavior is indicative of the future. I expect that most of my errors of commission will come from this.
It was also the perfect case study for understanding the difference between “no-brainers” and “high conviction bets.” No-brainers are the initial decisions that you make the investment. Conviction kicks in when you are holding the investment. A value-play like Movado would have really tested your conviction during the peaks, during the valleys, and during the times when stock price moved ahead of performance.
It was also a great first case study because I did not make or lose any money over the holding period. There were outcomes that affirmed my ability to protect the downside, and there were outcomes that challenged my ability to measure the upside.
The case study took about 10-15 hours over the course of two weekends. Half of the time was spent on actively reading and thinking about the Singular Diligence write-up, a quarter analyzing the information after the 5-year period, and a quarter on writing the newsletter. I recommend that anyone looking to improve their process find their own way to do their own case studies.
If you want to read write-ups similar to Geoff Gannon’s Singular Diligence newsletter, please visit focusedcompounding.com where Geoff and Andrew currently publish their content.