L Brands Sells Majority Stake in Victoria's Secret

Narrow-moat L Brands LB announced it was divesting a majority stake (55%) in its languishing Victoria’s Secret brand, along with 45% of the company’s Pink brand for $525 million. In our opinion, this appears like a fire sale price for the brand, implying the full VS enterprise would be worth $1.1 billion. The VS brand delivered more than $7 billion in sales and $462 million in operating profits in 2018 (down from $932 million in operating profits in 2017). We were surprised the board supported this sale price, given the historic economics of the business and its ability to throw off significantly more cash flow than it currently generates. The buyer, Sycamore Partners, has had a long relationship with L Brands and the retail space, purchasing L Brands Mast Global Fashions sourcing business and attempting to turnaround other retail operators like Aeropostale and Nine West.

We believe shares are trading down nearly 10% on the deal’s valuation, given the market capitalization at market close Feb. 19 was $6.8 billion and Victoria’s Secret represented more than 55% of sales and 37% of operating profit in 2018. We would expect to lower our $40 fair value estimate in response to the transaction, as we don’t expect the $1.1 billion in cash received will be enough to offset the lost revenue and EBIT stream from the majority stake in the VS business. Although L Brands has confirmed that it will use the proceeds from the transaction, plus $500 million in excess cash to pay down its $5.5 billion long-term debt load, we will wait for final capital structure details to unfold before making changes to our model. Initial remarks imply VS will take $2.5 billion of the $3.5 billion total lease obligation with it when it separates. If VS gets saddled with most of the long-term debt load, Bath & Body Works could be positioned for healthy cash flow generation, supporting higher investment in innovation and marketing spend around the brand, which could further engage consumers.

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