Strong Cash Flow, Prospects For Growth Drive Cherokee
Corporate Focus
by Anthony Palazzo
Staff Reporter
One of the few local winners in the nascent year on Wall Street has been Cherokee Inc., the former apparel maker that remade itself into a brand-licensing operation in the mid-1990s.
Cherokee, based in Van Nuys, has enjoyed a 25 percent appreciation in its stock price since Dec. 31, to $13.87 a share recently, slightly off of its 52-week high. The success can be tied to strong cash flows which will improve substantially as debt is worked off along with new growth opportunities and a marketing program designed to attract institutional investors.
“They’ve got a sexy business model to help retailers sell attractive brands,” said Bobby Melnick, general partner with Terrier Partners LP, a New York hedge fund.
Cherokee made its name in the 1970s as a purveyor to the then-hip crowd that favored bellbottoms and platform shoes. But like all great times, those ended, and by late 1994, the company was in bankruptcy court for the second time.
To survive, Cherokee did away with much of the operational overhead that helped sink it in earlier times design, inventory, manufacturing. Instead, it sold discount retailer Target Corp. a license to place a Cherokee label on its own shoes, shirts and other items.
The plan worked. Target has been among the most successful discount retailers in recent years, controlling costs while capitalizing on the still-potent Cherokee brand, which makes up 5 percent of its overall sales. Cherokee has other large customers, but the lion’s share of Cherokee’s royalty income still comes from Target.
Despite these successes, Cherokee has been better-known to Target shoppers than Wall Street investors and analysts. But that’s changing, as a steady management team shifts gears for a new growth spurt.
Last year, Cherokee licensed its name to U.K. discount retailer Tesco PLC, which this fall will launch the brand in Ireland and the U.K. It signed a similar deal with a French partner, Carrefour, covering 26 European and Latin American countries.
“We haven’t gone public on what we expect,” said Cherokee Chief Financial Officer Carol Gratzke.
Besides the Cherokee and Sideout brands it owns, Cherokee has been serving as a middleman, helping to set up licensing deals between retailers and other apparel names. Cherokee played matchmaker between Target and Mossimo Inc., and now shares in royalties collected by Mossimo through Target stores.
Most recently, Cherokee signed a deal to represent teen apparel manufacturer Hot Kiss Inc., setting up international licensing deals.
Gratzke said Cherokee is looking for additional branding deals, ranging from simple matchmaking to outright purchase of distressed names. “We would review any brand opportunities that come our way,” she said.
Cherokee’s also been using its prodigious cash flow with few expenses, operating income runs at about 70 percent of revenues to buy back stock, and Gratzke has been meeting with potential investors to get the company’s story out.
Some have taken notice. If any of Cherokee’s new deals or future ones they may sign are a hit, “then the earnings power of the company is dramatically greater than it is today,” said Melnick.
One reason Cherokee may have scared off investors in the past is its obscure capital structure. In 1998, Cherokee renegotiated its deal with Target, securing minimum royalty payments of $60 million over six years. Instead of waiting for the money to come in, Cherokee borrowed against the guaranteed future income, and gave the money to shareholders in the form of a special dividend of $5.50 per share. Gratzke said the deal was done for tax purposes, but it left Cherokee with negative shareholder equity. Payments on the notes that were issued run about $10 million a year.
The good news is that Target royalties have been running much higher than its interest obligations. When the note is paid off, in early 2004, that extra $10 million per year will boost profitability.
Financial Editor Anthony Palazzo can be reached at 323-549-5225, ext. 224 or at
[email protected].
