sprott student investment fund...with other well-known brands such as ralph lauren, calvin klein and...

Michael Kors Holdings

Sprott Student Investment Fund Equity Research

Buy, Current: $44.06, Target: $57 July 13, 2015

Kyle Stolys BCom Candidate 2016 Finance

Portfolio Manager [email protected]

Spiridoula Karasavva BIB Candidate 2018 Global Financial Management and Systems

Sector Manager [email protected]

Research Highlights

Performance since IPO

Source: Bloomberg

Stock Price Overreaction Michael Kors’ stock has undergone a violent decline of 60% since its March 2014 peak. We

believe that while much of the decline was warranted, the stock has now overshot to downside

and presents an attractive opportunity for investment.

Sustainability Concerns

Room for Growth

Porter’s 5 Forces

Investors today are concerned that Michael Kors is a fad and may experience a long period of

negative growth as interest in the brand declines. These concerns became more prevalent after

the company’s negative same store sales reading in Q4 of FY2015. This was the first negative

reading since Kors’ 2011 IPO and has elevated concerns that Kors’ decline has begun.

Michael Kors currently operates 526 company owned stores in North America, Europe, and

Japan. Management has a target to operate 700 stores in these regions which should drive

revenue growth in the near term as they open new stores in new areas.

We re-conducted an analysis on the attractiveness of the luxury accessories category, and

concluded that the space is attractive for investment. We expect the category will become more

competitive over time, but since companies tend to compete on quality and brand image over

price, the category should continue to generate high returns on capital over the long-term.

Sprott Student Investment Fund | Equity Research

Update on Recent Events On Wednesday, May 27, Michael Kors (Kors) released its earnings report for the quarter ended March 28, 2015. The company reported revenue growth of 18% in the quarter and EPS growth of 15%. Same Store Sales Growth (comps) negatively surprised investors with a negative reading of 6.7% in North America – the first negative reading since Kors’ 2011 IPO. As a result of the news, shares plunged nearly 24% the next day. Kors’ stock price has been witnessing a continuous decline for over a year, falling 60% since its March 2014 peak. There are three main reasons for this decline. These include brand pressures, tightening margins, and investors’ worries over a major shareholder’s decision to sell its stake in the company. Brand Pressures The main area of concern for investors has been the fact that Kors has been reporting weakening same store sales in the U.S. for six consecutive quarters. In addition, during the last quarter, U.S. same store sales had a negative growth rate of 6.7%. Declining/negative same store sales are attributed to a list of factors. These include a potential brand dilution, a saturated US market, and weaker tourist traffic in the U.S. due to the stronger USD. Kors has also been facing increased competition in the handbag and watch segments from other affordable luxury retailers such as Coach, Kate Spade, Tory Burch as well as Apple (Apple watch). With respect to brand related issues, investors are concerned that Kors might have fallen under the umbrella of luxury brands that after enjoying meteoric rises end up suffering from overexposure. The opinion that the company might have over-expanded has been gaining popularity over the past year. Investors are skeptical about whether Kors can still be considered a "luxury" brand when the company’s products can be found all over America and in such a large number of discount outlets. They are worried Kors’ products have become ubiquitous, and that the brand is losing its fashion credibility. Another thing that’s been hurting not only Kors, but also other high end retailers’ revenues (such as Macy’s, Tiffany) is the stronger USD. Executives said that visits to stores in large U.S. urban centers suddenly dropped once the Euro dipped violently in February. Europeans were apparently less willing to fly to the U.S. to shop since it became more expensive to travel. So unless the euro starts to strengthen, or U.S. consumers increase their consumption, investors don’t expect to see a near term bounce in US same store sales. Margins Another reason for the continuous decline in Kors’ share price is a tightening in the company’s margins. Kors’ operating margins were 30.5% in FY2014, 28.8% in FY2015, and are expected to be between 26% and 27% in FY2016. This is a common issue for luxury firms right now with other well-known brands such as Ralph Lauren, Calvin Klein and Tommy Hilfiger also struggling. Many of these brands have focused their efforts on the accessible luxury segment which have lower price points and thus lower margins. As a result, the product mix of these companies have shifted to lower priced goods and margins have been under pressure as a result. Sportswear Holdings The last point that has made the above concerns more prevalent was Kors’ largest shareholder – Sportswear Holdings liquidating their 5.7% stake in Kors in September 2014. The Hong Kong-based private equity firm initially purchased a majority stake in Kors over 10 years ago. Over the years their stake declined as a result of sales to other investors combined with dilution from additional equity offerings, including the IPO. In September 2014, Sportswear Holdings sold off their final 20 million shares in a secondary offering and many investors have used this as evidence of the above concerns and that Kors is entering a brand decline. In our initial report on Michael Kors, the biggest risk that was highlighted was that Kors could fail to adhere to consumers’ interests. Quoting from our November 2014 report, “A good measure of whether Michael Kors is keeping up with the interests of consumers is same store sales. If Michael Kors begins to experience negative same store sales growth, an investment in Michael Kors should be reconsidered.” As a result of the Q4 negative same store sales reading, we have undergone a review of the holding, to determine if Kors’ common stock is worthy of an investment.


Michael Kors operates in the global luxury goods industry. Its business can be explained in three different ways, geographically, by product type, and distribution type. Kors has direct operations in North America, Europe, and Japan, and licensing agreements in other parts of Asia. In FY2015 Kors had sales of $4.37B split 78% in North America, 20% in Europe, and the last 2% in Asia. This is illustrated in figure 1. Kors’ product assortment is split into four categories: Accessories, Apparel, Footwear, and Licensed product. Accessories consist mainly of handbags and other leather goods and are the largest segment making up 68% of sales in FY2015. Apparel and Footwear made up 13% and 11% of FY2015 sales respectively. Licensed Product which mainly consists of watches as well as eyewear and fragrances, comprised 8% of FY2015 revenues. This is illustrated in figure 2. Kors’ business model is split into three distribution segments: retail, wholesale, and licensing. Retail is the operation of company owned stores; wholesale is the placement of Kors’ products in department stores; and licensing is an agreement with a third party to sell products under the Kors brand. In FY2015 retail comprised of 49% of revenues, wholesale: 47%, and licensing: 4%. Licensed product and licensing are two separate types of sales. Licensing refers to the agreements in Asia, where entities pay Kors a fee to operate Kors branded stores and sell Kors branded products. Licensed product, are products that Kors pays companies such as Fossil, Estee Lauder, and Luxottica to manufacture watches, fragrances, and eye-wear which is then sold under the Michael Kors brand. In FY2015, Kors’ sales grew 32%, with gross margins of 60.6% and operating margins of 29%. Kors has experienced rapid growth with sales growing from $500M in FY2010 to now $4.37B in FY2015. With the rapid growth, gross margins increased from 52.5% to now 60.6%, and operating margins increased from 11% to now 29%. This is due to operating leverage with the rapid growth in sales resulting in less fixed costs per dollar of sales. Profit margins have increased from 6% in FY2010 to 20% in FY2015. Figure 4 illustrates the change in revenues and margins over the past 6 years.

Company Overview

Figure 4: Historical Revenues and Margins

NA78%

Europe20%

Other Regions2%

Accessories68%

Apparel13%

Footwear11%

Licensed Product8%

Figure 1: 2015 Sales by Geography Figure 2: 2015 Sales by Product Type

Retail49%

Wholesale47%

Licensing4%

Figure 3: 2015 Sales by Operating Segment

0%

10%

20%

30%

40%

50%

60%

70%

$-

$500

$1,000

$1,500

$2,000

$2,500

$3,000

$3,500

$4,000

$4,500

$5,000

2010 2011 2012 2013 2014 2015

Revenue Gross Margins Operating Margin Profit Margins


Kors operates in the Luxury Goods industry with a focus on the handbag segment. According to Euromonitor, luxury goods sales grew 3.9% in 2014 to $339 Billion and growth in 2015 will slow slightly to 3.5%. Europe, one of largest consumers of luxury goods has been a laggard with sales only forecast to increase 1.2% in 2015. This has been the story over the last few years as Europe continues to undergo problems. The Boston Consulting Group which calculates total luxury goods sales differently, expects that the global luxury goods market will grow at a rate of 7% over the next few years. Despite differences in calculating total luxury goods sales, the consensus is that global luxury goods will continue to grow faster than global GDP. The market for luxury goods includes designer apparel, luxury jewellery, accessories, premium beauty products, fine wines, and travel goods, among many others. Of these segments Euromonitor forecasts that luxury accessories (leather goods, jewellery) will continue to grow faster than the overall luxury market from 2015-2019 at a rate of 5.4% per annum. The accessories category has undergone drastic changes over the last 10 years with many new entrants crowding the market. New players have emerged, such as Michael Kors, Tory Burch, and Kate Spade adding pressures to existing market participants. The older players (Louis Vuitton, Prada, Hermes, Gucci) have transformed their business model and shifted their focus from wholesale to retail – wholesale being department stores, and retail being an independent company store. This is illustrated in figure 5. To achieve such a change in the underlying business, the trend has been for companies to open a significant number of new retail stores, as illustrated in figure 6. Current Trends More recently companies with in the luxury segment have put their focus on e-commerce. Kors launched their own e-commerce platform in the Fall of 2014 and is launching similar platforms in other regions this year. This is a trend across the industry where companies are trying to gain exposure on as many platforms as they can. Footwear is also gaining traction as a source of growth for luxury companies, with the segment growing at double digit rates. Many companies are putting a focus on this segment and it should result in a strong source of growth going forward. Due to the increased competition, many companies at the higher end of the price spectrum are moving up their initial price points to maintain an image of exclusivity. This effectively cuts out a portion of customers and reduces the volume of product in circulation. As a result, newer brands have been able to move into the accessible luxury space such as Michael Kors, Tory Burch, and Kate Spade, and have thrived in this environment stealing market share from competitors such as Coach.

Industry Dynamics

Figure 5: Leather Brands - Retail as a % of Sales (2004 vs. 2013)

Source: Company Reports, Exane BNP Paribas estimates

Figure 6: Retail Stores in Operation by Luxury Brands

Source: Exane BNP Paribas Analysis (Note: Brands include: Prada, Miu Miu, Burberry, Hermes, Hucci, Bottega Veneta, Saint Laurent, Louis Vuitton, Coach.)


Porter’s 5 Forces

We have conducted a Porter’s 5 Forces Analysis of the accessories category.

Competitive Rivalry: Within the accessories category, competitive rivalry runs very high

with a large number of market participants.

Threat of New Entrants: The threat of new entrants is very high within the accessories

market, with very low barriers to entry, and attractive returns on capital currently being

generated by companies.

Threat of Substitute Products: The threat of substitute products is moderate. While

people don’t need high-end handbags, there is an image associated with them that has created

a sustainable level of demand.

Bargaining Power of Suppliers: Most firms within the accessories category have strong

control over their costs, but the high prices of their products give suppliers moderate

bargaining power.

Bargaining Power of Customers: Customers have plenty of options within the

accessories category, but most brands do not compete on price. Customers are willing to pay

high prices for the products, which gives them low bargaining power and allows costs to be

passed onto customers. This is why firms within the accessories category can sustainably

generate high returns on capital.

Currently in the U.S. market, Coach, Michael Kors, Kate Spade, Marc Jacobs, and Tory Burch

comprise of approximately 50% of the accessible handbag category (Goldman Sachs, 2015).

Coach has undergone significant issues during the last two years, and is currently undergoing

a transformation of their business, closing 20% of its North American stores. Marc Jacobs is

also de-emphasizing its $300 handbag offerings, and Tory Burch is reported to be struggling.

This opens up an opportunity for brands such as Kors to capture greater market share.

We expect the luxury accessories category will continue to grow more competitive and

problems will continue to loom. The make-up of the industry is favourable with firms that

compete on quality instead of price, leading to sustainably high returns on capital being

generated over the long-term. With the category projected by Euromonitor to continue to

grow at a faster pace than the overall luxury goods industry and GDP, we feel favourable about

the luxury accessories category.

Growth & Risk Analysis Growth Outlook Retail Kors business is split into 3 operating segments: retail, wholesale, and licensing. Kors has established LT targets on the number of retail stores they seek to operate in each of their operating regions. They are targeting 400 stores in NA, 200 stores in Europe, and 100 stores in Japan, a total of 700 retail stores. As of March 31st 2015, Kors operated 526 stores, and has plans to open an additional 85 stores in FY2016. As Kors grows its number of retail stores from 526 to 700 we expect near term revenue growth from the increased reach of its brand. Wholesale In wholesale, Kors has been converting a number of its wholesale locations into shop-in-shops. Shop-in-shops are a designated portion of a department store that feature one brand and are designed to look like a mini store inside the department store. Figure 7 displays an image of a Macy’s in New York City with a Michael Kors shop-in-shop. These shop-in-shops help build the Michael Kors brand and drive consumers towards the products when inside a department store. Kors currently has over 4000 wholesale locations, up from 3,700 in FY2014.


Of these department stores, Kors has shop-in-shops in 2100 locations and has plans to convert an additional 600 locations into shop-in-shops in FY2016. Going forward, the conversion of wholesale locations into shop-in-shops should spur growth. In addition, FY2015 was the first year Kors had wholesale operations in Japan. As the business expands in Japan, this will also provide opportunities for growth. Licensing Transitions Kors also has opportunities for growth throughout Asia. Originally, to enter this market Kors expanded into the region by licensing out their brand and allowing other entities to sell Kors’ products. Kors plans to repurchase their licensing agreement in Korea in 2017, which will enable them to run the operations in this country themselves and generate significantly more revenues and profits. Kors considers Korea to be a $100M market long-term. In comparison, Kors considers Japan a $300M market long-term, and Europe a $1.5B market long-term. In the years following, we expect Kors to repurchase their licensing agreements in China, however, management has not provided a timeline for such a move. China is poised to become the 2nd largest luxury market by 2019, second only to the U.S., with spending in China poised to rise 52% by that time (Euromonitor). Expansions into China, Korea and the surrounding Asian countries present great opportunities for growth over the long-term. E-Commerce In FY2015, Kors launched their e-commerce platform in the U.S. Prior, Kors’ e-commerce platform was outsourced and Kors only received a small royalty on the sales. The e-commerce launch has so far been very successful with sales on e-commerce growing 44% in the most recent quarter. Kors also recently launched their e-commerce platform in Canada, and expects to launch their e-commerce platform in Europe in FY2016. These e-commerce launches help Kors build out their Omni channel strategy, enabling greater ease for customers to make purchases. Major Risks The largest risk to an investment in Michael Kors is that the company fails to adhere to consumers interests. If Kors begins to fall behind or another brand becomes more favourable, Kors will struggle. An example of such is Coach, which has arguably not kept up with its customers’ interests, and the business has struggled as a result. A good measure of whether Kors is keeping up with the interests of consumers is same store sales growth (comps). Over the past 6 quarters, same store sales growth has been decelerating and entered negative territory in the 4th quarter of FY2014. This is a very negative sign for the business and could be an indicator that the Kors brand is beginning to fade. The second largest risk to Kors is the economy. If the economy in one of Kors’ operating regions enters a recession, sales will face headwinds, and may decline. Kors operates a highly discretionary business that tends to perform very well in strong economic climates, but in weak economic climates, consumers tend to delay purchases of luxury goods. If a global recession were to occur, Kors’ business would be sure to perform negatively.

Figure 7: Michael Kors shop-in-shop - Macy’s, NYC

Source: Google Images


Scenario Analysis We have created two scenarios to analyze Kors; a base case, serving as what we expect to happen, and a bear case, serving as what we are concerned could happen.

Scenario 1 - Base Case

Revenue: In 2016 Management expects revenues to be between $4.7B and $4.8B, a growth rate of 7.5-10%. As part of this forecast Management expects comps to be flat for the year (after currency effects), and expects to open 85 new stores during the year; 30 in NA, 45 in Europe, and 10 in Japan. Management also expects single digit growth in their wholesale and licensing segments. We have incorporated these expectations into our forecasts for 2016 and have projected 2% growth in the licensing and wholesale segments. Many analysts are skeptical that Kors will be able to have flat comps in 2016 due to the poor figures in Q4 and the poor outlook for 1H 2016. We have projected a 6% comps decline combined with 85 newly opened stores to generate growth of 15% in the retail segment. These projections combine for $4.74B revenue in 2016. We feel that management is being optimistic in their comps guidance but conservative in their revenue guidance for 2016. This results in total expected revenue growth of 8.5% in 2016. We feel that despite near term issues, Kors will still be able to generate comps growth in the not so distant future. With retail stores opening at a rapid pace over the last six years we believe there has been some cannibalism of sales across the business, which was felt in Q4 2015. With store openings slowing after 2016 we expect demand for Kors’ products to continue albeit at a slower rate than in the past, but still positive. In 2017 we believe 5% comps is reasonable, especially after a year of flat or possibly negative comps. Combining 5% comps with 40 new store openings, we compute growth of 16.5% in the retail segment. In wholesale, we expect 2% growth as pressures on mall traffic continue. Within the licensing segment, revenues in NA actually declined in 2015, while Europe revenues rose over 300% following the launch of that business in 2014. Management expects mid-single digit growth in this segment in 2016, with the Watch business providing serious headwinds. Kors is revamping 30% of the watch product portfolio for the Fall of 2016 which we believe will begin to turn around the decline within the NA licensing segment but will only have an effect in the 2nd half of 2016. This will lead to more growth in 2017. As a result, we expect high single digit growth to low double digit in 2017 within the licensing segment, and have projected 10% growth in this year. This results in total revenue growth of 9.8% in 2017. In 2018 we expect management to open 25 new stores reaching a total of 676 stores by year end, and nearing its target of 700 total stores. We expect competition within the accessory category will continue to increase, leading to greater pressure on Kors. As a result we have forecasted comps growth of 2% in retail and a 2% growth rate in wholesale. We expect the licensing segment to slow slightly to 5% growth. This results in total revenue growth of 5%. In 2019 we expect management to open around 15 stores bringing the total to 691. Combined with expected comps growth of 2% we expect the retail segment to grow at 5% in the year. We expect the wholesale segment to again grow at 2% in line with the prior year and for the licensing segment to continue growing at 5% as that portion of the business continues to thrive in Asia. This results in total revenue growth of 3.8% in 2019. In 2020 we expect wholesale and licensing to continue growing at the same rate as 2018 and 2019, and we expect management will open approximately 9 more retail stores reaching the target of 700 stores. Combining the store growth with expected 2% comps we project retail sales to grow at 3.8%. This results in total revenue growth of 3.1% in 2020.

Scenario 1 2016E 2017E 2018E 2019E 2020E

Revenue Growth 8.5% 9.8% 5.0% 3.8% 3.1%

Global Comps -6% 5% 2% 2% 2%

Store Growth 85 40 25 15 9

EBIT Margins 26.0% 26.9% 26.9% 26.8% 26.8%

Capex (6% of Rev's) 400 312 328 340 351


In our CV year, we have broken down our expectations into three components: retail, wholesale, and licensing. Within retail we have broken the segment down into NA, Europe, and Japan, and combined our expected number of operating retail stores with an expected level of sales per store. In NA in 2015, each retail store generated an average of $5.25M in sales. In Europe in 2015, each store generated $3.87M in sales. In Japan in 2015, each store generated $1.53M in sales. All three figures have been growing at rapid rates over the last 5 years, which is seen in the high rate of growth in comps. With the NA segment being the most mature of the three, we project average sales per store of $5.5M. This is slightly above our 2020 forecasted figure. We believe that the NA segment has room to expand slightly as the industry continues to expand and we are comfortable projecting a terminal level of $5.5M per store. In Europe we have projected average sales per store of $4.5M. We do not expect sales per store in Europe to reach that of North America but we also believe there is room for expansion from current levels of slightly below $4M. In Japan we have projected $2.5M sales per store, significantly higher than the level of $1.53M in 2015. We believe Japan sales still have catching up to do with Europe and NA but will not reach the levels of those regions. We believe $2.5M is a sufficient level of sales per store in perpetuity. By combining these figures we come to an average level of sales per retail store of $4.8M for all 700 stores. This results in $3.35B of retail sales in our terminal year ($4.8M*700). Projecting the perpetual level of sales in the wholesale segment is more difficult than the retail segment because the data is not as granular. But wholesale has been a continued source of growth for Kors. In 2015 in NA, wholesale sales grew 24%, grew 66% in Europe, and launched for the first year in Japan. Kors’ management has stated that they expect Europe to be a $1.5B market long-term, and Japan to be a $300M market long-term. Having projected retail sales of $900M for Europe in CV, we have forecasted $600M in wholesale sales adding up to the $1.5B target. In Japan we projected $250M of retail sales in CV, and as a result we forecast $50M of wholesale sales adding up to the $300M target. In North America, we believe $2B sales in wholesale is a feasible long-term figure, only slightly below our expected retail sales figure of $2.2B and $340M above actual wholesale sales in FY2015. In licensing we forecast $300M of licensing revenue in CV, up from $171M in FY2015. With an expected growth rate of 5% for the years FY2017-FY2020 we are forecasting licensing revenues of $223M in FY2020. With market growth in much of Asia we expect $300M to be a fair estimate of long-term revenues. In addition to these three segments of the business we have added in expected revenues from Korea. The Korean licensing agreements are being bought back, and Kors is expected to begin full scale operations in Korea in Q4 of FY2016. Management expects Korea to be a $100M market long-term. We have added $100M to our level of revenue in CV. All of the above results in CV revenue of $6.4B. Margins Over the last three years, Kors’ operating margins have been between 29% and 31%. In FY2016, management expects operating margins to be between 26% and 27%. They see this level as a multi-year floor as they undergo significant global investments. In FY2016 we have forecasted operating margins of 26%, which we expect to slightly increase in FY2017 to 27% and to stabilize around that level until FY2020. In CV, we have projected operating margins of 26.5%, which we see as a sustainable level going forward. Capex In FY2016 management forecasts capex spending of $400M, which we have also forecasted. During the years 2010-2014, capex bounced between a range of 5.6% and 6.8% of revenues. FY2015 was a year of significant investment and capex rose to 8% of revenues. FY2016 is the last year of Kors’ aggressive expansion and the $400M forecast equates to 8.4% of revenues. From the years FY2017-2020 we have forecasted capex to equal 6% of revenues. Kors continues to expand its business but at a less aggressive pace than in recent years. In addition, management is very adamant about investing in the long-term sustainability of the business and as a result we do not expect capex to fall too much from FY2014 and FY2015 levels.


Scenario 2 - Bear Case

There is a serious risk that Michael Kors has grown too quickly and is a fad. This is a draconian

scenario but is also a possibility in our opinion.

Revenues

In 2016 we have left our projections in line with that in scenario 1, since expectations are

fairly well cemented and changes in the perception of Kors’ brand likely won’t have drastic

effects until the years beyond 2016. In 2017 however, we believe there is a risk that if the

brand is a fad, comps in NA will continue to be negative, and Europe and Japan will fade. As a

result we have projected global comps of -10% in 2017, -20% in 2018, 0% in 2019, and 2% in

2020. We expect a stabilization in 2019 and 2020 since management will likely take significant

steps to turnaround the business similar to what has been seen at Coach, which had comps of -

15% in 2014, but has since stabilized. We have also not factored in any increased revenues

due to store openings because we expect management will halt its expansion if such a drastic

negative change were to occur in the business. As a result, comps is equal to our projected

growth in the retail segment. We have projected the wholesale business to decline at the same

pace as retail. We have projected the licensing segment to grow at a rate of 5% in 2017, due to

expansions abroad, but in the years 2018-2020 we expect this segment to decline at a rate of

5% per annum as interest in the Kors brand fades.

To project a sustainable level of sales in our CV year we have first assumed that Kors does not

reach its current target of 700 retail stores, and only operates 500 stores: 300 in NA, 150 in

Europe, and 50 in Japan. In addition, with the brand fading, we expect sales per store to

decline back to levels seen in 2012 and 2013 with sales per store of $3M in NA, down from

$5.3M currently, $1.5M sales per store in Europe, down from $3.9M currently, and $0.75M

sales per store in Japan, down from $1.5M currently. Matching these figures together we

compute retail sales of $1.16B in CV. Wholesale has consistently been a similar portion of

revenues as retail, and we have set CV wholesale revenues equal to our retail forecast. We

have also forecasted licensing revenues of $100M down from $175M currently. Combining all

of this we compute CV revenues of $2.4B.

Margins

As sales per store decline, margins are sure to decrease due to Kors’ operating leverage. We

have forecasted operating margins of 26% in FY2016, and then forecasted them to decrease

approximately 1% each year down to 22% in FY2020. We have used Coach as a parameter for

these declines as their business experienced significant margin declines in recent years. In CV

we forecast an operating margin of 20%, in line with Coach’s current operating margin, and

slightly above Kors’ 2012 margins.

Capex

We have assumed that as Kors’ brand fades, management will halt its expansion. As a result we

expect capex to be lower than our projected levels in our base case. However, we still expect

significant capital spending from management as they try to turn around the business. Since

revenues are expected to decrease, but we still expect investment in the business we have

projected capex to be 7% of revenues in the years 2017-2020. This is a higher % of revenues

than our 1st scenario, but a lower nominal amount of revenues.

This is a draconian scenario and may appear overly pessimistic, but if Kors’ business is a fad,

and enters a serious decline, we believe these assumptions are reasonable.

Scenario 2 2016E 2017E 2018E 2019E 2020E

Revenue Growth 8.5% -9.4% -19.4% -0.3% 1.7%

Global Comps -6% -10% -20% 0% 2%

EBIT Margins 26.0% 24.9% 23.9% 22.8% 21.8%

Capex (7% of Rev's) 400 301 243 242 246


To calculate a target price for each of our scenarios we derived an adjusted beta of 1.13 by examining weekly price changes in Kors’ stock since 2012. Using a risk-free rate of 2.5% and a market risk premium of 6.5% we derive a cost of equity of 9.85%. Since Kors does not have any long-term debt or preferred stock, 9.85% is also our WACC. For CV, we calculated the value generated in perpetuity using the formula from Chapter 10: Valuation, McKinsey: CV = (NOPLAT (1-g/RONIC)) / (WACC-g) NOPLAT (Net Operating Profit Less Adjusted Taxes): In scenario 1 we forecasted CV revenues of $6.4B. This results in NOPLAT of $1.1B in CV. In scenario 2 we forecasted CV revenues of $2.4B. This results in NOPLAT of $315M in CV. RONIC (Return on New Invested Capital): To forecast RONIC, we examined the long run returns on capital that have been generated in the Retail Apparel industry from 1965-2007. The median return on capital generated over this period was 16% (McKinsey). We believe this is a fair estimate of future returns on capital within the retail apparel industry, but because of the high margin business Kors operates in, and its ability to generate extra high returns on capital we have used a RONIC of 20%. This figure applies to both scenarios. Growth: In scenario 1 we have assumed a CV growth rate of 5%. This is driven by the continued growth of the U.S. economy (78% of revenues). The U.S. economy continues to slowly grow at a real rate of 2-3% per annum. Using this as a long term parameter combined with a long-run inflation rate of 2%, this results in nominal U.S. GDP growth of 4-5%. In addition, China is currently one of the world’s largest consumers of luxury goods, and is one of the fastest growing regions for luxury goods. Kors currently has licensing operations in this region. Over the long-term we expect Kors to repurchase these licensing agreements and fully enter the Chinese market which will be a significant source of long-term growth. As a result of these two factors we believe a CV growth rate of 5% is a reasonable assumption. In scenario 2, we have set CV revenues to a level we believe to be sustainable. From this point we expect Kors can grow but at a rate slower than the U.S. economy. As a result we have used a CV growth rate of 3% in this scenario. We have also used an alternative method of calculating Kors’ growth in perpetuity by using the multiple method. An examination of EV/EBITDA multiples of Kors’ peers over the last 10 years, resulted in a median EV/EBITDA of 10. We felt that this figure may be slightly inflated due to the success this industry has had over the past decade. As a result, in scenario 1 we have assumed Kors will trade at an EV/EBITDA multiple of 8 over the long term. In scenario 2, since Kors will be considered a low growth opportunity with a meagre outlook we believe the stock will trade at an EV/EBITDA multiple of 6 over the long term. Scenario 1 results in the following calculations of per share value:

Valuation

9.85%

5%

20%

2,834.9

10,181.0

978.9

0.0

13,994.8

198.9

70.36$

44.06$

60%

Equity Value

Shares Outstanding

PV of forecasted FCF

CV

Cash & Cash Equivalents

DCF Value per share

WACC

CV Growth Rate

Per Share Value

Current Share Price

% Upside (downside)

MV of Debt

RONIC

8

1,984.0

1183.7

2,834.9

9,469.7

978.9

0.0

13,283.5

198.9

66.78$

44.06$

52%


Exit Multiple Method

EV/EBITDA

CV EBITDA

Discounted EBITDA

Per Share Value

Current Share Price

% Upside (downside)

CV


MV of Debt

Equity Value

Shares Outstanding

Scenario 2 results in the following calculations of per share value:

Peer Analysis

We have compiled data on a set of Kors’ peers - as defined by J.P. Morgan - to examine how

Kors’ stock currently trades in comparison to its peers. We have selected 3 common valuation

metrics: EV/EBITDA, P/E, and EV/FCF. For each metric we have computed two figures, one

using trailing 12 month EBITDA/Earnings/FCF, and the other using the next years consensus

estimate by analysts.

As can be seen in the figure below, Kors trades at a significant discount to its peers under all

valuation metrics. It is important to note the differences seen in the TTM and fwd multiples.

Forward mutliples are typically considered to be the most valuable since they are forward

looking and take into account future expectations rather than past results. Using the popular

fwd EV/EBITDA metric Kors trades at 5.5x next years expected EBITDA, 2x lower than the

next lowest firm, Fossil, at 7.4x, and significantly below the average of 10.2x. Kors’ fwd P/E of

10.2x is also the lowest of all comparable firms, with the next lowest firm being Fossil, trading

at 12.1x. The median is 19.1x. Kors’ fwd EV/FCF is the 2nd lowest of all comparable firms

trading at 14.0x, with Fossil being the lowest at 12.1x. This is surprising considering FY2016 is

considered a year of large investment for Kors. This is also significantly below the average of

23.0x.

Source: Bloomberg, Analyst Consensus Estimates

Peer Group Analysis

- as at Jul-13-15

Michael

Kors Burberry Coach Fossil

Louis

Vuitton Prada

Ralph

Lauren Richemont Salvatore Swatch Tod's Tiffany Average Median

Enterprise Value 7,763 10,368 8,010 3,889 98,278 11,925 10,869 41,336 5,019 20,939 2,701 12,451 19,462 10,619

Market Cap 8,742 11,128 9,135 3,472 90,687 12,048 11,481 47,150 4,913 22,263 2,856 12,071 19,662 11,305

EBITDA (TTM) 1,395 934 1,445 672 10,493 1,246 1,346 4,042 389 2,307 253 1,085 2,134 1,296

EBITDA (est.) 1,399 935 971 524 9,266 1,073 1,183 3,500 369 2,164 223 1,086 1,891 1,080

Net Income (TTM) 882 566 873 379 4,315 591 713 1,533 221 1,514 138 545 1,023 652

Net Income (est.) 861 546 528 287 4,401 499 606 2,502 201 1,393 117 548 1,041 547

Free Cash Flow (TTM) 502 528 766 293 4,177 160 503 1,400 94 884 36 368 809 503

Free Cash Flow (est.) 553 476 532 322 3,486 431 417 1,931 140 1,003 97 490 823 483

EV/EBITDA (TTM) 5.6 11.1 5.5 5.8 9.4 9.6 8.1 10.2 12.9 9.1 10.7 11.5 9.1 9.5

EV/EBITDA (fwd) 5.5 11.1 8.2 7.4 10.6 11.1 9.2 11.8 13.6 9.7 12.1 11.5 10.2 10.8

P/E (TTM) 9.9 19.7 10.5 9.2 21.0 20.4 16.1 30.8 22.2 14.7 20.7 22.1 18.1 20.0

P/E (fwd) 10.2 20.4 17.3 12.1 20.6 24.1 18.9 18.8 24.4 16.0 24.4 22.0 19.1 19.7

EV/FCF (TTM) 15.5 19.6 10.5 13.3 23.5 74.5 21.6 29.5 53.4 23.7 75.0 33.8 32.8 23.6

EV/FCF (fwd) 14.0 21.8 15.1 12.1 28.2 27.7 26.1 21.4 35.9 20.9 27.8 25.4 23.0 23.6


9.85%

3%

20%

1,944.1

2,335.6

978.9

0.0

5,258.6

198.9

26.44$

44.06$

-40%

Equity Value

Shares Outstanding


CV


DCF Value per share

WACC

CV Growth Rate

Per Share Value

Current Share Price

% Upside (downside)

MV of Debt

RONIC

6

594.1

354.5

1,944.1

2,126.8

978.9

0.0

5,049.9

198.9

25.39$

44.06$

-42%


Exit Multiple Method

EV/EBITDA

CV EBITDA

Discounted EBITDA

Per Share Value

Current Share Price

% Upside (downside)

CV


MV of Debt

Equity Value

Shares Outstanding

Disclaimer This report was written by a student currently enrolled in a program at the Sprott School of Business. The purpose of this report is to demonstrate the investment analysis skills of Sprott students. The analyst is not a registered investment advisor, broker or an officially licensed financial profes-sional. The investment opinion contained in this report does not represent an offer or solicitation to buy or sell any securities. This report is written solely for the consideration of this student managed investment fund and should not be used by individuals to make personal investment decisions. Unless otherwise noted, facts and figures included in this report are from publicly available sources. We cannot guarantee that the information in this report is 100 percent accurate, although we believe it to be from reliable sources. Information contained in this report is only believed to be accurate as of the day it was published, and it is subject to change without notice. It cannot be guaranteed that the faculty or students do not have an investment position in the securities mentioned in this report.

Overall, we are concerned about Kors’ future. There is a serious risk that Kors’ brand is a fad

and last quarter’s poor results may be evidence of this. Because of these concerns we

completed two valuation scenarios on Kors. A base case, which covered what we expect to

happen, and a bear case of what we are concerned might happen. At this current time we

weight the probability of the base case occurring at 70%, and the bear case 30%. To compute a

target price we are using the DCF value per share as computed in the first method using the

Valuation, McKinsey CV formula. This resulted in a value per share of $70.36 in scenario 1, and

a value per share of $26.44 in scenario 2. Multiplying each by their probability we compute a

target price of: $57.18, 30% above the share price of $44.06 at the close of July 13, 2015.

We currently believe that the concerns that Michael Kors is entering a decline is overblown.

Kors has faced a rough past 15 months, with the exit of their largest shareholder, margin

pressures, and more recently a very poor reading of comps in North America. Because of the

concerns facing the brand, Kors deserves to trade at a discount to its peers. Although the

discount of almost 50% of the P/E, EV/EBITDA, and EV/FCF averages of its peers is excessive

in our opinion. Kors will continue to face headwinds throughout FY2016, and its situation may

get worse. We are very interested to see the results of Q1 FY2016 and to see how management

responds if comps declines continue.

At this time we feel that the negativity facing Kors’ stock has reached extreme levels, and our

valuation models back up this view. We feel that Kors still has a place in our portfolio and that

we should take advantage of the current weakness to scale into the position.

Conclusion



Appendix A Scenario 1 - Base Case, Financial Statements

Figure A1: Income Statement

Income Statement 2010 2011 2012 2013 2014 2015 2016E 2017E 2018E 2019E 2020E CV

Revenue 508.1 803.3 1,302.3 2,181.7 3,310.8 4,371.5 4,744.0 5,211.0 5,471.8 5,681.9 5,859.8 6,400.0

COGS 241.4 357.3 549.2 875.2 1,294.8 1,723.8 1,945.0 2,084.4 2,188.7 2,272.8 2,343.9 2,560.0

SG&A 191.7 279.8 464.6 621.5 926.9 1,251.4 1,375.8 1,511.2 1,586.8 1,647.8 1,699.4 1,856.0

Impairment of long-lived assets 0.0 3.8 3.3 0.7 1.3 0.8 1.0 1.0 1.0 1.0 1.0 0.0

EBITDA 75.0 162.4 285.2 684.3 1,087.8 1,395.4 1,422.2 1,614.4 1,695.2 1,760.4 1,815.5 1,984.0

Dep'n 18.8 25.5 37.6 54.3 79.7 138.4 189.8 213.7 227.1 238.6 249.0 288.0

EBIT 56.2 136.9 247.7 630.0 1,008.2 1,257.0 1,232.4 1,400.8 1,468.2 1,521.7 1,566.5 1,696.0

Interest Expense 2.1 1.9 1.5 1.5 0.4 0.2 0.0 0.0 0.0 0.0 0.0 0.0

EBT (Before other Items) 54.1 135.0 246.2 628.5 1,007.8 1,256.8 1,232.4 1,400.8 1,468.2 1,521.7 1,566.5 1,696.0

Foreign Currency Gain (Loss) 0.8 (1.8) 2.6 (1.4) (0.1) (4.1) (4.0) 0.0 0.0 0.0 0.0 0.0

Other Income 0.0 0.0 0.0 0.0 0.0 3.1 0.0 0.0 0.0 0.0 0.0 0.0

EBT (After other items) 54.9 133.2 248.8 627.1 1,007.6 1,255.8 1,228.4 1,400.8 1,468.2 1,521.7 1,566.5 1,696.0

Income Tax Expense 15.7 60.7 101.5 229.5 346.2 374.8 356.2 490.3 513.9 532.6 548.3 593.6

Preferred Div's 8.5 15.6 21.2 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Net Income 30.7 56.9 126.1 397.6 661.5 881.0 872.2 910.5 954.3 989.1 1,018.2 1,102.4

Profit Margin 6% 7% 10% 18% 20% 20% 18% 17% 17% 17% 17% 17%

Common Shares Outstanding 140.6 140.6 158.3 196.6 202.6 202.7 190.6 184.3 174.6 161.8 150.1 150.0

Diluted Shares Outstanding 179.2 179.2 189.3 201.5 205.6 205.9 193.6 187.3 177.6 164.8 153.1 150.0

Basic EPS 0.22 0.40 0.80 2.02 3.27 4.35 4.58 4.94 5.47 6.11 6.78 7.35

Diluted EPS 0.17 0.32 0.67 1.97 3.22 4.28 4.51 4.86 5.37 6.00 6.65 7.35

Effective Tax Rate 29% 46% 41% 37% 34% 30% 29% 35% 35% 35% 35% 35%


Figure A2: Cash Flow Statement

Cash Flow Statement 2010 2011 2012 2013 2014 2015 2016E 2017E 2018E 2019E 2020E

Cash Flows From Operating Activities

Net Income 39.2 72.5 147.4 397.6 661.5 881.0 872.2 910.5 954.3 989.1 1,018.2

Adjustments:

Change in Non-Cash WC 40.2 9.0 63.5 (25.8) 66.5 184.1 14.8 54.3 37.1 31.6 28.0

Depreciation 18.8 25.5 37.6 54.3 79.7 138.4 189.8 213.7 227.1 238.6 249.0

Amortization of deferred expenses 1.6 3.2 4.7 3.9 7.1 5.8 5.0 5.0 5.0 5.0 5.0

Impairment and disposal losses 0.0 3.8 3.3 1.0 5.1 2.8 3.2 3.2 3.2 3.2 3.2

Deferred income taxes & tax benefits 11.0 12.4 (40.0) (141.3) (84.6) (39.0) (71.2) (78.2) (82.1) (85.2) (87.9)

Other (2.0) 1.8 25.8 22.6 30.9 53.0 47.4 52.1 54.7 56.8 58.6

Cash From Operations 28.5 110.3 115.3 363.8 633.1 857.9 1,031.6 1,051.9 1,125.1 1,175.9 1,218.1

Cash Flows from Investing Activites

Capital Expenditures (30.8) (57.3) (88.2) (121.3) (184.7) (356.2) (400.0) (312.7) (328.3) (340.9) (351.6)

Purchase of intangible assets (1.4) (0.5) 0.0 (8.5) (28.8) (29.2) (9.6) (7.0) (3.9) (3.2) (2.7)

Investment in joint venture (2.9) 0.0 0.0 0.0 0.0 0.0

Equity method investments 0.0 (3.2) (2.0) 0.0 0.0 0.0 0.0 0.0 0.0

Loans receivable - joint venture 0.0 0.0 0.0 (6.0) 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Cash From Investing (32.2) (57.8) (88.2) (139.1) (215.5) (388.4) (409.6) (319.7) (332.2) (344.1) (354.3)

Cash From Financing Activities

Net Debt Additions (Reductions) 4.5 (31.2) 9.9 (22.7) 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Share Repurchases 0.0 0.0 0.0 0.0 (2.4) (495.3) (750.0) (500.0) (750.0) (1,000.0) (1,000.0)

Proceeds and benefits from employee options 0.0 0.0 42.0 174.9 73.7 60.6 96.1 105.5 110.8 115.1 118.7

Other 1.0 (6.5) 6.8 (1.7) (0.2) 0.0 0.0 0.0 0.0 0.0 0.0

Cash From Financing 5.6 (37.7) 58.6 150.6 71.1 (434.7) (653.9) (394.5) (639.2) (884.9) (881.3)

Foreign Exchange Rate Gain (Loss) 1.2 0.6 (0.5) (1.6) (4.7) (27.1) (28.5) (5.2) (5.5) (5.7) (5.9)

Net Change in Cash 3.1 15.4 85.3 373.7 483.9 7.7 (60.5) 332.5 148.2 (58.7) (23.4)

Cash Balance, Beginning 3.2 6.3 30.8 113.6 487.3 971.3 979.0 918.5 1,251.1 1,399.2 1,340.5

Cash Balance, End 6.3 30.8 113.6 487.3 971.3 979.0 918.5 1,251.1 1,399.2 1,340.5 1,317.1


Figure A3: Balance Sheet

Balance Sheet 2010 2011 2012 2013 2014 2015 2016E 2017E 2018E 2019E 2020E

Assets

Current Assets

Cash and Cash Equivalents 5.7 21.1 106.4 472.5 955.1 978.9 918.5 1,251.1 1,399.2 1,340.5 1,317.1

Receivables, net 65.2 80.1 127.2 206.5 314.1 363.4 393.8 427.3 443.2 454.6 462.9

Inventories 64.9 117.2 187.4 266.9 426.9 519.9 603.0 646.2 678.5 704.6 726.6

Deferred tax assets 7.5 7.3 11.1 8.5 30.5 27.7 38.0 41.7 43.8 45.5 46.9

Prepaid expenses and other current assets 10.8 19.8 31.9 34.9 50.5 127.4 94.9 104.2 109.4 113.6 117.2

Total Current Assets 154.0 245.5 464.0 989.2 1,777.1 2,017.4 2,048.1 2,470.4 2,674.2 2,658.7 2,670.8

Property and Equip., net 84.0 119.3 170.8 242.1 350.7 562.9 773.2 872.2 973.4 1,075.7 1,178.2

Intangible assets, net 18.7 15.8 14.1 21.0 48.0 61.5 71.2 78.2 82.1 85.2 87.9

Goodwill 14.0 14.0 14.0 14.0 14.0 14.0 14.0 14.0 14.0 14.0 14.0


Other assets 2.4 3.0 7.5 18.9 23.4 33.5 38.0 41.7 43.8 45.5 46.9

Total Assets 281.9 399.6 674.4 1,289.6 2,216.9 2,691.9 2,948.4 3,480.5 3,791.4 3,883.1 4,001.8

Liabilities & Shareholders Equity

Current Liabilities

Accounts Payable 30.2 52.9 67.3 83.0 132.0 142.8 175.1 187.6 197.0 204.5 211.0

Accrued payroll, and related expenses 13.8 26.1 33.7 38.6 54.7 62.9 71.2 75.6 76.6 76.7 76.2

Other accrued expenses 58.8 48.8 64.0 42.7 121.7 124.4 130.3 137.9 139.3 139.0 137.4

Total Current Liabilities 102.8 127.8 165.0 164.3 308.3 330.1 376.5 401.0 412.9 420.2 424.6

Long-term Debt 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Deferred Rent 18.8 29.4 43.3 57.0 76.8 88.3 110.0 117.2 121.7 124.4 126.0

Deferred tax liabilities 0.0 5.5 6.3 13.2 5.9 10.5 10.0 10.0 10.0 10.0 10.0

Other long-term liabilities 111.3 111.6 3.6 7.9 19.8 22.0 20.0 20.0 20.0 20.0 20.0

Total Liabilities 232.9 274.3 218.2 242.4 410.8 450.9 516.4 548.2 564.6 574.6 580.6

Retained Earnings 8.8 81.3 228.7 626.3 1,287.7 2,168.8 3,041.0 3,951.4 4,905.8 5,894.9 6,913.1

Additional paid-in capital 40.0 40.0 228.3 424.5 527.2 636.7 780.2 937.9 1,103.4 1,275.3 1,452.5

Accumulated other comprehensive loss 0.2 4.0 (0.7) (3.5) (6.4) (66.8) (141.5) (209.3) (284.6) (363.9) (446.7)

Treasury shares, at cost 0.0 0.0 0.0 0.0 (2.4) (497.7) (1,247.7) (1,747.7) (2,497.7) (3,497.7) (4,497.7)

Total Equity 49.0 125.3 456.3 1,047.2 1,806.1 2,241.0 2,432.0 2,932.3 3,226.8 3,308.5 3,421.2

Total Liabilities & Equity 281.9 399.6 674.5 1,289.6 2,216.9 2,691.9 2,948.4 3,480.5 3,791.4 3,883.1 4,001.8


Figure A4: ROIC Calculations

ROIC Calculations 2010 2011 2012 2013 2014 2015 2016E 2017E 2018E 2019E 2020E CV

Revenue 508.1 803.3 1,302.3 2,181.7 3,310.8 4,371.5 4,744.0 5,211.0 5,471.8 5,681.9 5,859.8 6,400.0

COGS (241.4) (357.3) (549.2) (875.2) (1,294.8) (1,723.8) (1,945.0) (2,084.4) (2,188.7) (2,272.8) (2,343.9) (2,560.0)

SG&A (191.7) (279.8) (464.6) (621.5) (926.9) (1,251.4) (1,375.8) (1,511.2) (1,586.8) (1,647.8) (1,699.4) (1,856.0)

Dep'n (18.8) (25.5) (37.6) (54.3) (79.7) (138.4) (189.8) (213.7) (227.1) (238.6) (249.0) (288.0)

Adjusted EBITA 56.2 140.7 251.0 630.7 1,009.5 1,257.8 1,233.4 1,401.8 1,469.2 1,522.7 1,567.5 1,696.0

Tax Rate 29% 46% 41% 37% 34% 30% 29% 35% 35% 35% 35% 35%

Operating Cash Taxes 16.1 64.1 102.3 230.8 346.8 375.4 357.7 490.6 514.2 533.0 548.6 593.6

NOPLAT 40.1 76.6 148.6 399.9 662.7 882.4 875.7 911.1 955.0 989.8 1,018.9 1,102.4

Invested Capital

Operating Working Capital 38.1 89.3 181.5 343.9 483.1 680.7 715.1 776.7 818.3 852.5 882.2

Gross PP&E 135.6 188.2 275.0 366.2 531.2 821.7 1,221.7 1,534.4 1,862.7 2,203.6 2,555.2

Invested Capital (excluding goodwill) 173.7 277.4 456.5 710.1 1,014.3 1,502.4 1,936.8 2,311.0 2,680.9 3,056.1 3,437.3

Goodwill and acquired intangibles 32.7 29.8 28.1 35.0 62.0 75.5 85.2 92.2 96.1 99.2 101.9

Cumulative amortization and unreported goodwill 0.0 11.0 12.7 14.5 16.7 22.5 24.9 27.4 28.7 29.8 30.8

Invested capital (including goodwill) 206.4 318.3 497.3 759.5 1,093.1 1,600.5 2,046.9 2,430.5 2,805.7 3,185.2 3,570.0

Return on invested capital

ROIC exlcuding goodwill (average) 23.1% 34.0% 40.5% 68.6% 76.9% 70.1% 50.9% 42.9% 38.3% 34.5% 31.4%

ROIC including goodwill (average) 19.4% 29.2% 36.5% 63.6% 71.5% 65.5% 48.0% 40.7% 36.5% 33.0% 30.2%


Figure A5: Free Cash Flow

Free Cash Flow 2010 2011 2012 2013 2014 2015 2016E 2017E 2018E 2019E 2020E

NOPLAT 40.1 76.6 148.6 399.9 662.7 882.4 875.7 911.1 955.0 989.8 1018.9

Dep'n 18.8 25.5 37.6 54.3 79.7 138.4 189.8 213.7 227.1 238.6 249.0

Gross Cash Flow 58.9 102.1 186.2 454.2 742.4 1020.8 1065.5 1124.8 1182.0 1228.4 1267.9

Change in Operating Working Capital (positive) (40.2) (51.2) (92.2) (162.4) (139.2) (197.5) (34.4) (61.5) (41.6) (34.3) (29.6)

Capital Expenditure (30.8) (57.3) (88.2) (121.3) (184.7) (356.2) (400.0) (312.7) (328.3) (340.9) (351.6)

Investments in goodwill and acquired intangibles (2.9) (1.7) 6.9 27.1 13.5 9.6 7.0 3.9 3.2 2.7

Gross Investment (71.0) (111.4) (182.1) (276.8) (296.9) (540.2) (424.8) (367.2) (366.0) (372.0) (378.5)

Free Cash Flow -12.1 -9.3 4.1 177.4 445.5 480.6 640.7 757.6 816.0 856.4 889.4

Discounted FCF 556.5 599.1 587.5 561.3 530.6


Appendix B Scenario 2 - Bear Case, Financial Statements

Figure B1: Income Statement

Income Statement 2010 2011 2012 2013 2014 2015 2016E 2017E 2018E 2019E 2020E CV

Revenue 508.1 803.3 1,302.3 2,181.7 3,310.8 4,371.5 4,744.0 4,295.9 3,464.3 3,455.6 3,513.0 2,425.0

COGS 241.4 357.3 549.2 875.2 1,294.8 1,723.8 1,945.0 1,782.8 1,455.0 1,468.6 1,510.6 1,067.0

SG&A 191.7 279.8 464.6 621.5 926.9 1,251.4 1,375.8 1,267.3 1,039.3 1,053.9 1,089.0 763.9

Impairment of long-lived assets 0.0 3.8 3.3 0.7 1.3 0.8 1.0 1.0 1.0 1.0 1.0 0.0

EBITDA 75.0 162.4 285.2 684.3 1,087.8 1,395.4 1,422.2 1,244.8 969.0 932.0 912.4 594.1

Dep'n 18.8 25.5 37.6 54.3 79.7 138.4 189.8 176.1 143.8 145.1 149.3 109.1

EBIT 56.2 136.9 247.7 630.0 1,008.2 1,257.0 1,232.4 1,068.7 825.2 786.9 763.1 485.0

Interest Expense 2.1 1.9 1.5 1.5 0.4 0.2 0.0 0.0 0.0 0.0 0.0 0.0

EBT (Before other Items) 54.1 135.0 246.2 628.5 1,007.8 1,256.8 1,232.4 1,068.7 825.2 786.9 763.1 485.0

Foreign Currency Gain (Loss) 0.8 (1.8) 2.6 (1.4) (0.1) (4.1) (4.0) 0.0 0.0 0.0 0.0 0.0

Other Income 0.0 0.0 0.0 0.0 0.0 3.1 0.0 0.0 0.0 0.0 0.0 0.0

EBT (After other items) 54.9 133.2 248.8 627.1 1,007.6 1,255.8 1,228.4 1,068.7 825.2 786.9 763.1 485.0

Income Tax Expense 15.7 60.7 101.5 229.5 346.2 374.8 356.2 374.0 288.8 275.4 267.1 169.8

Preferred Div's 8.5 15.6 21.2 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Net Income 30.7 56.9 126.1 397.6 661.5 881.0 872.2 694.6 536.4 511.5 496.0 315.3

Profit Margin 6% 7% 10% 18% 20% 20% 18% 16% 15% 15% 14% 13%

Common Shares Outstanding 140.6 140.6 158.3 196.6 202.6 202.7 190.6 183.8 173.1 159.3 146.5 150.0

Diluted Shares Outstanding 179.2 179.2 189.3 201.5 205.6 205.9 193.6 186.8 176.1 162.3 149.5 150.0

Basic EPS 0.22 0.40 0.80 2.02 3.27 4.35 4.58 3.78 3.10 3.21 3.39 2.10

Diluted EPS 0.17 0.32 0.67 1.97 3.22 4.28 4.51 3.72 3.05 3.15 3.32 2.10

Effective Tax Rate 29% 46% 41% 37% 34% 30% 29% 35% 35% 35% 35% 35%


Figure B2: Cash Flow Statement

Cash Flow Statement 2010 2011 2012 2013 2014 2015 2016E 2017E 2018E 2019E 2020E

Cash Flows From Operating Activities

Net Income 39.2 72.5 147.4 397.6 661.5 881.0 872.2 694.6 536.4 511.5 496.0

Adjustments:

Change in Non-Cash WC 40.2 9.0 63.5 (25.8) 66.5 184.1 14.8 (67.9) (125.6) 1.5 12.9

Depreciation 18.8 25.5 37.6 54.3 79.7 138.4 189.8 176.1 143.8 145.1 149.3

Amortization of deferred expenses 1.6 3.2 4.7 3.9 7.1 5.8 5.0 5.0 5.0 5.0 5.0

Impairment and disposal losses 0.0 3.8 3.3 1.0 5.1 2.8 3.2 3.2 3.2 3.2 3.2

Deferred income taxes & tax benefits 11.0 12.4 (40.0) (141.3) (84.6) (39.0) (71.2) (64.4) (52.0) (51.8) (52.7)

Other (2.0) 1.8 25.8 22.6 30.9 53.0 47.4 43.0 34.6 34.6 35.1

Cash From Operations 28.5 110.3 115.3 363.8 633.1 857.9 1,031.6 925.3 796.6 646.0 622.9

Cash Flows from Investing Activites

Capital Expenditures (30.8) (57.3) (88.2) (121.3) (184.7) (356.2) (400.0) (257.8) (207.9) (207.3) (210.8)

Purchase of intangible assets (1.4) (0.5) 0.0 (8.5) (28.8) (29.2) (9.6) 6.7 12.5 0.1 (0.9)

Investment in joint venture (2.9) 0.0 0.0 0.0 0.0 0.0

Equity method investments 0.0 (3.2) (2.0) 0.0 0.0 0.0 0.0 0.0 0.0

Loans receivable - joint venture 0.0 0.0 0.0 (6.0) 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Cash From Investing (32.2) (57.8) (88.2) (139.1) (215.5) (388.4) (409.6) (251.0) (195.4) (207.2) (211.6)

Cash From Financing Activities

Net Debt Additions (Reductions) 4.5 (31.2) 9.9 (22.7) 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Share Repurchases 0.0 0.0 0.0 0.0 (2.4) (495.3) (750.0) (500.0) (750.0) (500.0) (200.0)

Proceeds and benefits from employee options 0.0 0.0 42.0 174.9 73.7 60.6 96.1 87.0 70.2 70.0 71.1

Other 1.0 (6.5) 6.8 (1.7) (0.2) 0.0 0.0 0.0 0.0 0.0 0.0

Cash From Financing 5.6 (37.7) 58.6 150.6 71.1 (434.7) (653.9) (413.0) (679.8) (430.0) (128.9)

Foreign Exchange Rate Gain (Loss) 1.2 0.6 (0.5) (1.6) (4.7) (27.1) (28.5) (4.3) (3.5) (3.5) (3.5)

Net Change in Cash 3.1 15.4 85.3 373.7 483.9 7.7 (60.5) 257.0 (82.1) 5.3 278.9

Cash Balance, Beginning 3.2 6.3 30.8 113.6 487.3 971.3 979.0 918.5 1,175.5 1,093.4 1,098.7

Cash Balance, End 6.3 30.8 113.6 487.3 971.3 979.0 918.5 1,175.5 1,093.4 1,098.7 1,377.7


Figure B3: Balance Sheet

Balance Sheet 2010 2011 2012 2013 2014 2015 2016E 2017E 2018E 2019E 2020E

Assets

Current Assets

Cash and Cash Equivalents 5.7 21.1 106.4 472.5 955.1 978.9 918.5 1,175.5 1,093.4 1,098.7 1,377.7

Receivables, net 65.2 80.1 127.2 206.5 314.1 363.4 393.8 352.3 280.6 276.4 277.5

Inventories 64.9 117.2 187.4 266.9 426.9 519.9 603.0 552.7 451.1 455.3 468.3


Prepaid expenses and other current assets 10.8 19.8 31.9 34.9 50.5 127.4 94.9 85.9 69.3 69.1 70.3

Total Current Assets 154.0 245.5 464.0 989.2 1,777.1 2,017.4 2,048.1 2,200.7 1,922.1 1,927.2 2,221.8

Property and Equip., net 84.0 119.3 170.8 242.1 350.7 562.9 773.2 854.8 918.9 981.1 1,042.6

Intangible assets, net 18.7 15.8 14.1 21.0 48.0 61.5 71.2 64.4 52.0 51.8 52.7

Goodwill 14.0 14.0 14.0 14.0 14.0 14.0 14.0 14.0 14.0 14.0 14.0


Other assets 2.4 3.0 7.5 18.9 23.4 33.5 38.0 34.4 27.7 27.6 28.1

Total Assets 281.9 399.6 674.4 1,289.6 2,216.9 2,691.9 2,948.4 3,172.3 2,938.7 3,005.8 3,363.2

Liabilities & Shareholders Equity

Current Liabilities

Accounts Payable 30.2 52.9 67.3 83.0 132.0 142.8 175.1 160.5 131.0 132.2 136.0

Accrued payroll, and related expenses 13.8 26.1 33.7 38.6 54.7 62.9 71.2 62.3 48.5 46.7 45.7

Other accrued expenses 58.8 48.8 64.0 42.7 121.7 124.4 130.3 113.7 88.2 84.5 82.4

Total Current Liabilities 102.8 127.8 165.0 164.3 308.3 330.1 376.5 336.4 267.6 263.3 264.0

Long-term Debt 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Deferred Rent 18.8 29.4 43.3 57.0 76.8 88.3 110.0 117.2 121.7 124.4 126.0

Deferred tax liabilities 0.0 5.5 6.3 13.2 5.9 10.5 10.0 10.0 10.0 10.0 10.0

Other long-term liabilities 111.3 111.6 3.6 7.9 19.8 22.0 20.0 20.0 20.0 20.0 20.0

Total Liabilities 232.9 274.3 218.2 242.4 410.8 450.9 516.4 483.6 419.3 417.7 420.0

Retained Earnings 8.8 81.3 228.7 626.3 1,287.7 2,168.8 3,041.0 3,735.6 4,272.0 4,783.5 5,279.5

Additional paid-in capital 40.0 40.0 228.3 424.5 527.2 636.7 780.2 910.2 1,015.0 1,119.5 1,225.8

Accumulated other comprehensive loss 0.2 4.0 (0.7) (3.5) (6.4) (66.8) (141.5) (209.3) (269.9) (317.2) (364.3)

Treasury shares, at cost 0.0 0.0 0.0 0.0 (2.4) (497.7) (1,247.7) (1,747.7) (2,497.7) (2,997.7) (3,197.7)

Total Equity 49.0 125.3 456.3 1,047.2 1,806.1 2,241.0 2,432.0 2,688.8 2,519.3 2,588.0 2,943.2

Total Liabilities & Equity 281.9 399.6 674.5 1,289.6 2,216.9 2,691.9 2,948.4 3,172.3 2,938.7 3,005.8 3,363.2


Figure B4: ROIC Calculations

ROIC Calculations 2010 2011 2012 2013 2014 2015 2016E 2017E 2018E 2019E 2020E CV

Revenue 508.1 803.3 1,302.3 2,181.7 3,310.8 4,371.5 4,744.0 4,295.9 3,464.3 3,455.6 3,513.0 2,425.0

COGS (241.4) (357.3) (549.2) (875.2) (1,294.8) (1,723.8) (1,945.0) (1,782.8) (1,455.0) (1,468.6) (1,510.6) (1,067.0)

SG&A (191.7) (279.8) (464.6) (621.5) (926.9) (1,251.4) (1,375.8) (1,267.3) (1,039.3) (1,053.9) (1,089.0) (763.9)

Dep'n (18.8) (25.5) (37.6) (54.3) (79.7) (138.4) (189.8) (176.1) (143.8) (145.1) (149.3) (109.1)

Adjusted EBITA 56.2 140.7 251.0 630.7 1,009.5 1,257.8 1,233.4 1,069.7 826.2 787.9 764.1 485.0

Tax Rate 29% 46% 41% 37% 34% 30% 29% 35% 35% 35% 35% 35%

Operating Cash Taxes 16.1 64.1 102.3 230.8 346.8 375.4 357.7 374.4 289.2 275.8 267.4 169.8

NOPLAT 40.1 76.6 148.6 399.9 662.7 882.4 875.7 695.3 537.1 512.1 496.7 315.3

Invested Capital

Operating Working Capital 38.1 89.3 181.5 343.9 483.1 680.7 715.1 654.5 533.3 537.5 552.1

Gross PP&E 135.6 188.2 275.0 366.2 531.2 821.7 1,221.7 1,479.4 1,687.3 1,894.6 2,105.4

Invested Capital (excluding goodwill) 173.7 277.4 456.5 710.1 1,014.3 1,502.4 1,936.8 2,133.9 2,220.6 2,432.1 2,657.5

Goodwill and acquired intangibles 32.7 29.8 28.1 35.0 62.0 75.5 85.2 78.4 66.0 65.8 66.7

Cumulative amortization and unreported goodwill 0.0 11.0 12.7 14.5 16.7 22.5 24.9 22.6 18.2 18.1 18.4

Invested capital (including goodwill) 206.4 318.3 497.3 759.5 1,093.1 1,600.5 2,046.9 2,234.9 2,304.8 2,516.1 2,742.6

Return on invested capital

ROIC exlcuding goodwill (average) 23.1% 34.0% 40.5% 68.6% 76.9% 70.1% 50.9% 34.2% 24.7% 22.0% 19.5%

ROIC including goodwill (average) 19.4% 29.2% 36.5% 63.6% 71.5% 65.5% 48.0% 32.5% 23.7% 21.2% 18.9%


Figure B5: Free Cash Flow

Free Cash Flow 2010 2011 2012 2013 2014 2015 2016E 2017E 2018E 2019E 2020E

NOPLAT 40.1 76.6 148.6 399.9 662.7 882.4 875.7 695.3 537.1 512.1 496.7

Dep'n 18.8 25.5 37.6 54.3 79.7 138.4 189.8 176.1 143.8 145.1 149.3

Gross Cash Flow 58.9 102.1 186.2 454.2 742.4 1020.8 1065.5 871.4 680.8 657.2 646.0

Change in Operating Working Capital (positive) (40.2) (51.2) (92.2) (162.4) (139.2) (197.5) (34.4) 60.7 121.1 (4.2) (14.6)

Capital Expenditure (30.8) (57.3) (88.2) (121.3) (184.7) (356.2) (400.0) (300.7) (242.5) (241.9) (245.9)

Investments in goodwill and acquired intangibles (2.9) (1.7) 6.9 27.1 13.5 9.6 (6.7) (12.5) (0.1) 0.9

Gross Investment (71.0) (111.4) (182.1) (276.8) (296.9) (540.2) (424.8) (246.8) (133.8) (246.2) (259.6)

Free Cash Flow -12.1 -9.3 4.1 177.4 445.5 480.6 640.7 624.7 547.0 411.0 386.3

Discounted FCF 556.5 494.0 393.8 269.4 230.5


Appendix C Valuation Charts and Sensitivity

Figures C1-C3: Scenario 1: Base Case DCF Sensitivities

70.36$ 2% 3% 4% 5% 6% 7%

7% 89.31 101.72 122.42 163.80 287.96 #DIV/0!

8% 74.49 81.75 92.64 110.78 147.08 255.97

9% 63.92 68.44 74.77 84.26 100.07 131.70

10% 56.02 58.95 62.86 68.32 76.53 90.20

11% 49.89 51.84 54.35 57.69 62.38 69.40

12% 45.00 46.32 47.97 50.09 52.92 56.88

WA

CC

CV Growth Rate

66.78$ 4 5 6 7 8 9 10

7% 48.04 54.92 61.80 68.67 75.55 82.42 89.30

8% 46.17 52.70 59.24 65.77 72.30 78.83 85.37

9% 44.40 50.61 56.82 63.03 69.24 75.45 81.66

10% 42.73 48.63 54.54 60.44 66.35 72.25 78.16

11% 41.14 46.76 52.38 58.00 63.62 69.24 74.85

12% 39.64 44.99 50.34 55.69 61.04 66.38 71.73

WA

CC

Exit Multiple

70.36$ 2% 3% 4% 5% 6% 7%

10.0% 52.90 52.99 53.12 53.30 53.57 54.04

12.5% 54.58 55.89 57.64 60.12 63.89 70.31

15.0% 55.71 57.82 60.66 64.67 70.77 81.16

17.5% 56.51 59.20 62.82 67.92 75.69 88.91

20.0% 57.11 60.24 64.43 70.36 79.37 94.72

22.5% 57.58 61.04 65.69 72.26 82.24 99.24

25.0% 57.95 61.69 66.70 73.77 84.53 102.86

RO

NIC

CV Growth Rate


Figures C4-C6: Scenario 2: Bear Case DCF Sensitivities

26.44$ 2% 3% 4% 5% 6% 7%

7% 35.18 38.73 44.65 56.48 91.99 #DIV/0!

8% 30.79 32.86 35.98 41.17 51.55 82.69

9% 27.62 28.91 30.72 33.43 37.95 47.00

10% 25.21 26.05 27.17 28.73 31.08 34.98

11% 23.32 23.88 24.59 25.55 26.89 28.90

12% 21.79 22.16 22.64 23.24 24.05 25.18

WA

CC

CV Growth Rate

25.39$ 4 5 6 7 8 9 10

7% 23.75 25.81 27.87 29.93 31.99 34.05 36.11

8% 23.04 25.00 26.95 28.91 30.87 32.82 34.78

9% 22.37 24.23 26.09 27.95 29.81 31.67 33.52

10% 21.73 23.50 25.26 27.03 28.80 30.57 32.34

11% 21.12 22.80 24.49 26.17 27.85 29.53 31.22

12% 20.54 22.14 23.75 25.35 26.95 28.55 30.15

WA

CC

Exit Multiple

26.44$ 2% 3% 4% 5% 6% 7%

10.0% 24.34 24.37 24.40 24.45 24.53 24.67

12.5% 24.82 25.20 25.70 26.41 27.48 29.32

15.0% 25.14 25.75 26.56 27.71 29.45 32.42

17.5% 25.37 26.14 27.18 28.64 30.86 34.64

20.0% 25.54 26.44 27.64 29.33 31.91 36.30

22.5% 25.68 26.67 28.00 29.88 32.73 37.59

25.0% 25.79 26.85 28.29 30.31 33.39 38.63

RO

NIC

CV Growth Rate

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