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FOSSIL INC FOSL

January 11, 2012 by skca74
Price:
79.80
Shares Out. (in M): 63,800
Market Cap (in M):
5,000
Net Debt (in M):
225
TEV:
4,750

2012
EPS
$4.50
P/E
17.7x
P/FCF
20.0x
EBIT
470
TEV/EBIT 10.0x

2013
$5.57
14.3x
15.0x
543
8.7x

Description
Investment Thesis: Recent market volatility due to macroeconomic pressures and
misunderstanding about Fossils near term investments/cost pressures have pushed the stock to
bargain valuations. Fossil is a well-managed retailer with signicant and underappreciated growth
potential trading at 8.0x 2012 EV/EBITDA and 14.0x 2012 P/E, while generating a 7.0% 2012 FCF
yield. Fossil is worth $120/share, or over 50% upside from todays price of $78.08 using a blended
EBITDA and P/E valuation. Due to the external issues mentioned above and the companys cost
pressures, which I believe are not fundamental and will be xed, the multiple has compressed
dramatically (recently trading at forward 12x EBITDA and 23x P/E multiples) despite revenue growth
in the 20% plus range (which could prove conservative considering the company has posted 30%
plus growth over the last 5 quarters) over the next several years and earnings growth in the 25-30%
range. By 2013, the company should earn $7.00 per share and will be generating over $400MM in
cash (a 8.6%FCF yield). This is extremely cheap given the strength of this management team to
navigate what I believe to be a multi-year growth story. Fossils growth is multi-fold coming from the
expansion of its retail stores in theUS and worldwide, as well as from the emerging watch cycle,
which is only in its beginning phases. The move away from stainless steel and leather watches to
various other materials has and will positively impact Fossil's GM as the newer modern materials
are often cheaper. Additionally Fossil's international growth, particularly inAsia (especially as
international has higher margins) and its emergence as a worldwide known lifestyle vintage
American brand, is also a signicant contributor to its growth and margin expansion.

Why now?
The market is mispricing Fossils stock due to macroeconomic volatility and misunderstanding
about near term cost pressures and its inventory. Due to the sovereign debt crisis in Europe and the
corresponding austerity measures put into place, along with slowing GDP in the US and the
downgrade of US debt, the stock market is extremely nervous and is panic selling high multiple
growth stocks in favor of the safety of US Treasuries. Fossil stock has dropped double digits on
little to no company specic or fundamental news, providing the wonderful opportunity to pick up a
well-run growth name for cheap.

Despite the weak macroeconomic backdrop, Fossil and its wholesale retailers, continues to see
strong double digit sales growth in all channels. In terms of the cost pressure, Fossil faced
unanticipated increases in labor costs in itsChinafactories. It is working on its sourcing to lessen
that pressure in the future. Moreover, after recently speaking with the CFO, Mike Kovar, it is clear that
Fossil has pricing power and will be able to increase prices to further offset cost pressures without
affecting its sales growth (expected by Q411 or early 2012). Additionally, the market is fearful that
inventory is up on a year over year basis, but that is a result of Fossil trying to smooth its inventory
over the year versus having it back ended loaded where it has a bulk of its sales. This allows its
factories to run at full utilization year around.

Recent Events
On January 10, 2012, Fossil agreed to acquire Reno, NVbased Skagen Designs, Ltd. for $225 million
in cash plus 150,000 shares. Fossil also agreed to pay an additional 100,000 shares if sales exceed
certain threshold requirements. Skagen is a Danish-inspired manufacturer, marketer and distributor
of watches, jewelry, sunglasses and clocks sold in 75 markets. Skagens is complementary to
Fossils current portfolio from a design and pricing perspective (prices range from $90-$325
between Fossil and Michael Kors.) The acquisition should be synergistic as Fossil leverages its
distribution footprint and back ofce capabilities. Long term there is signicant potential for Fossil
to take Skagen from a watch/jewelry brand to a lifestyle brand while also expanding its distribution
further into Europe andAsia.

Brief Description
Fossil is a global aspirational lifestyle brand that designs, manufactures and distributes consumer
fashion accessories globally. Originally a mono-brand company, Fossils now sells an extensive line
of watches for men and women as well as accessories, jewelry, handbags, soft leather goods and
shoes, under its own brand name as well as under licensed brand names. Due to its broad
distribution points, product categories and price range, Fossil caters to a wide spectrum of
consumers. Fossils wholesale distribution includes retailers from Neiman Marcus to Wal-Mart.
Additionally Fossil sells through specialty as well as its own retail stores.

Investment Highlights
Early Stages of Watch Cycle
Fossil is to watches what Coach was to handbags about 10 years ago. The company realizing a void
in fashion and was the rst to market innovative, fashion forward styles using new materials, such
as acrylics, resin, ceramics and rose gold. As evidence of the excitement in the watch and
accessory categories, one of Fossils wholesale customers, Macys, has consistently called out the
strong performance of those categories in its earnings conference calls since mid-2010. Moreover,
other retailers have indicated the strength of watches including Signet (who called out fashion
watches) and Tiffanys (who said Watch sales continued to post 30% plus growth in our own
stores. Additionally, as of June 2011, Swiss watch worldwide exports climbed 45% on a two year
basis which indicates the ongoing strength of watches.

Looking at past cycles, like the Deckers Ugg boot cycle (which continues after over 8 years) or
handbag cycle (which Coach capitalized on for about 10 years), indicates that this watch cycle will
likely last at least 5-8 years (we are in year 2). This provides Fossil with multiple years of double
digit growth. The cycle, because it is about fashion, innovation and newness and not about time
keeping, engages the customer who buys multiple watches on a more regular basis, further driving
sales. The handbag cycle is the clearest example as it shows how consumers moved from 1-2
handbags per year to multiple purchases per year. Management has indicated this phenomenon in
watches as well. Fossil, as one of the worlds largest watch manufacturers and distributors, can
now drive trend themselves, further benetting from the increased interest in watches. The last
watch cycle management saw was twelve years ago when there was movement from leather to
stainless steel watches. Now the move is even broader going from stainless steel and leather to
new materials such as acrylic and plastic. There is also increased awareness about watches as a
fashion accessory and it caters to both men and women so the potential growth is even greater
than the handbag explosion seen a few years ago.
International Growth Opportunity

Asia Pacic
International expansion, especially into Asia, remains Fossils largest growth opportunity. Asiais
currently only 12% of total sales with current OPM in the low 30s, but is expected to grow to a third
of the business with the long term year or year growth of at least 30%. Fossil began its international
Asian business through distributors, who charged premium prices (sometimes up 25-40% vs. US
prices, and who set up the brand to be aspirational. As Fossil takes over from the distributors, it is
able to maintain that premium pricing and thus earn higher margins (80% gross margins). Fossil is
capitalizing on its current momentum in Asia by investing in the region it has recently added
signicant resources to the area including personnel who used to run Nike Asia and Swatch China.
In Korea, Fossil is currently selling the licensed product but has plans to develop the Fossil brand in
the region by opening two stores in Seoul. As the Fossil brand grows, the company plans to develop
the same model of concessions within department stores. In the Korean department stores, there
may be 3 to up to 8 cases with sales of over $1500 per sq. ft. with 35-45% pretax margins. Korean
revenue last year was $25M and this year is expected to be $75M, up 200%. The growth opportunity
in Japan is also tremendous as Fossil only has 15 Fossil stores and less than 30 concessions while
Coach has over 150 locations inJapan.
Within the Asian market, Fossil only has between 200-250 concessions (shop n shops). Within a
few years, it is expected to grow concessions by another 500 locations and, in the next ve or six
years, have thousands of concessions. As Fossil increase its DTC business (vs. wholesale
business) within the Asia segments, segment operating margins should increase to the low 40s
from the current low 30s (GM in the concession business are 80-90%.) More importantly,
consolidated OPM should improve from current high teens range to 23-24%, signicant upside. In
terms of concession growth, the biggest growth opportunity within Asia is inChina.Chinais currently
only $10M in sales with only 30 concessions.Chinas luxury focused market, Fossil sells licensed
brands such as Armani and Burberry, where it can leverage its relationships and marketing that the
brands themselves have already done. Additionally due to the growing middle class who seeks
aspirational product, Fossil sees a huge opportunity for its namesake brand in addition to its

licensed brands such as Adidas and Michael Kors. According to a study completed by Bain &
Company in November 2010, watches (in the mid-price range which is Fossils sweet spot) and
handbags are indicated as the drivers of growth of the domestic luxury market.

Europe
Europe, at 25% of sales, is developing in a similar manner toAsiawith a distributor model that Fossil
expects to eventually take over (maybe 5-10 years). After speaking with the Company, I feel
condent about the growth rates as Q3 quarter-to-date is running up 35%. Europe is just now where
theUSwas at the early stages of the watch cycle, so it is expected to see continued increased sales
as the new materials and innovative designs are introduced through its wholesale channels despite
the broader macro issues. While it has great distribution and sales inGermanyand theUK, there is
enormous growth potential in Scandinavia as well asEastern Europe,RussiaandAfrica. Furthermore,
like inAsia, Fossil plans to grow out its namesake band as well.
Growth in DTC Business

Store Growth Potential Domestically and Internationally

Fossil is in the nascent stage of its worldwide store growth. With just over 360 total worldwide retail
stores, including 95 outlets, Fossil has signicant opportunities to increase its customer reach.
Fossils branded stores allow it to more fully showcase its products, including brand extensions
such as clothing and footwear. This is important in conveying to customers that Fossil is a lifestyle
aspirational brand, not just a watch company. Within theUS, Fossil has less than 200 stores and
only 103 full price accessory stores compared to Coach which has over 350 full price accessory
stores. The potential for full price in theUSis at least 400 units. Internationally, Fossil also has a
huge runway in which to grow its store base potentially in the thousands according to management.
The growth of Fossils footprint internationally is imperative to further developing the brand,
especially in the Asian markets. The retail stores have had strong success in the last few years with
double digit comparable store sales including a 22.2% comp on top of a 15.5% comp in 2010.
Management expects that strong performance to continue. Overall, Fossils stores are extremely
productive with sales per square foot rates of $623, $775, and $693 in itsUSaccessory stores,
European accessory stores, and Asia Pacic accessory stores, respectively.
Fossils outlet stores are used only to discontinue merchandise. It does not buy for the outlets or
make new assortments for it. The key benets of having an outlet strategy is that it allows Fossil to
liquidate inventory at a better price vs. third party liquidators and it further promotes the brand. Its
discounts are about 25-75% off suggested retail price. In Q2, however, Fossil was able to raise AUR
to reduce its promotional rate without negatively impacting sales.
Fossil also operates 27 clothing stores in the US. These stores also include some watches and
accessories and help to promote Fossil as a lifestyle brand. Additionally they operate stores under
the Watch Station name and sell their own brands as well watches by other manufactures.

Ecommerce Business
The last aspect of the DTC business is Fossils ecommerce initiative which is used as both a
revenue and marketing tool. Fossil has ve commercial websites at this point in
theUS,Germany,UK,SingaporeandAustralia. It is currently expanding online

intoKorea,Italy,Japan,FranceandAustria. Fossil is repurposing old media spend into controllable

items such as its websites and catalogs which will further sales and also allow the company to
manage and tell the brands story. From a commercial aspect, Fossil has the necessary technology
(IBM web sphere) to do merchandising globally so it doesnt need signicant resources in each
country and it can have uniform and tight assortments.

Strength of Fossils Brand Portfolio

Fossil Brand
Well known domestically, Fossils namesake brand will generate about $1.2bn in revenue this year
and is viewed as an authority in the watch/accessory community. The Fossil brand includes its
namesake brand Fossil, as well as Michele, Relic and Zodiac. Fossil expects that it can generate 45x this revenue as it grows its international business. In Q211 alone, the Fossil brand was 17% of
sales and saw growth in, not only watches, but also Fossil branded accessories, which grew 22%.
Because Fossil has the ability to reach consumers at many different price points, it is able to push
innovation and trend even further. Fossil has seen great results (even its wholesale retailer Macys
mentioned in its Q2 earnings call that watches were very strong), Key growth drivers of the name, in
addition to building international brand awareness and retail presence, is to grow its domestic retail
presence as well as its extension businesses such as clothing and footwear (which bring in a larger
trafc base). Within accessories, handbags and jewelry continue to outperform. In handbags,
Fossil is using better leather and hardware and has seen AUR increase to $159 to $169 leading it to
increase 44% in Q2. It is positioned in the sweet spot just under the price point of Coachs offerings
and also competes very favorably with private label brands.

Fossil has stores in inGermany,UK,Italy, HK Australia,Singapore,Taiwanand now expanding

intoJapan,Korea, and china. Consumers are reacting strongly to the offering and the brand is
gaining momentum through the new websites, catalogs and recently launched CRM initiative.

Licensed Brands
Fossil has a strong portfolio of licensed brands, including high end names such as Marc by Marc
Jacobs and Armani. These brands have performed above average. In Q2 alone, Michael Kors brand
grew over 90% and contributed over $100m in revenue while focused mostly in the U.S.It is in the
early stages in Europe and showing tremendous potential in Asia. It is expected to earn $300m by
year end. Other key brands (though in earlier stages), such as Marc by Marc Jacobs grew 156% and
are should follow the same trajectory as the Michael Kors brand thus several years of signicant
growth. Fossil is also able to leverage the marketing and brand cache of its licensed portfolio to
further sales in emerging markets. Fossil expects that these newer licensed brands will follow in
Michael Kors growth trajectory. Fossil is very selective about brands its licenses as it does not
want to cannibalize it others brands and only wants names that can be at least $100m in revenue. In
October of 2011, Fossil announced a strategic partnership with Karl Lagerfeld, under which Fossil
will design, develop and distribute a line of mens and womens watches under the Karl Lagerfeld
label. Given the strength of the Karl Lagerfeld brand, it too, expects to follow the growth

demonstrated by Michael Kors. Under its licensed brands, Fossils manufactures and distributes
watches as well as jewelry with prices points on average of $95. Fossils success has led to calls
from many people/brands who want to partner with them and, due to its strong performance, it has
had no issues with renewals.

Valuation
Summary Multiple
(In Thds)
Price
Shares Out
Mkt Cap
Net Debt
EV

$78.08
63,809
$4,982,207
($224,701)
$4,757,506

EBITDA
EPS

EV/EBITDA
P/E

2011
519,164
$4.32

9.2x
18.1x

2012
595,838
$5.57

8.0x
14.0x

2013
712,117
$7.01

6.7x
11.1x

To see the true upside potential of Fossils growth, you need to look at the valuation post the near
term solvable cost pressures/margin issues. By looking at the valuation from a point one year from
today, you can account for the increased penetration of the watch cycle as well as increased growth
inAsiaand N. America DTC. Additionally, it shows the amount of FCF generated in that time, which
can be added back to the valuation. So as of December 2012, using a one year forward multiple of
10x EBITDA (which is less than where FOSL was trading at just six months ago) and adding in the
cash generated over the next four quarters gets to a value of $120.

Target Multiple

'13 EBITDA
EV

Add Net Cash

Add Cash FY2012
Market Cap
Shares Out
Price Target
Upside

9.5x
10.0x

712,117
712,117
6,765,116
7,121,174
$224,701
$224,701
$333,745$333,745
7,323,561
7,679,620
63,809
63809
$114.77
$120.35
47%
54%

10.5x

712,117
7,477,233
$224,701
$333,745
8,035,679
63809
$125.93
61%

Appendix

InThousands

FYE
Revenue
RevenueGrowthRate
RevenueEstFirstCall
RevGrowthRateFirstCall

2007A

2008A

2009A

2010A

2011E

2012E

2013E

$1,432,984

$1,583,242

$1,548,093

$2,030,690

$2,588,717

$3,031,015

$3,563,203

10.5%

2.2%

31.2%

27.5%

17.1%

17.6%

$1,970,880

$2,577,800

$2,988,000

$3,421,400

27.3%

30.8%

15.9%

14.5%

GM%

51.8%

53.8%

54.6%

56.9%

56.4%

56.5%

57.0%

OM%

13.0%

13.0%

13.7%

18.5%

18.1%

17.9%

18.4%

NM%

8.6%

8.7%

9.0%

12.6%

10.5%

11.3%

EPSActual/Projected
EPSGrowthRate
EPSFirstCall

$1.75

11.9%

$2.02

$2.07

$3.77

$4.50

$5.57

$7.01

2.5%

81.9%

19.4%

29.0%

25.9%

$3.65

$4.51

$5.49

$6.50

70,333

15.3%

FullyDilutedShares

68,323

67,153

67,687

63,000

61,750

60,500

$219,281

$243,412

$252,961

$416,974

$519,164

$595,838

$712,117

Capex

(40,246)

(63,934)

(37,687)

(46,538)

(125,000)

(75,000)

(75,000)

CashInterest

755

569

443

1,026

1,821

2,000

2,000

CashTaxes

40,219

77,240

62,957

107,787

157,144

185,093

228,287

$138,061

$101,669

$151,874

$261,623

$235,200

$333,745

$406,830

EBITDA

FCFE
FCFYield

2.77%

2.04%

3.05%

5.25%

4.72%

6.70%

8.17%

EV/Sales

3.3x

3.0x

3.1x

2.3x

1.8x

1.6x

1.3x

EV/EBITDA

21.7x

19.5x

18.8x

11.4x

9.2x

8.0x

6.7x

EBIT/EV

3.9%

4.3%

4.4%

7.9%

9.9%

11.4%

13.7%

P/E

44.6x

38.6x

37.7x

20.7x

18.1x

14.0x

11.1x

Catalyst
Continuation of the watch cycle and continued sales momentum
Increased DTC growth in 2012 and beyond
International expansion
Signs of turn in macroeconomic situation

Messages
Subject
RE: Cheap?
Entry
01/11/2012 07:40 PM
Member
skca74
I know it's not a typical VIC idea but I do think it is cheaprelative to what i think the growth will be over the next few years.If
i think 20-30% sales growth is sustainable for the next few yearsand margins will grow based on mix (geographic, DTC), 12
months from now you are looking forward and it's trading at 11x earnings and an 8% fcf yield while growing 20-30% - that's
cheap. The stock is down 60% from the $140 highs and mgmt has recently bought shares. ROICs are very high and this is
a high quality international brand with very highbarriers to entry - this is not your typical retailer. Thx for the question.
Subject
RE: RE: Author Exit Recommendation
Entry
03/06/2012 01:13 PM
Member
skca74
Thx. I hope this comes in again.
Subject
any updated thoughts
Entry
02/04/2013 02:22 PM
Member
tyler939
I am looking at this as a a short, but would appreciate any thoughts, particularly concerning margin compression.