Editor’s note: This is the first of a two-part series examining clothing retailer Steve Madden (SHOO).


This report provides a detailed analysis of the question of whether or not an LBO of Steve Madden (ticker: SHOO) is viable. Thus this report will focus not on Steve Madden’s earning potential but its ability to generate cash flows that will be able to service acquisition-related debt, while still leaving room for further investment to drive the company’s growth - thus leading to of appreciation of the underlying assets

In this analysis we learn that Steve Madden reports its service revenue in two different revenue streams, the wholesale division and the retail division. An analysis of Steve Madden’s financial statements shows that both the retail division and the wholesale division experienced a drop in revenues in their year over year reporting for the second quarter of 2007. Given this financial information and using a discounted cash flow (DCF) valuation model, we determined that the present implied value of Steve Madden is $34.25 a share or $687.2 million. This is the maximum amount that we would recommend buying Steve Madden for, and further recommend acquiring the company if the price stays below $34.25 a share.

Overview:

Steve Madden was originally incorporated as a New York Corporation in 1990 by its founder and current Creative and Design Chief, Steve Madden. The company went through the initial public offering process in December of 1993. The initial public offering was handled by Stratton Oakmont, a now defunct stock brokerage that was shut down in the late 1990s due to charges of stock manipulation. In 1998 Steve Madden Corporation was reincorporated in Delaware. Then in 2001 the company faced a major hardship when Founder and then Chief Executive Officer Steve Madden was investigated for stock manipulation in Steven Madden stock. Mr. Madden ended up being sentenced to over three years in jail for his actions. Part of Mr. Madden’s sentencing included a stipulation that he could not return as a Chief Executive Officer of a publically traded company for a set number of years. Mr. Madden is still employed by Steve Madden under the heading Creative and Design Chief. The company now trades on the Nasdaq Stock Exchange under the ticker symbol SHOO.

Steve Madden’s main business is the designing, sourcing, marketing, and selling fashionable footwear brands for men women and children. Steve Madden distributes their products through four major venues. The four venues are their online e-commerce website, its retail stores, department stores, and specialty stores. The company has core brands along with updated styles that are constantly being changed in order to capitalize on market trends. Being a trend setter in the shoe market has propelled Steve Madden to a top name brand.

Steve Madden has three distinct business segments; its wholesale division, its retail division, and private label division. The whole sale division is made up of seven different brands: Steve Madden, Steven, l.e.i, Candie’s, Stevies, Unionbay, and the Steve Madden Men’s brand. The retail division is a wholly own subsidiary that operates Steve Madden, Steven, and Shoe Biz retail stores. The retail division also operates the Company’s outlet store and the e-commerce website.

10-Year Revenues, Courtesy Morningstar.com

Analysis:
Steve Madden’s accounting method breaks its revenue streams into two portions. The first portion is revenue from its wholesale operations and the second portion is revenue from its retail operations. Steven Madden uses the First in First Out (FIFO) method of valuing inventory stated at the lower of cost or market. Since wholesale and retail are handled in a different manner each section will be analyzed independently when looking at the company’s current performance, market trends, and the current economic state. Once these areas are touched on, the numbers will provide us the information to determine Steve Madden’s implied present value. The numbers in the following analysis are taken from Steve Madden’s 10-Q quarterly reports that were announced August 9th.

The Wholesale Division:
The wholesale division of Steve Madden made up 73% of total sales revenue in the second quarter of 2007. When comparing the overall numbers of the wholesale division of Steve Madden from the 3 and 6 month periods in 2007 to those same periods of 2006 one thing that immediately becomes apparent is the drop in revenues and income from 2006 to 2007. The fall in revenues were attributed to a decrease of net sales in the Men’s Division along with a miscalculation of fashion trends amongst the Candies Division. The revenue numbers also suffered from the lack of a strong trend in the shoe market such as peep toe shoes last year. The subprime lending meltdown and subsequent credit crunch that ensued has caused consumers in the retail markets to cut back spending. Lower year-over-year sales have been a common theme amongst retailers this year and are not exclusive to Steve Madden. Along with a drop in revenue, the wholesale division also saw a drop in gross profit margins to 34% from 38% from the previous time period. The company attributed this drop to an increase in markdowns required to move inventories of the Candies Division. The company also increased advertising expenditures for women’s fashion in order to try to combat the lower sales of shoes during the first quarter of this year.

The Retail Division:
The retail division of Steve Madden made up 27% of total sales revenue for the second quarter of 2007. The retail division has been undergoing many changes over the past year in order to improve gross profit margins. The changes consist of job cuts, reducing freight costs, store to store transfers, and inventory shrinkage. These changes improved gross margins to 62% from 54% from the same period in the prior year. While YoY revenues were down for the retail division, income from operations increased from $2.1 to $3 million. Along with increasing income, the retail division opened a new store during the last 2 quarters. The same store sales for existing stores declined 18% from 2006 to 2007. The drop in sales was attributed to the lack of any major trends in the shoe market over the past two quarters.

Coming tomorrow: outlook, valuation, and recommendation.

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Disclosure: Author is long SHOO.