Decker’s Quarter: What’s Up with Sanuk?

I think the last analysis I wrote on Deckers may have had the same title. Which is okay because though Deckers also owns UGG, Teva and other brands, we’re mostly interested in Sanuk which spring from the surf industry and was acquired by Deckers. I’ll give you a brief overview of Decker’s March 31 results, and then tell you what we know about Sanuk. 

Decker’s sales rose 7.1% to $264 million from $246 million in the same quarter last year. The gross profit margin was up slightly from 46% to 46.8%. But selling, general and administrative expenses went up 19% from $101 million to $121 million. As a result, operating income fell 78% from $11.9 million to $2.6 million and net income was down 87.5% from $8 million to $1 million. Below is a chart from the 10Q that breaks down Decker’s sales and income from operations by brand and channel including Sanuk. Ecommerce and retail includes the sale of the brands sold through those channels.
 
 
The first thing you might notice is that Sanuk’s wholesale revenue was down 7% to $30 million. On a different chart I’m not going to reproduce here we find that Sanuk sold, in addition, $918,000 in the ecommerce channel, up from $107,000 in last year’s quarter. Retail sales of Sanuk were $17,000. Total Sanuk sales, then, were $30.95 million.
 
CEO Angel Martinez tells us that domestic sales of Sanuk were up “double digits” versus last year’s quarter. The wholesale business was up “mid-single-digits.” The overall revenue decline was mostly due to Asia. “I believe,” he says, “much of the decrease can be attributed to the normal growing pains many young brands experience, as they make the transition from niche player into a larger market participant. Until now, the Sanuk brand relied solely on distributors to launch and grow the business in the international markets, namely Asia-Pacific. And with the formation of the Sanuk management team and Deckers’ subsidiaries in Japan, we now have the infrastructure to take a more direct involvement in the Sanuk brand’s operation throughout the region.”  
 
In the wholesale channel, Sanuk’s $30 million in revenue produced $9.4 million in operating income. That’s a 31% operating margin. UGG’s operating margin was 17% and Teva’s 19%.
 
Deckers paid a high price for Sanuk. They are still paying it. In 2013, 36% of Sanuk’s gross profit will be paid to the former owners. In 2015 it’s 40% of gross profit. No payment in 2014.   Partly, they paid for that operating margin. But partly they paid due to expected growth. In the conference call, CEO Martinez tells us they’ve opened the first Sanuk brand store in Santa Monica. He continues:
 
“The store is in the heart of Southern California, home to the surf culture, from which the Sanuk brand was born, and one of the busiest tourist destinations in the country.”
 
“It’s the meeting of these 2 worlds that serves as the basis for our strategy with the Sanuk brand. First and foremost, we must continue to connect with our core consumer who influences much of the U.S. market and other markets inspired by surf culture. At the same time, we need to expand the brand’s conversion beyond the beach and evolve the product line to reach new audiences, while still retaining and maximizing our current audience.”
 
So they are going to connect the core market and the tourist market? Is that the new audience he wants to reach? While “maximizing our current audience?” Shit oh dear. I don’t want to read too much into a single paragraph, but it does leave me wondering if they understand what they’ve bought and know how to maximize its value. Interestingly, there’s very little discussion of Sanuk in the question and answer part of the conference call. I would have thought the analysts would be all over how Deckers could get some more of that 31% operating margin.
 
Mr. Martinez is not on my distribution list. If he were, I would direct him to some of my comments in the last two days on Skullcandy and VF, to my presentation at the IASC Skate Conference, and to some of my earlier articles. The Sanuk brand can certainly expand, but it has to be to some part of the youth culture market- not the tourist market.
 
To say again what regular readers must be really tired of hearing, the further a core based brand gets from the core market, the less identification there is with the brand and the bigger the danger of losing that core market without getting the broader market. Consumers in the broader market may know your brand, but they won’t know its story, and there goes your point of differentiation.
 
In the 10Q they say, “We believe that the Sanuk brand provides substantial growth opportunities within the action sports market, as well as other domestic and global markets and channels in which Deckers is already established.” I’d be interested in knowing which markets and channels they are referring to though I don’t expect to read that in public documents.
 
We also learn that, “Wholesale net sales of our Sanuk brand decreased primarily due to a decrease in the average selling price, as well as a decrease in the volume of pairs sold. The decrease in average selling price was primarily due to a shift in product mix, as well as an increase in the amount of discounts given as the brand moves from an at once to more of a prebook business.” Each of the price and volume declines cost about $1 million in revenue.
 
Sanuk inventory increased from $12.1 million to $15.1 million, or by 25%. Kind of seems like a big increase when sales are declining, though some of that may be due to the transition of the Sanuk business in Asia. For the year, they are projecting that Sanuk revenues will grow 10% to 13%, down from prior guidance of 15%.
 
Sanuk is a great brand. I try to be cautious in reading too much into the comments in the 10Q and conference call because you don’t get the whole story there. Yet some of the comments, as you will have noticed, leave me a bit concerned. I will look forward to better news in future quarters.

 

 

Interesting Comments From Deckers; What Will They Do With Sanuk?

Deckers, the owner of UGG and Teva as well as Sanuk, filed their 10K annual report with the SEC and I’ve been through it. As you may remember, Deckers bought Sanuk on July 1, 2011 so the year ended December 31, 2012 is the first complete year with Sanuk included. 

For the year, revenue rose 2.8% to $1.41 billion, but net income fell 36% from $202 million to $129 million. The biggest reason for the decline was a gross profit margin that fell from 49.3% to 44.7%. The big problem was the cost of sheepskin, which was 40% higher than in 2011. By itself, that hit the gross margin by 4.5%. Deckers tried to push a chunk of this cost increase through to consumers and found they had pushed too hard. Consumers became reluctant to buy the product. With sheepskin prices declining some, Deckers expect things will start to get better in 2013.
 
UGG wholesale revenues were down 10.5% to $819 million. Teva at wholesale fell 8.5% to $109 million. Sanuk at wholesale was up from $26 to $90 million, but remember that last year Deckers only owned Sanuk for half a year, and Sanuk’s strongest quarters are the first two of the year. 
 
Decker’s other brands at wholesale were down about $1.5 million to $20 million at wholesale.
 
Ecommerce sales, on the other hand, grew 22.6% during the year from $106.5 to $130.6 million. Sales at retail stores rose 30% from $189 to $246 million.
 
Looking at brand sales across all channels, UGG was down 1.5% from $1.20 to $1.18 billion. Teva fell 7.2% from $125 to $116 million. Sanuk was up from $26.6 million to $94 million. They are selling almost no Sanuk ($20,000) in their retail stores, but ecommerce sales were up from $539,000 to $4.17 million. Other brands fell from $24.1 to $21.3 million. 
 
Without Sanuk, then, total revenues would have fallen from $1.35 to $1.32 billion.
 
I’ll get back to Sanuk. Decker’s presentation got me thinking strategically about the intersection of wholesale, ecommerce, and retail. The question is simply this; to what extent does growth in one of those three channels support or diminish sales in one or more of the others?
 
Thoughts on Ecommerce and Brick and Mortar
 
Deckers certainly believes that their net profit is higher because they are in brick and mortar and ecommerce than it would be if they weren’t. But I doubt they, or any other brand, would try and convince me that there isn’t some cannibalization among channels. And they’d also assert that the channels are supportive of the brand and, hopefully, ultimately, revenue growth.
 
Where’s the balance? What are the “things to consider” as we think about the intersection of wholesale, retail, and ecommerce. 
 
First, being on the internet and participating in ecommerce is somewhat defensive. I really don’t think you have a choice but to be there.
 
Second, a brand opening stores is a choice, not a requirement. A few stores are probably a good idea if only because of what you will learn about your brand, what sells, and why. A lot of stores is a whole different management challenge and should not be undertaken solely for financial reasons. Those few extra margin points can turn out to be illusionary if you aren’t very, very careful.
 
Third, opening stores and ecommerce should not be what you do because you can’t figure out how to grow your business any other way. This, I think, has particularly been a public company problem.
 
Fourth, stores and a good ecommerce presence may help your brand beyond countering what your competitors are doing, but if you’re brand isn’t already strong and well defined with your customers, it’s not a solution. Being everywhere can still be being nowhere. There’s a certain almost circular, unsatisfying, and ambiguous logic here. As we watch the evolution of brands, ecommerce and brick and mortar, I guess the winners will be the ones who are best at quantifying without deluding themselves the impact of each channel on the other.
 
Fifth, this ecommerce and brick and mortar stuff costs a whole lot of money. See point four again. You better know why you’re doing it and how it will impact your overall business. “To grow” isn’t a good answer.
 
Finally, once companies start opening stores, they seem to keep opening them. We can all think of some instances where that hasn’t worked out too well. Deckers had 77 stores worldwide at the end of the year. In 2012, they opened seven stores in the U.S. (giving them a total of 26) and 23 internationally. At end of the year, they had 56 UGG Australia concept stores and 21 UGG outlet stores worldwide. They expect to open more in 2013 and beyond. Same store sales were down 3.4% during the year.
 
Plans for Sanuk
 
Deckers paid around $200 million for Sanuk. That’s $123 million in cash plus additional contingency considerations that they are presently estimating to be $70 million for a company that was doing around $40 million at the time it was acquired. So I’m thinking they’d like to see it do well.
 
In 2012, Sanuk’s wholesale operating profit was 17.3% of revenue. That was well below UGG’s at 32.7% but better than Teva’s 9.3%.
 
“We believe,” they say, “that the Sanuk brand provides substantial growth opportunities within the action sports market, as well as other domestic and global markets and channels.”
 
They go on to say in, “Sanuk brand complements the Company’s existing brand portfolio with its unique market position…The Sanuk brand also brings additional  distribution channels to the Company, as it sells to hundreds of independent specialty surf and skate shops throughout the US that were not significantly in the Company’s existing customer portfolio.”
 
In the conference call, we’re told, “The acceptance of the Sanuk brand expanded collection of cold-weather shoes- colder weather shoes rather, and boots was very positive…” They want to “…evolve the Teva and Sanuk brands into year-round businesses.”
 
I’m looking the Sanuk web site right now, and I can’t find any boots or colder weather shoes so I’m not quite sure what it was that was well accepted. I guess I can understand why Deckers management might try to steer Sanuk towards boots and colder weather. UGG is by far the dominant brand in the company, and you can imagine that Deckers is confident in that market. And they’ve got to justify that $200 million purchase price.
 
Let’s just say I’m a little nervous about Deckers trying to expand the Sanuk franchise that way too fast. I have just three words for Decker’s management: Reef skate shoes. If you don’t know what I mean, then I’m right to be worried.
 
For 2013, Deckers is expecting a 15% increase in Sanuk, but only 4% for UGG and 6% for Teva. When you first see that comparison, you think, “Gee, Sanuk is doing well.” But when you think about it, it feels like Sanuk’s growth has slowed rather precipitously. I know big percentage increases are harder to come by as you grow, but that feels like too much slowing too quickly. What’s going on?
 
Other Deckers Stuff
 
Revenues in Decker’s fourth quarter rose 2.2% to $617 million. But the gross profit margin fell from 51% to 46.3%. As a result, net income was down from $124.5 million to $98 million.
 
Most of their production is done in China, but since 2009, they have started to source in other parts of the world. In 2011, they opened manufacturing locations in the U.S. and Latin America.
 
Their December 31, 2012 backlog was $323 million, down 16.5% from a year ago. They acknowledge an ongoing change in the inventory cycle, and think it’s “…likely that an even higher percentage of classic and cold-weather product sales are going to be concentrated in the fourth quarter. We are adjusting our supply chain resources accordingly, while also introducing new fall products for the transitional period between summer and the holiday selling season.” Anybody who sells winter product is going to have to think about that.
 
They are also looking at distribution, especially domestically. CEO Angel Martinez put it this way in the conference call.
 
“As the brand has evolved…it requires a commitment of inventory, it requires a commitment on the brand by a retailer. And where we get those commitments and we see that kind of support for the brand, we have partners for life, if you will. However, there are some environments where we don’t — we’re not happy with the brand presentation, we’re not happy with the support for the year-round elements of the business and the support for the men’s product, so we have to reevaluate whether or not those are long-term participants in the brand success going forward. Consumers today expect a full brand experience when they have a brand they love like UGG. They don’t want to see a piecemeal representation and a brand that gets cherry picked and put out there at retail.”
 
Well, obviously, you can’t blame him for feeling that way. But if every brand were to expect all its retailers to offer a “full brand experience” and carry the inventory that required, the smallest specialty shop would be 30,000 square feet. Either that or it would just be a brand retail shop. Opps.
 
Deckers highlights, and is addressing, some of the issues we’re all facing. More interesting to me is how they are going to manage Sanuk. The brand is highly credible in its market. If they try and push it into other markets too quickly, bad things could happen.

 

 

Decker’s Quarter: The Issue is Not with Sanuk

The September 30 quarter (here’s the link to the 10Q) was not one of great happiness for Decker, the owner of UGG, Teva and, of special interest to us, Sanuk. But perhaps we should be interested in their other brands as well. Most of you who sell shoes and sandals are competing directly in the broader casual footwear market after all. 

Anyway, Decker’s sales fell 9.2% from $414 million to $376 million. In last year’s quarter, the gross profit margin was 49%. This year, it came in at 42.3%. Net income was down from $62.3 million to $43.1 million. What happened?
 
Well, it’s not Sanuk’s fault. Its sales for the quarter grew $15.6 million to $18.3 million, or by 17.3%. $1.3 million of these sales were on line. Sanuk is not sold in Decker’s retail stores. The brand’s sales for the whole year are projected to be $95 million. 
 
Sanuk’s operating income was up nicely from $1.5 million to $3.2 million. However, that increase “was primarily the result of a $1,400 reduction in accretion expense related to the contingent consideration liability from the Company’s purchase of the brand, a $900 reduction in amortization expense largely related to an order book that was fully amortized in 2011, and $500 of increased gross profit, partially offset by approximately $600 of increased marketing and promotional expenses.” After reading that closely, it’s hard to conclude that the operating income increase was primarily the result of selling more product.
 
Sanuk’s wholesale sales growth was the result of an increased selling price “…partially offset by a decrease in the volume of pairs sold.” Apparently they didn’t just increase prices for Sank. There was a shift in the product mix (sorry, no details given) and the introduction of a new shoe and boot line with higher prices.   
 
Unhappily for Deckers, Sanuk’s wholesale business represented only 4.9% of total revenue during the quarter. UGG, with revenues in the quarter of $284 million (down from $334 million), represented 76% of quarterly revenues.
 
Sheepskin is a primary material in UGG products. The cost of said sheepskin was up 30% in 2011 and another 40% in 2012. Obviously this sent the costs of UGG products through the roof. Deckers responded by raising prices and found that, as Chairman, CEO and President Angel R. Martinez put it“…our price increases over the past 2 years had pushed us above the consumer’s price value expectations for the UGG brand.” The warmest winter in the U.S. since they started keeping records didn’t help either.
 
There was probably no good answer for Deckers in the short term. Either they could hold their prices and see their gross profit go to hell, or they could raise prices to hold margins and see their sales drop. Not a happy place to be. The lesson for all of us, and I think it’s especially important these days, is that no matter how sophisticated your strategy, how well thought out your competitive positioning, how differentiated by marketing and features your product, and how many people “like” you on Facebook, every product can be substituted for and sometimes the stuff just costs too much.
 
Deckers sees sheepskin prices coming down some, and they “…made the decision to adjust our domestic pricing in mid-September on select classic styles, retroactive to all orders shipped since July 1.” They reversed some, but not all of their price increases. The issue is whether they can make enough of the price increases stick so that, given a decline in raw material costs that it sounds like will be less than the initial increase, they can recover their gross margins. Price increases, even when justified, have to be gradual I think.
 
Mr. Martinez goes on to say, “The price adjustment has been mischaracterized in recent industry coverage as “discounting.” But in fact, it’s an important strategic decision that we believe is in the best interest of the brand for the long term.” The good thing is that it sounds like they didn’t close this product out or take it to other channels. They worked with their existing retailers for everybody’s benefit, which is something we in the action sports world perhaps haven’t always done as well as we could. But I wonder where that high quality strategic analysis was when they raised their prices so much in the first place. Maybe subsumed by some pressure to make the quarter?
 
Deckers has hit what we hope is a one time bump in the road due to the large and rapid increase in the price of sheepskin. Sanuk seems to be doing fine. Given the price Deckers paid for it, I imagine they will push the brand for even better results. Please don’t push too hard.

 

 

Decker’s Quarter and Sanuk’s Role in it.

I’m looking at Decker’s filings not because of a general interest in Deckers, but because they purchased Sanuk last July. Unlike Reef as part of VF Corporation, Sanuk is a significant part of Decker’s sales and profits so we can find out way more about how it’s doing as part of Deckers than we can find out about Reef as part of VF, just to use one industry example.

Maybe more importantly, we can get some insight into how Decker views Sanuk and what its plans for it are. As more and larger corporations acquire action sports/youth culture brands as a means to learn about and penetrate that market, it’s increasingly important we think that way.

Before I start, here’s the link to the 10Q in case anybody wants to see it.
 
Deckers owns Ugg, Teva, Sanuk, and a few other small brands that generated only $6 million of their March 31 quarter revenue of $246.3 million. That’s up 20.2% from $204.9 million in the same quarter last year. But they didn’t own Sanuk in last year’s quarter, and Sanuk accounted for $32.4 million of their sales in this year’s quarter, or 13.2% of the total. That $32.4 million represents 78% of Decker’s $41.5 million increase. The rest came from the Ugg brand.   Without Sanuk, sales were up 5%.
 
Decker’s overall gross margin fell from 50% to 46% mostly due to a whopping increase in the price of sheep skin used in the Ugg products. Selling, general and administrative expenses grew from $74 million to $101 million. $9 million of that was due to the acquisition of Sanuk. Decker’s net income for the quarter fell from $19.8 million to $8 million. The balance sheet is in good shape, though inventory has grown quite a bit with the largest factor being the increase in the cost of sheep skin. 
 
Deckers reduced its guidance for the year. They now expect sales to grow 14% rather than 15%. Earnings per share are expected to decline 9% to 10% rather than be flat. The company is under a bit of pressure and that was reflected in some of the analyst’s questions.
 
With that as background, where does Sanuk fit in? Obviously, given the price Deckers paid for Sanuk, expectations are high. That price was $120 million plus an earn out. As of March 31, 2012, the “contingent consideration for acquisition of business” (the expected remaining earn out) was $62.8 million. A year earlier it was $91.6 million. Deckers has already paid $30 million to the former owners of Sanuk.
 
In calculating that contingent consideration, Deckers used sales forecasts that “…include a compound annual growth rate of 17% through 2015.” Note 10 of the 10Q tells us that the earn out, without any limit on amount, is 51.8% of Sanuk’s gross profit in 2012, 36% in 2013 and 40% in 2015. No, it doesn’t say anything about 2014.
 
For that price, Deckers is expecting big things from Sanuk.
 
“We believe that the Sanuk brand is an ideal addition to the Deckers family of brands and that each of our brands can leverage off each other’s distribution channels. The Sanuk business is a profitable business that we believe provides for substantial growth opportunities within the action sports market, as well as other markets and channels in which Deckers is already established, including retailers such as Dillard’s, Journey’s, Nordstrom, Zappos.com, and REI.”
 
One wonders if Sanuk will fit as well in some of those retailers as other Decker brands. Well, that’s what you pay management to figure out; keeping a brand authentic while growing its recognition and penetration. “The product,” they say, “is resonating very well with a broader cross-section of consumers and we’re also excited about the rapid growth trajectory.” Sanuk’s margins, they tell us, are “…ahead of expectations.”
 
Before Decker’s unallocated overhead costs of $41.4 million, Decker’s income from operations for the quarter was $53.3 million. Of that, Sanuk accounted for $10.6 million, or 19.9% of the total, even though it’s only 13% of sales. After those unallocated overhead costs, Decker’s income from operations was $11.9 million.
 
By way of comparison Ugg, Decker’s largest brand, generated $91.9 million of wholesale business in the quarter (37% of the total) and operating income of $28.4 million. That’s 31% of sales compared to 33% for Sanuk. Wow- imagine what Ugg can do when the winter isn’t lousy (unless you like warm winters) and the price of sheep skin isn’t through the roof.
 
Deckers did $46.2 million in retail revenue during the quarter, almost all with the Ugg brand. They have 46 stores of their own worldwide and expect to continue opening stores in 2012 and beyond. There’s a chart on page 19 of the 10Q that breaks down brand sales between wholesale, retail and ecommerce. Except for $107,000 of ecommerce sales, all of Sanuk’s sales are wholesale.
 
When you buy a brand as a public company, you need performance from that brand commensurate with the price you paid. Inevitably and appropriately, the purchasing management pushes the acquired brand into expanded distribution utilizing the channels, expertise and beliefs about the market that lead it to acquire the brand. As an industry, that’s our reality. Successful brands reach a level beyond which they can’t go without help and the owners want their pay day.
 
If that’s what’s happening, and if it’s the future, how does it impact your company? There’s a longer article coming up on this article I think.     

 

 

Sanuk Gets Bought, Who’s Deckers Anyway, Analysis of the Deal, Broader Industry Implications, and Related Ramblings

Three times sales?!?! They sold a $43 million company for $120 million cash plus an earn out?!?! Not in the middle of snowboard industry lunacy in the mid 90s did a company go for three times sales. Okay, there are three possibilities. First, the team at Sanuk (here’s the website link) is a bunch of silver tongued negotiating devils. Second, the management team at Deckers went drinking with the management team at Sanuk and the Sanuk team won. I suppose that’s just a variation of the first one.

The real second possibility, then, is that the guys at Deckers are desperate to be cool and didn’t know what they are doing. As you’ll see below where I describe Deckers, that’s unlikely. Decker’s history makes that clear.

The third possibility is that Sanuk’s margins justify this kind of purchase price. As much as I would like it to be one of the other two (because that would make a much better story) I’m think that’s probably it; Sanuk’s margins are through the roof.
 
Let’s look at the buyer, the seller, and the deal in a little more detail and see why I think that and what we can learn.
 
Deckers is a billion dollars company (2010 revenues) founded in 1975. In 2010 it earned $160 million. In 2006, revenues were $304 million and net income $30 million and yes, I wish I’d bought the stock back then. It owns the Ugg, Teva, Simple, TSUBO, Ahnu and Mozo brands. In 2010, Ugg was $875 million of its revenue and Teva $100 million. Obviously, the other brands are pretty small. Probably smaller than Sanuk.
 
25% of their business is international, and that’s where they see the most growth potential. They have 27 stores worldwide, and can see that growing to 150 in five years.   Here’s how they describe their business:
 
“We strive to be a premier lifestyle marketer that builds niche brands into global market leaders by designing and marketing innovative, functional and fashion-oriented footwear developed for both high performance outdoor activities and everyday casual lifestyle use. We believe that our footwear is distinctive and appeals broadly to men, women and children. We sell our products, including accessories such as handbags and outerwear, through quality domestic and international retailers, international distributors, and directly to end-user consumers, both domestically and internationally, through our websites, call centers, retail concept stores and retail outlet stores. Our primary objective is to build our footwear lines into global lifestyle brands with market leadership positions. We seek to differentiate our brands and products by offering diverse lines that emphasize authenticity, functionality, quality and comfort and products tailored to a variety of activities, seasons and demographic groups.”
 
You can see why Deckers would be interested in Sanuk and why Sanuk might feel it was a good match.
 
Deckers is another billion dollar company with solid brands that plans to expand internationally and into retail and wants a solid entrée into the action sports/youth culture market. Well, there’s a new strategy none of us have ever heard of.
 
Sanuk is a strong, some would say unique, brand that, to use the old cliché, got a deal they couldn’t refuse. Let’s look at that deal as best we can and see why they got it.
 
What do we know?  Not much, but why let that stop me from a little financial fantasizing.  Purchase price of $120 million cash plus a five year earn out. 2010 Sanuk sales of $43 million. Deckers says the deal will add to their earnings this year. Even at that price.
 
I picked myself up off the floor after I initially saw the price and called somebody who’s familiar with our industry and has been both a strategic and a financial buyer of companies like Sanuk. Strategic buyers pay more and Deckers is definitely a strategic buyer in the case of Sanuk. What she told me is that the price discussion might start somewhere around eight to ten times EBITDA (earnings before interest, taxes, depreciation, and amortization) for this kind of deal.
 
I don’t know how to value the earn out, so let’s just work with the $120 million purchase price and assume they paid nine times EBITDA. That means that Sanuk’s EBITDA was $13.3 million.
 
I’m not going to try and get specific because, let’s face it, I’m creating this analysis with very limited information. But I’m guessing Sanuk’s depreciation and amortization is pretty low because they haven’t bought any companies and I don’t think they own a factory. With the margins Decker’s purchase price implies, they may not have had to pay much interest expense either. The biggest number below EBITDA, then, would be taxes. Pick a tax rate and remember this is California. Whatever reasonable rate you pick, you’ll see there’s a bunch of money going to the bottom line.
 
Let’s wander back to the upper part of their income statement. What do you think Sanuk spends for selling, general, and administrative expenses? I have no idea. What if we assume $10 million? That would be 23% of 2010 sales. Amortization and depreciation would be included in that. That would suggest that Sanuk’s gross margin is north of 60%. How much? You decide.
 
While we’ve been talking about 2010 numbers, it’s almost June of 2011. I’m guessing sales might be up for Sanuk this year, and that was certainly part of the discussion. Buyers don’t like to pay sellers for what might happen in the future. Hence the earn out. But significant growth in 2011 would help explain why the deal would add to Decker’s earnings this year.
 
Let’s talk strategically about some of the deals we’re seeing. The Wall Street Journal’s online Market Watch (catchy name) reported PPR CEO Pinault as saying, during his discussion of the Volcom acquisition, that “PPR didn’t make an offer for Volcom’s larger rival Quiksilver Inc. because Quiksilver has ‘reached a level of maturity.’” I agree with him and have raised the issue myself of where Quik’s growth could come from.
 
There’s kind of a perfect storm forming. Sellers remember that during the financial crisis and associated recession there were just no buyers out there unless you wanted to give your company away. They are also sitting there and wondering just how strong the economic recovery is and will be in the future. And they recognize that as the action sports business evolves into the youth culture business or maybe just the fashion business that they need some help breaking through in a number of areas that a large parent can provide.
 
Buyers need to reach the demographic our industry represents. Not just by age, but by culture and attitude. There’s some evidence that growing that kind of business internally is hard. Nike finally got it right, but it took them a lot of tries and a long time.
 
If you need to be in this market, and you can’t build it internally, it looks like you have to buy somebody. Should you buy somebody big? Well, there aren’t very many big ones and those that are big may have reached “a level of maturity” that makes them less attractive. Besides the intangibles you want to acquire aren’t necessarily related to the size of the acquired company. Is Volcom seven and a half times cooler than Sanuk just because it’s that many times bigger by revenue? Nah.
 
You are also making this acquisition because, as a strategic buyer, you believe that through your sourcing, back office, financing and existing distribution you can help the acquired company grow and be more efficient. A larger acquisition may not need that kind of help and the synergies you’re expecting may not exist. If there are no synergies, you probably can’t afford to be a strategic buyer and the price you’re willing to pay has to go way down.
 
You can see why more deals like this are happening in our industry. The economy is at kind of an inflection point where they make sense and market dynamics make them attractive to buyers and sellers.