Barington Urges Victoria’s Secret To Uncover Value, Show How Bath & Body Works

Is breaking up retail conglomerates about to become a trend? Last week, Gap(GPS) announced the planned spinoff of its Old Navy brand. Now, Barington Capital is urging L Brands(LB), parent of Victoria’s Secret and Bath & Body Works, to spinoff one of the two brands. Barington has a history of activism and last appeared in these pages when it was pushing for change at Darden Restaurants(DRI) together with Starboard Value. L Brands has a long history of brand divestitures, including the 1996 spinoff of Abercrombie & Fitch(ANF). We actually reported several years ago on a suggestion that Abercrombie should spin off Hollister. Other brands divested by L Brands include The Limited(that’s where the ‘L’ comes from), and New York & Company, now known as RTW Retailwinds(RTW, formerly NWY). More recently, the company gave away La Senza for no upfront payment, and shut down Henri Bendel.  Still, founder and CEO Leslie Wexner, who has served for over 40 years has created a powerhouse company and enormous wealth for himself and his family.

Barington released a letter that it sent to Mr. Wexner.  They begin with praise for Mr. Wexner’s leadership.

L Brands has a long and impressive history under your leadership. We have great respect for your skills as a merchant and the value that you created for shareholders as the Company grew its core brands, Victoria’s Secret, PINK and Bath & Body Works.

Then, of course, comes the “but”.

Unfortunately, the performance of L Brands has been disappointing over the past few years. As illustrated in the table below, the Company’s common stock has underperformed its self-selected peer group and the market as a whole by a substantial margin over the last one-, three- and five-year periods, plummeting from a high of $100.22 per share on November 4, 2015 to $26.81 per share at the close of the market yesterday, a decrease of more than 73%:

1-Year (3/2/18-3/1/19) 3-Year (3/2/16-3/1/19) 5-Year (3/3/14-3/1/19)

L Brands -32.1% -63.1% -36.7%

Peer Group1 19.9% 35.6% 71.7%

S&P 500 Index2 6.3% 50.0% 68.4%

Russell 2000 Index2 5.1% 55.5% 44.7%

The Company’s declining share price over this time period is primarily the result of the disappointing financial performance of its Victoria’s Secret segment. While the operating income of this segment had reached $1.4 billion in fiscal 2015, it fell to approximately $500 million in fiscal 2018 – a staggering reduction of approximately $900 million in just three years. EBITDA margins have similarly declined, falling from over 20% in fiscal 2015 to 15% in fiscal 2018. We believe that the declining performance of Victoria’s 2 Secret is primarily due to merchandising missteps and the failure to maintain a compelling brand image that resonates with its target consumers. Despite these issues, Victoria’s Secret and PINK are still market-leading brands with store productivity higher than most of their peers. However, even leading brands must evolve to meet their customers’ changing demands or risk suffering declining profits and a loss of market share. While the financial performance of Victoria’s Secret over the past three years has been concerning, the performance of Bath & Body Works has been exceptional. Bath & Body Works operating income has grown from $858 million in fiscal 2015 to $1.08 billion in fiscal 2018. The business generates industry-leading EBITDA margins of approximately 25%, and has delivered strong same store sales growth of 5% or more in each of the last five years and 11% comparable sales growth in fiscal 2018. Unfortunately, the market does not appear to be ascribing appropriate value to the solid financial performance of Bath & Body Works, most likely because it is being overshadowed by the struggles at the Company’s more visible Victoria’s Secret segment.

Barington goes on to make a series of suggestions for improving performance, but, most relevant to our focus is the suggestion of separating the two main brands.

The Board Should Consider a Spin-off of Victoria’s Secret or an IPO of Bath & Body Works

We believe that L Brands can unlock substantial value for shareholders by spinning off Victoria’s Secret or pursuing an IPO of Bath & Body Works. We believe that a transaction of this type would not only facilitate the market more appropriately valuing each segment, but would also enhance the financial performance of each business by helping improve its strategic focus. Bath & Body Works and Victoria’s Secret both have the hallmarks to be a successful stand-alone publicly traded company. Bath & Body Works is well positioned in attractive high-margin categories which lend themselves to repeat purchases. Victoria’s Secret is an iconic brand with the potential to reignite sales growth and expand margins by reestablishing its connection with its customers. Each brand has substantial e-commerce operations which enables it to reach customers through multiple channels of distribution, as well as a growing international business that we believe could one day match its 5 domestic business in sales. While Victoria’s Secret and Bath & Body Works utilize a number of shared services, we believe that these services could easily be co-owned or provided by one company to the other after a spinoff. In addition, we believe that the strong operating profits of Bath & Body Works are sufficient to service all of the Company’s current indebtedness. The Company could also issue new debt at Victoria’s Secret and reduce some of the parent company debt in order to achieve a more balanced level of indebtedness between the two entities. Alternatively, an IPO of Bath & Body Works could provide equity capital which could be used to deleverage the Company’s balance sheet and finance the international expansion of both businesses, while positioning the Company for a subsequent separation. As you well know, L Brands has a history of successfully utilizing strategic transactions to improve shareholder value and enhance the Company’s focus on its core businesses. Past spinoffs have included Abercrombie & Fitch and Limited Too, and past brand divestitures have included Lane Bryant, New York & Company, Express and The Limited. Most recently, the Company has taken steps to streamline the Company by exiting its Henri Bendel business and entering into an agreement to divest La Senza. We strongly recommend that the Board consider continuing on this successful path by retaining a financial advisor to evaluate opportunities to improve long-term shareholder value through the separation of Bath & Body Works and Victoria’s Secret.

Notably, Barington does not disclose what its position in L Brands is and it did not appear in the firm’s most recent 13F. Wexner, on the other hand, controls 16.91% of the company. L Brands responded, listing steps it has taken to increase value, but, notably, not addressing a potential split, or Bath & Body Works at all.

L Brands welcomes open communications with our shareholders and values input that may advance our goal of enhancing shareholder value.

L Brands is focused on bringing merchandise to market that aligns with consumer trends around the globe, proactively managing our real estate assets and maintaining a disciplined approach to our cost structure and deployment of capital. The Company, in consultation with its financial advisors, has made significant changes in its business to focus resources on core categories to enhance performance and accelerate growth. These actions include:

• Closure of Henri Bendel;
• Sale of the La Senza business;
• Reduction of our regular dividend by half to normalize the payout and free up capital to reduce debt levels and invest in the business;
• Promotion of Amy Hauk to run PINK and the appointment of John Mehas to lead Victoria’s Secret Lingerie;
• New product launches in Lingerie, PINK and Beauty, including a new online Swim assortment in March;
• Disciplined and proactive management of inventory, expenses, real estate and capital structure; and
• Heightened focus on the customer and our merchandise assortments at Victoria’s Secret Lingerie and PINK, including a review of all aspects of brand marketing and communications.

L Brands is committed to creating long-term shareholder value by delivering growth, strengthening its financial performance and building its leading market positions, and we will continue to take actions that we believe will enable us to achieve this objective.

Barington has had some success in the past, but we’re not sure how successful they are likely to be with a small stake against a founder and longtime CEO who controls a significant amount of stock. Meanwhile, Barron’s continues to be negative on the stock,“arguing that the problems at Victoria’s Secret are very difficult to solve.” and concluding “While a spinoff could lead to more upside for the stock, we’re not sure it will actually happen.” Agreed.

Disclosure: The author has no position in any stock mentioned