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  • #5627


    During Office Hours on February 2, 2017, we talked about Under Armour (UA / UAA) and have agreed to work on a valuation of the company together. Here is a summary of our discussion:

    1. Under Armour was started by Kevin Plank, a former University of Maryland football player. He started the business out of his grandmother's basement and has built it into a multi-billion enterprise 20 years later.
    2. University of Maryland's football team was one of the early adopters of UA goods and the team is known for its cutting edge uniform designs.
    3. The company has three shares of stock, A, B, and C classes. B is the founder stake, with preferential voting rights. A shares were the first shares listed on public markets and have voting rights (ticker = UAA). The C-class shares were first issued in March, 2016 and have no voting rights (ticker = UA).
    4. More background (including live model and financials) available in the Article's section through this link: https://frameworkinvesting.com/?s=under+armour

    Demand Environment
    1. Recent sharp fall in shares may be related to slowing US domestic growth.
    2. In 2015, roughly 15% of sales were made in overseas markets, and revenues overseas are growing at around 60% Year-over-Year (YoY)
    3. If a revenue source representing 15% of total sales is growing at 60% per year, that equates to a (0.15 * 0.60 =) 9% tailwind on revenues. As the overseas sales become a larger proportion of total, this tailwind will also grow.
    4. Our group assignment was to come up with best- and worst-case revenue growth assumptions over the next five years for Under Armour and to be able to explain why we chose those numbers.

    1. We noted a very negative OCP profitability in FY 2015 and looked through the Statements of Cash Flows. We identified several very large cash outflows in Inventories and Accounts Receivable.
    2. Robert has sent some research along regarding inventory write-downs. I'll post this in a separate post.

    1. Ra'uf mentioned UA's declining quality ratio and wondered if that was something about which we should be worried. This was such an interesting question, I wrote a separate post about it, which you can find here: https://frameworkinvesting.com/under-armour-ua-uaa-quality-company/



    Robert wrote in the following email regarding Under Armour write-downs:


    Hi Erik/Joe,

    I put together an quick spreadsheet that compares UA Inventory Turnover Vs some peers, the comps universe is limited. Nike is the most impressive company. Their inventory turnover has trended down slightly over the time period. However, operating profits are high and they've grown those profits faster than sales.

    Lululemon has very high growth rates but you'll notice operating profits peaked in 2014 even though sales have kept growing, at a slower pace than before.

    UA inventory write downs are buried in COGS. However, I don't think its a material number. In the 2015 AR they do disclose “inventory obsolescence” as part of deferred tax assets, it looks to have been about $3M. More importantly I think it is showing up in gross margin as the discounted products deflate sales. You'll notice that their inventory turnover has improved over the time period.

    I found an article from Jan 2016 that mentions that they are working with SAP on inventory optimization and are rolling out in Q1 2017:

    SAP engagement
    UA is collaborating with SAP (SAP) (SAP.DE) to provide enterprise resource planning (or ERP) solutions for inventory optimization, process improvements, and improved cost management. On the inventory side, the biggest benefit is expected to come from higher inventory visibility across selling channels and geographies.
    The first phase of implementation is expected to commence in 1Q17 according to comments by Paul Fipps, chief information officer at UA.
    Other companies in the industry implementing ERP solutions include Adidas (ADDYY) (ADS.DE) and Columbia Sportswear (COLM)



    Here is a link to the file Robert sent:



    Meeting Minutes from Office Hours on 2/4/2017

    Good discussion about UA – talked about the marketing challenges to UA's increased growth. Specifically, UA came onto the scene to exploit a niche (compression wear) that was unoccupied by any of the majors. Now, as it is becoming a major player in its own right, it needs to figure out how to build on its unique “technical” capabilities. Does this mean it will have to rely on its “Connected Fitness” segment? Maybe, but the segment revenue share is still very low, so will have to increase very strongly to have a material impact on the firm (said Erik). Others disagreed – saying that even if the Connected Fitness didn't bring direct sales, it might bring a halo effect to the brand or might encourage use of its other products as a complement to the Connected Fitness devices.

    Lee pulled together product-line revenue forecasts for the next five years (thanks, Lee!), and those are in the linked workbook in the tab entitled “Segment Model”.

    I pulled some stats on Nike's early growth and created a couple graphs of that (also in linked workbook). Robert R. made the suggestion that we take a look at how fast Nike grew at the early stage of its development and triangulate on that.

    Next Steps
    We pulled together a really rough valuation, but need now to look more closely at capital requirements to grow the business. In the IOI model, this equates to “Expansionary Cash Flow as a percentage of Owners' Cash Profits”.

    Getting very close to our first group valuation! Very exciting!

    Here's the workbook: https://frameworkinvesting.com/wp-content/uploads/2017/02/UA-GroupWork_2017.02.04.xlsx




    Note From Robert on 2/8/2017

    Christina and I did some work on UAA today. We added 4 tabs to the beginning of the valuation model. The “first 15” tab uses the data that Erik put together. Notice that through the first 15 years and Years 6-15 UA had a higher revenue CAGR than Nike. In Years 11-15 (1988-1992) Nike had higher growth than UA, could be the Air Jordan effect?

    After the initial 15 Year period Nike was able to grow revenue at the following CAGR:
    • Next 5 15.2%
    • Next 7 14.5%
    • Next 10 11.3%
    Since 1995, when Nike reached 4.7B in sales, close to UAA now , they have a revenue CAGR of 8.96%.

    Second tab is Nike OCP Average, Nike average and median OCP is 7.4%-7.8% since 1993. Removing the top 3 and bottom 3 outliers had little effect.

    Third tab looks at CAGR's for OCP and Free cash flow to firm (proxy for FCFO available in Y Charts) as a starting point during stages 1 & 2. The annual data is all over the place. OCP margin is about 9.5% Free Cash Flow CAGR is over 12% during stage 2

    We started building the valuation model consistent with some of the above comps. No inputs for expansionary cash flow or balance sheet. Worst case scenario is around $17. That is the same floor as what a worst case P/S ratio of about 1.6 infers . UAA has rarely traded for 1.6, during the financial crisis it briefly traded for less than 1 times sales, it is possible UA could go to 1 X sales.

    PS Ratio Graph

    Finally, UAA missed sales by approximately $100 million. If we back that out and attribute that entire loss (big assumption) to Sports Authority they hit top line growth:
    Sports Authority estimates

    Figures were in this article, I'm assuming from the 10Q or conference call back in Q2.

    Now Under Armour says it will take a $23 million impairment charge in the second quarter, and was only able to collect $43 million of $163 million in revenue it expected through Sports Authority in 2016. Those effects warranted revisions to Under Armour's full-year guidance, but only tiny ones. The company, which counts star athletes like Stephen Curry, Jordan Spieth and Bryce Harper among the faces of its brand, cut its 2016 net revenue forecast to $4.925 billion, a shade below its previous guidance of $5 billion, and said it expects profits of $440 million, rather than $445 million.

    Click here for the model with additional tabs



    Trump and Under Armour

    Believe it or not, there's a connection… Here's the note from Robert:

    Kevin Plank made a positive comment on Trump and one of the key athletes, Steph Curry, spoke out against trump. I was thinking how this ties in with the video that Erik produced on Trump.

    I thought this was an interesting video that CNN put together and wanted to share it with you. Please don't feel any obligation to watch.




    Notes from 2/9/2016 Conference Call

    Christina presented a revenue model that she and Robert had been working on. This model compared Under Armour's first fifteen years of sales to Nike's first fifteen years, then extrapolated compound annual growth rates for the next 10 years out for Under Armour based on how Nike had performed.

    The group saw a few potential problems with this:
    1. When Nike was young, the industry was still in its infancy, so growth trajectories might not be identical between UAA and NKE.
    2. The base product lines are different – shoes (NKE) versus apparel (UAA).
    3. Nike had much less access to international markets in its infancy than Under Armour does now.

    Erik's Take
    In general, I expressed my opinion that a statistical model like this was usually best left for the end – sort of a sanity check to see how your revenue growth assumptions might look compared to the history of an older, more established company. If your revenue assumptions imply growth much faster than – in this case Nike – you know that you should probably go back and take a closer look.

    We then took a look at Lee's product-line model. Some of the assumptions seemed to bullish; Kyle brought up the fact that the company itself had only targeted $10 billion in revenues by 2020, but Lee's model was much higher in the best case.

    Erik's Take
    In general, I really liked this approach, but thought we should look more closely at the input assumptions.

    Conclusions / Homework
    I suggested that we try making similar assumptions for geographical expansion as Lee had done for product-line revenue growth. The idea would be to triangulate between a few different approaches to see if it was actually possible for UAA to grow at a certain rate assuming certain conditions.

    For example, overseas revenues make up around 15% of total and are growing at over 60%. If they continue to grow at 60% for the next five years and the domestic market slows from the teens percentages to the upper single-digit percentages, what will the revenue picture look like in 2020? Does this model agree with the product-line model? How do the geographical and product-line models compare to a statistical model like Christina's and Robert's? Most importantly, are there enough feet in the world that need UAA tennis shoes for our growth assumptions to work out?! It might seem like a silly question, but some Crocs models were doing the equivalent of assuming that every man, woman, and child in the US would buy 1 pair of Crocs every season…

    Here is the most recently updated model. All orange tabs are ones that members of the group created.
    IOI Integrated Valuation Model for Under Armour



    Notes from 2/11/2017 Office Hours

    1. “Skin in the game”
    Kyle noted that he had made a small investment in Under Armour call options because he had a hard time concentrating on a company if he didn't have “skin in the game.” Indeed, this is the same strategy an old portfolio manager of mine had as well, and I've found it to be effective too. The PM would buy a small stake – say 1%-2% of the total assets under management (this PM's mandate was that he could not hold a position with more than a 10% weight, and most of his positions ranged in the 5%-8% range) – then say “Okay, let's go figure out if we want to buy more.” The small allocation meant that even if it turned out that the stock was not attractive, and we ended up getting rid of it, the fact that we had taken a position and knew that a final decision had to be made meant that we worked harder on the analysis.

    The important thing about this is first, not to take a position that is too large compared to what you consider to be a comfortable maximum position size. Second, to make the commitment to either increase the position size appropriately, or sell the thing off; you don't want to be left with a bunch of tiny positions that you don't care about! Third, if you're using options, my advice always is to make the smallest “immediate realized loss” as you can by limiting the amount of time value you pay. A good way to use options in this kind of a situation is a small position in a sold put. This way, you're collecting premium from time value rather than paying it out!

    2. Modeling
    We created a new “Geographical Segments” tab in the model and started with Best- and Worst-case assumptions for the N. American market. For International, we noticed a huge jump in revenues in 2014, and Kyle was going to check into the root cause for that. The geographical splits look like a nice way to model this company. My suggestion would be to look at geographical, then try to use product-line and statistical methods (Kyle mentioned the Maubossin study regarding revenue growth and Christina and Robert were looking at NKE stats) to triangulate a set of reasonable best- and worst-case scenarios.

    Here's a link to the most recent model with the Geographical model already set up. Members are invited to download the model and start thinking about how they would model geographical and product-line revenues in the short-term!

    IOI Valuation Model for Under Armour 2/11/2017



    Note from Kyle R. Regarding International Segment Growth

    To answer the question you posed on the call as to why the growth rate shot up internationally in 2014 to a 98% revenue increase:

    in 2014 they opened 68 new brand stores outside of North America. This was an increase from only 13 brand house stores in 2013.They also rolled out underarmor.com in a litany of new markets and languages. They signed tennis star Andy Murray (from the UK). At the end of 2014 they targeted to open 100 more international brand stores in FY 2015. In 2014 they obtained a new distributor agreement to the middle east. It appears much of the growth was in EMEA. They appeared to have just begun entrance into “Asia Pacific” i.e. China and Southeast Asia. They had just opened their first brand store in Latin America. They had “new” launches in Brazil, Chile, “Southeast Asia” and the Middle East. So as of December 2014, most growth had come in Europe. They were targeting having half revenue global half from international “some day” and accomplishing this would mean it was a global brand. (All info obtained from February, 2015 earnings call discussing FY 2014 results).

    September 2015 investor day presentation: During the investor day presentation they guided that by 2018 they would have 2,000 brand stores outside of North America. They also explained that by 2018 they would have 30 localized e-commerce experiences which would cover 80% of the markets around the world. UK Germany and France represent 70% of the EMEA revenues. They were looking at entry into india in 2018. “So, where do we end up in 2018? By 2018, we are projecting that 80% of our stores will be outside of North America. We will have over 1,000 stores worldwide. We will have stores in close to 40 countries and over 3 million square feet of retail space. We are tripling our footprint.
    75% of that growth is coming from international locations and 60% from partner-operated retail. We will have over 150 million athletes visiting our stores each year. We are truly just getting started.”

    In 2015, Under Armor gear was sold in 60 countries. They had more than doubled the amount of “in country” websites in 2015. In 2015 they saw “triple digit growth” from Asia Pacific, and opened new brand stores. Europe's focus was UK and Germany. They launched 9 in country new websites for Europe. Latin America faces “macro challenges” in Brazil, but expansions into Chile “more than offset” the Challenges in brazil. They continued to work on direct to consumer sales and wholesale internationally. (All info obtained from January 2016 earnings call discussing FY 2015 results).

    after q3 2016 they said: EMEA continued to be strong but greatest growth now in China. China posted q3 revenue equivalent to the entire first half of the year, which means they were looking to double total revenue of $80MM from china the previous year.” They had already opened 100 stores in china, and were driving e-commerce. China “just getting started.” “With sports and fitness being promoted strongly by the government, we continue to be viewed by the Chinese consumer as the Performance Brand or referred to often as the Professional Brand.” They had now reached 30 country specific e-commerce sites adding Mexico, Australia, New Zealand and Chile. This means they had beaten their 2015 e-commerce site projection by over 2 years.

    in the most recent earrings call they said:

    We feel particularly strong on China, very bullish on that market. It’s been one of our highest growth and becoming very, very profitable for us. A lot of great, great relationships that we’re building in that market with great leadership. Europe as well. We’ve had some great strides there also, making some good traction with the right marketing investments there.
    And then Latin America, which is kind of our newest region, is one that we’re still cultivating, but it’s growing well. And if you look at our total international profitability, y-over-y we’re seeing significant improvement there. So it’s a great play for us, and we’re going to continue pushing hard in that area.”

    This was the best I could do on short notice to get some numbers. They are kind of confusing in how they talk about stores. There are company owned stores. Then there are stores within stores. And then they have distribution partner stores. Sometimes its hard to tell which type of store they are talking about. China is crushing it and seems to be the biggest growth driver and their biggest focus. Europe continuers to grow. They sound like they still lost money or break even in Latin America, and have yet to open in India. They've only been in China since mid-2014. That gives you some idea of the runway.



    2/16/2017 Office Hour Notes

    Spoke mainly about geographical growth and started plugging in some tentative numbers. A few things we found:

    1. Sales in Japan and Korea are all license sales through a company called “Dome.” Under Armour holds a minority stake in Dome, so may receive some dividends in addition to a share of profits.
    2. In 2013, UA started to build out its international stores, so International profitability took a big, sudden hit. On an op profit basis, looks like 10%-15% is a mature market's typical profitability. On an OCP basis, 5%-10%?
    3. Investment spending over the last three to four years has been very high – probably due to Connected Fitness. We need to make sure we understand the capital requirements for the firm going forward (One idea is to look at NKE and Adidas for comps. Another idea is to take a look at spending pre-Connected Fitness. My guess is that pre-Connected Fitness cap requirements are about the same level as NKE's…).

    Christina had brought up the issue that just looking at geographical segment and guessing best- and worst-case revenue growth was not much better than a shot in the dark. This is certainly true – it's better to understand the numbers behind the growth rather than looking at percentage growth.

    Next Steps
    1. Erik suggested looking through past 10-Ks to find data about the number of retail locations selling UA products. Recent data is available for “brand stores” (i.e., UA-owned retail outlets – 1 location in Chicago metro area) and “factory stores” (i.e., discount outlets – 2 locations in Chicago metro area).
    2. It might be good to pull FCFO data for NKE to get a view of how much a mature business spends on investments.

    Looking through an old 10-K, I noticed that there is a very large proportion of the company's US sales to a few large distributors. Probably worth thinking about what happens to inventory if a retailer goes bankrupt…



    Notes from 3/9 Office Hours
    We started off talking a little about Caterpillar (CAT). IRS raid on Peoria headquarters was related to tax avoidance through “transfer pricing” schemes. PwC – the company who won infamy for giving the wrong envelopes to Warren Beatty at the Oscars – was in charge of the tax avoidance. (All big accounting firms make a ton of money doing this kind of business though… It's not only PwC, but KPMG, and D&T as well).

    For those of you unfamiliar with Excel, we have a video series in the Video section of the site entitled “Excel for the Intelligent Investor”. Take a look at those!

    Moved to talking about Nike (NKE) as a model for Under Armour (UAA) revenue growth.
    1. We looked at long-term revenue increase data. Kyle mentioned that worldwide, sporting goods sales are forecast to rise at around 4% per year.
    2. Kyle had calculated that Nike's early international growth averaged around 18%. More recently, that growth had dropped to average 6% per year.
    3. Kyle mentioned that he was surprised that Nike's international sales and domestic had tracked each other so closely in the early years (1991-1999 or so)
    4. Kyle pointed out the international sales really took off starting in around 2002.
    5. Joe pointed out that domestic sales, in contrast, flatlined (Nike had a “lost decade” domestically from roughly 1997-2006).
    6. Kyle wondered how applicable looking at Nike's growth would be since the market for sporting goods was much more mature now than then.
    7. Erik pointed out that for a company like Under Armour, which was new to the Chinese (and European) markets, the secret to growth was simply increasing the number of distributor relationships, so anchoring too much on, for example, the 4% expected global growth rate was probably too conservative.

    1. Fill in a few years of “Expansionary Cash Flow” data for Nike. Eventually, we'll have these data available via an online tool, but it is helpful to understanding where the information comes from to do it oneself.
    2. Everyone should make some revenue projections for geographic segments at Under Armour.

    We'll review the homework on Saturday 3/11. Nike Model is below. Under Armour model is the same one posted in this forum on 2/11 (above).

    Nike Model



    Notes from 3/11 Office Hours

    1. Kyle walked us through his geographical assumptions for Under Armour after pointing out that UAA has started breaking out revenues by specific international markets. Kyle considers the resultant revenue increase in terms of the company's goal of having a $10 billion revenue line by 2020. Kyle's best-case revenues are just at that $10 billion level and worst-case revenues are a bit below.
    2. Erik also walked the group through his geographical assumptions for UAA. I have also keyed off of the $10 billion goal by 2020 in my best- and worst-case revenue scenarios. I had noticed that in the case of Nike, its foreign and domestic revenue growth slowed very quickly after a period of rapid growth. My revenue forecasts for UAA also replicate this pattern.
    3. I am still worried that these revenue forecasts are just “playing with numbers.” I'd be more comfortable with these forecasts if I understood more about UAA's building out of distribution networks overseas.
    4. Another possibility I think we should consider is that UAA does NOT grow domestically for some period. Even Nike had a lost decade from roughly 1997-2006, where domestic revenues hovered around $5.5 billion. Why could this not happen to UAA as well? Domestic revenue growth has become pretty tepid pretty quickly, after all.

    We also worked through Nike's investment spending (see linked spreadsheet below). Two important points:
    1. Our assumption for maintenance capex is usually based upon “Total depreciation and amortization” adjusted for inflation. There are cases where this does not hold true, but for UAA, it seems like a reasonable assumption.
    2. Nike has been issuing a lot more stock to its employees over the last few years than it had in the past, and doing so at a higher stock price. This means that our assumption for the cash it will need to spend to cancel out dilution is much higher.
    3. We also see a big pick-up in capital spending above maintenance capex in the last three years. Clearly, something is going on at Nike… wonder what that is!
    4. Looking at the Investment Spending Decomposition chart in the IOI model is a great way to see trends like this. We also spotted a big divestment a few years back – it would be interesting to know what that was as well.

    Nike Model (with Investment spending fields filled in)

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