Finance: Spyder Active Sports

Unit 3, Professor Martin Sinozich, Finance, Spyder Active Sports—2004.

The previous piece, Nantucket Nectars, was about the seller — a company is worth the most in the year someone else needs you. This one is about the seller too, but the question flips over: the same company, with a different shareholder, isn't worth the same number. Not because the model changed, but because the people showing up to work next Monday changed.

Here goes — enjoy:

Case Summary

Spring 2004, Boulder. David Jacobs is seventy, his office walls covered with ski photos and memorabilia. He can still ski the mountains near Denver, and still ski Europe. Outside the window is the company he started from his kitchen in 1978. Seven years ago, the Denver private equity firm CHB Capital Partners came in; over those seven years, sales grew from about $10 million to $61.4 million. Now CHB wants out, and it's time for him to turn his own stake into cash. What he has to think about is: what is this company worth in the public market, and — once it's sold to someone, will it still be the same company?

The story starts with the two times he fell. Jacobs was a Canadian downhill champion and national team coach. In the 1960s he and Bob Lange made racing ski boots; the company went public, then recalled 25,000 pairs over a liner material, and was eventually sold. He walked away with $80,000. In 1972 he started Jacobs Corp., making children's ski wear and adult cycling gear; he first sold 45% to venture capitalists, then sold the rest to García — which went bankrupt in 1978. The Hong Kong buyer asked him to stay on as vice president; he refused. He started two more companies of his own, one of them called Spyder: high-end racing sweaters, sold by mail order, made in Hong Kong, with a logo that had to be "powerful, a little menacing."

For the first two years it ran out of the family kitchen, with his two teenage sons, Bill and Jake, helping mail catalogs. To grow, he sold stock to Hanson in exchange for $75,000 and a warehouse; in 1982 Hanson itself went under first, and he either had to pay $50,000 to buy the company back or lose it. He had no money, so he brought in his Osaka manufacturer, Tsunehisa Shimokubo. The contract included a line he would go on to use again and again: once sales reached $2.5 million, Shimokubo's stake would be topped up to 50%. They hit the target in 1986 and became 50/50 partners. In his words:

The market isn't big, but I knew that if I could hold that small slice at the very top, there wouldn't be many people fighting me for it.

Fabrics came from Japan and Switzerland, insulation from 3M, snaps from Italy. In 1988 he landed the U.S. Ski Team, and Picabo Street and Tommy Moe appeared at World Cups and Olympics in spiderweb-patterned race suits. Sales went from $3.4 million in 1987 to $7.9 million in 1990, and the channel shifted from mail order to specialty ski shops. Jake went to the University of Colorado, to Los Angeles to study design, to factories in Japan, to Hong Kong to manage production, and was then poached by Nike to Singapore. In 1995 his father called him back as vice president of design and manufacturing.

By 1995, the company was stuck between $10 million and $15 million. Jacobs was nearly 65, and his money had always stayed in the company. Tommy Hilfiger, Nautica, Prada and Armani began making ski fashion, and Hilfiger ran a two-page ski ad in Men's Health. He said: this is my turf. His advisers' conclusion came down to two sentences — either sell the whole company or find a minority partner; selling 51% is the same as selling all of it.

In February 1997, Robertson Stephens took the materials to market. Nike was rumored at one point to want a majority stake, but went off into skateboarding and hockey instead. CHB caught his attention: its name was Closely Held Businesses — closely held. Tad Kelly said equity capital had become as commoditized as debt, "we have to offer more than money." They were willing to put in about $5 million and accept a minority stake, but required a minimum 30% return. After due diligence they felt the projections were too high, and proposed a stake that would slide with cumulative EBITDA from 1998 to 2002: if it fell short of $10.5 million, CHB would go up to 60%. Jacobs rejected the sliding scale and insisted on a fixed percentage.

On September 25, 1997, CHB invested an initial $2.5 million for 22%. By the end of 1998 at the latest it could invest another $2 million, bringing it to 37.9% fully diluted after both tranches. Jacobs and Shimokubo each kept 25.4%, with employee options at 11.3%. Kelly and Flanigan joined the board, and Blake Morris watched day-to-day operations. Board meetings went from "whenever I'm in Japan we meet and toss a page into the minutes" to formal quarterly meetings. They pushed the company to spend about $1 million on a J.D. Edwards ERP system — "if you want to build a $100 million brand, don't install a $10 million system, install a $400 million one." In May 1998 they brought in 31-year-old John Walbrecht from outside the industry, Dr. Martens' head of global sales and marketing. Marshall Field's in Chicago took a 1,500-square-foot concept shop. At the end of 1998 CHB put in the second tranche; Jacobs and Shimokubo chose not to take out that $1 million in cash.

The growth came with losses first, profits later. Walbrecht took the sales meeting, which under Jacobs had never cost more than $25,000, and turned it into a $150,000 launch in Vail, flying in 75 dealers from Germany and Australia. Kelly said it was a signal: Spyder was willing to spend money ahead of revenue and stake out its position in the market first. Walbrecht himself traveled 250 days a year, working out for retailers how to display the merchandise, what music customers should hear and what prices to charge. Morris boiled the industry statistics down to a one-page chart: third in insulated jackets, crushed by The North Face in shells — and only then did they act. Jake moved his father out of the design seat and expanded the product line and buying team the Nike way. Products expanded from the core $300–$1,000 line into kids' wear, snowboarding and a lower-priced line, and distribution reached Sports Authority, Dick's and Macy's. Europe switched from multiple distributors to direct sales. In 2000 the books showed a loss of $972,000, and the bank got nervous; they stripped out the one-time investments, and the bank accepted two sets of numbers, "before investment / after investment."

By 2004, the report card had turned a page. Net sales went from $27.3 million in 2001 to $61.4 million, jumping 52% in a single year; EBITDA went from $1.3 million to $9.6 million, with margin rising from 4.9% to 15.6%; net income went from $83,000 to $5.1 million. The Canadian and Austrian national teams were added. Retailers valued the high margins and high sell-through; Spyder's rule was always to sell one fewer — one fewer than the market wanted. Bill was also called back to run Northern California. CHB had tried to exit in 2002, but the market wasn't there; by the end of 2003 this was the only unrealized investment left in one of its funds, held for seven years, beyond the expected 3 to 5. Jacobs said there was a huge amount of cash out there with nowhere to go, and smart money was looking for brands.

An IPO was ruled out: the company was relatively small, could sell $22 million in June alone and almost nothing in January, and its working-capital borrowings swung from 0 to $23.4 million. They hired two investment banks to split the fees and responsibilities — Financo knew retail, Wachovia knew consumer products, and the banker in charge was someone they knew from the 1997 round. The last page of the case leaves three deals on the table: sell to another apparel company; sell a large block of equity to another PE firm; or he keeps control himself, and CHB can only sell its 37.9%.

The three questions in front of Jacobs:

1. Does this company's value depend on who owns it? Beyond ownership, what else determines the price?
2. By DCF, by trading multiples, by acquisition multiples, what is it worth? Do these numbers capture what really matters in a sale?
3. Of the three deals, which would he choose for himself? Which would CHB choose? Who else gets rewritten?

My Thinking

A company has no price independent of its owner

In the Nantucket piece, the same juice company was worth $47 million going it alone and $144 million inside a strategic buyer. The difference was the buyer's problem. In Spyder, the difference is whether the next shareholder will rewrite the company itself.

Strategic buyers — Columbia, VF, Nike, Adidas-Salomon — could plug Spyder into their own sourcing and their own stores. That's EBITDA that doesn't exist in the standalone model. Financial buyers don't have that. What they buy is the company as it is today, plus the governance they'll add, minus the extra leverage and a 3-to-5-year exit clock. CHB's own 37.9%, if sold on its own, is yet a third number: a residual stake that can't direct anything, can't go public and can't easily be resold, and buyers will pay less for it.

The harder part is the people. Blake Morris has one line that could carry an entire valuation: Jake and Walbrecht are "the creative engine of the company." The path in the selling memorandum — from $61 million to $166 million in four years, EBITDA from $9.6 million to $27.9 million — is a model in which they're still there. A strategic buyer that folds Spyder into its portfolio and pushes them out shouldn't pay for that path. A PE firm that lets them roll over their equity and keeps Jacobs on as coach can.

My own understanding is that ownership isn't a footnote to the DCF. It's an input that rewrites the cash flows. The wrong shareholder doesn't buy Spyder — they buy the brand that used to be Spyder. Hilfiger in Men's Health in 1995 was the first warning. The Snappleization in the last piece, Nantucket, was the same movie on a different shelf.

$100 million is a number you can say out loud; the DCF is a story hung on the wall

First, what can be defended.

Seven comparable companies, enterprise value over EBITDA: median 10.4x, mean 10.7x. Columbia at 10.3x, Quiksilver at 10.4x. Applied to the year Spyder just finished — EBITDA of $9.58 million — that's about $100 million. On sales, the median is only 1.13x, about $69 million — which still treats it as the 5%-margin company it was three years ago. It no longer is. Gross margin went from 39% to 49.5%, EBITDA margin from 4.9% to 15.6%. Europe moved to direct sales, scale arrived, the structure changed. The sales multiple misses this inflection point; the EBITDA multiple catches it.

Acquisition multiples write ownership back into the table. Strategic buyers, excluding the loss-making The North Face, have a median of 10.3x, about $99 million; financial buyers a median of 9.1x, about $87 million. The gap isn't large, but the direction is clear: control plus synergies is worth one tier; sponsor-style ownership is worth another.

The DCF is a different face. Using management's projections, a 35% tax rate, a 12% to 14% discount rate and an 8x to 10x exit multiple, enterprise value lands between $169 million and $204 million. That still requires 28% annualized sales growth for four years — after a year that already jumped 52%. This is the selling memorandum talking. FY2004 is still unaudited. One warm winter could change the tail years. CHB had them install an ERP fit for a $400 million brand; the DCF is that ERP talking. Buyers won't pay for the ERP's ambitions.

My own inclination: walk into the financial buyers' room with $90 million to $110 million, and into the strategic buyers' room with $100 million to $130 million. $100 million is a number you can say with a straight face. The DCF hangs on the wall to keep the auction honest, not for anyone to write a check against.

What's not in the tables is what you actually underwrite at closing

The multiples know the margins just appeared, and know 2004 is a better year to sell than 2002. What they don't know is whether Jake will sign.

A $186 million DCF that loses the engine is fiction. A $100 million check that keeps them and rolls the 11.3% of options in could be the better deal. Once channels cross, Christy's $600 jacket gets marked down to $300 at Gart — the board already spends half its time guarding against exactly this. A strategic buyer that pays 11x and then pushes into department stores, versus a PE firm that pays 9x and then writes channel protection into the covenants: this is where price and value part ways.

A 70-year-old Jacobs, CHB's overdue fund, two sons inside the company, the Japan line in Shimokubo's hands — none of these are in the discount rate. They're all in the term sheet: rollover equity, puts and calls, employment, non-competes, who can fire the conductor.

My own understanding is that the most important consideration in a sale isn't finding an even more refined multiple. It's getting clear on: next Monday, who's running this company.

He should pick the deal that keeps the engine

If I were Jacobs, I'd sell a large block to a new financial buyer. Take most of my own 25.4% out in cash, and let Jake and Walbrecht roll in. Keep a small slice only if the exit formula is written down in black and white.

Not a sale to an apparel company. That check is thicker, about 10 to 11x. It also hands both sons' careers over to an integration committee. He has walked this road twice: Lange sold into a bigger company, Jacobs Corp. sold into García, which later went bankrupt. He knows how this movie ends.

And not keeping control himself while CHB sells only its 37.9%. That was him in 1995 — "never below 50%." That man was 62 and still drawing the designs himself. The man today has already stepped back, and has said in his own words that being fairly cashed out matters more than controlling the direction again. Keeping control would give him something he just said he doesn't value as much, deny him the liquidity he says he wants, and leave his partner of seven years stuck with a residual stake.

The costs, stated plainly: he's no longer the boss. The new PE firm will want its own 3 to 5 years. Jake's second bite of the apple depends on someone he doesn't know yet. All of this has to be written down, not just sealed with a handshake.

CHB should keep the strategic buyers in the room to push up the price

If I were CHB, I'd want an auction aimed at a 100% strategic sale — while keeping two or three financial buyers in the process.

CHB's job isn't to protect the Jacobs family story. Its job is to pay back its first fund. Seven years, the last deal, a 30% target. At $100 million of equity, the 37.9% is about 8.4x, roughly 36% annualized; at a strategic $120 million, more; as a minority residual stake, it could fall back to around 30%, with its people still sitting on the deal. In 1997 Kelly said what they competed on wasn't money but expertise. In 2004 that line turns around: they don't have control, so they can't force the highest price. What they can do is run the process — two banks, one clock, more than one kind of buyer.

A strategic sale is the ask. A financial buyer taking out everyone is an acceptable close. Selling only the 37.9% is the failure case. If Jacobs refuses to sell his own stake, CHB shouldn't die on the hill of the highest price. A forced minority sale is worse than a slightly cheaper full exit.

What really gets rewritten is the next generation and that engine

Jake has been at it for 16 years, from the warehouse to the Japanese factory to Nike and back. In a strategic sale, he becomes an employee of a bigger company, or he leaves and the projections leave with him. In a financial recapitalization, he can become the public face. If his father keeps control, he's still the founder's son, waiting for a succession that hasn't been called yet.

Walbrecht isn't family. He's the man who turned a sleepy little company into a "player." A sale to an apparel group is where he runs into a corporate boss; a sale to a new PE firm is where he gets bought as an asset.

Shimokubo wants cash, and also holds Japan. Specialty ski shops buy Spyder because it's "the real thing," and because it won't turn up discounted at chain stores. The sponsorships of the U.S., Canadian and Austrian teams are a halo that a cost-cutting shareholder could pull in year one. The employees in Boulder are the reason Walbrecht could spend $150,000 on a sales meeting and have it work.

A deal's price is written in the multiple. A deal's consequences are written at these people's desks on Monday.

Takeaways for Arcus42

Reading this case, what came to mind wasn't ski wear, but a table we sit at almost every week: the first generation is past 60, the children are in the business, outside capital is on the shareholder register, someone wants liquidity, someone wants control, someone wants the next stretch of growth.

First, a family business has no price independent of its owner. The same factory is one number to a strategic buyer who would shut down lines, another to children who would keep the people, and a third to a PE firm that would add leverage and a time limit. The seller's job is to get the latter two numbers into the room, rather than accepting the first one as "the market."

Second, a minority stake isn't financing, it's control design. When Jacobs rejected the sliding scale in 1997, he was writing 50% into the contract at the front door. A friendly minority shareholder turns into an overdue seller. The clock should be announced on day one, not discovered in year seven.

Third, liquidity and succession are one decision, often sold as two. A strategic sale solves for cash and gambles with the next generation. A recap can do both, at a headline number one notch lower. The number to care about is the one that keeps the engine.

Fourth, key people aren't in the discount rate — they're in the term sheet. Who stays, how you pay them to stay, whether the channel can be crossed and discounted — if these aren't written clearly, the projections are just wishes.

Fifth, the 1995 line "never sell 51%" isn't the 2004 self. A founder's utility function changes. The record should date that change, rather than using a sentence from ten years ago to argue with the person of today.

Final Words

Before class, the line I agree with most is "ownership isn't a footnote to the DCF — it's an input that rewrites the cash flows."