L Brands' Sale of Victoria's Secret at Risk

Narrow-moat L Brands’ LB majority stake sale of Victoria’s Secret is at risk, with Sycamore using the material adverse effect clause to unwind the deal. According to CNBC, Sycamore is asking to be excused from the transaction, given that L Brands shuttered stores after the agreement and failed to pay rent in April, supposedly violating transaction terms. Overall, given the pressure COVID-19 has put on already troubled retailer performance, we weren’t shocked to hear Sycamore’s attempt to escape its offer. We’ve recently seen similar changes to prior deals/structures recently; specifically, 1-800-flowers.com postponed its purchase of personalizationmall.com from no-moat Bed Bath & Beyond, and no-moat Gap rolled back its Old Navy spin-off. We expect the ultimate decision for completion or termination will stem from court decisions that determine what constitutes a material adverse effect, but it has been noted that pandemic was specifically delineated in the original agreement.

When the deal was originally announced in February 2020, we perceived the $525 million for 55% stake as a fire-sale price for the brand, implying the full VS enterprise would be worth $1.1 billion. The VS brand delivered more than $6.8 billion in sales and $223 million in operating profits in 2019 (down from $7.4 billion in sales and $932 million in operating profits in 2017). Now higher risk stems from lower cash due to the elimination of the transaction, the lower pace of debt paydown and a higher level of lease liabilities that are likely to stay with L Brands, weighing on cash flow. We plan to reassess the likelihood of Victoria’s Secret turnaround success under a consolidated business model and will adjust our thesis accordingly. For now, we maintain our $35 fair value estimate and view shares as radically undervalued. There’s been no update to whether Les Wexner will still step down as CEO without the business bifurcation, but we surmise such executive decisions are likely to be unchanged.

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