Dr Martens’ shares have slumped by 85% since listing three years ago. Are they now cheap, or could there be more pain ahead for investors? In 2011, after 50 years in control, the owners of Dr Martens, the Griggs family, put the business up for sale. At first, they couldn’t find a buyer willing to pay the price they were asking. But eventually, in 2013, a deal was struck with private equity firm Permira for £300 million.
The takeover was for the assets of R Griggs & Co., the firm that manufactured and distributed the shoes, and for the right in perpetuity to use the Dr Martens brand. The actual ownership of the brand was retained by the Griggs family. In the year before the deal, the company generated £22.6 million in pre-tax profits on £126 million in revenue.
Permira owned the business for the following seven years before listing it on the London Stock Exchange in 2021. During its period of ownership, Permira expanded the company, with a fivefold increase in the number of stores worldwide and a twelvefold rise in online sales. In total, the seven-year ownership led to a tripling in revenues coupled with a quadrupling in pretax profits before the initial public offering (IPO).
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The firm, bought for £300 million in 2013, attracted a valuation of £3.7 billion in 2021. This included net debt of £250 million, so the enterprise value at the time of listing was close to £4 billion. Since floating, however, the shares have fallen considerably. Sales continued to rise for a time, but profits fell and even revenue now seems to be falling. Did a private equity firm really engineer such a jump in the value of the business, or was the supposed creation of value illusory?
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Is Dr Martens in decline?
The firm has blamed industry-wide softening of demand for boots, particularly in the important US market. The trend was exacerbated by falling sales via the internet – an area that was previously an engine for growth. The hope among management and investors is that there is a secular growth trend in place and that the business is going through a soft period. However, Dr Martens is a fashion brand, which is ultimately driven by the popularity of its footwear.
Fashion is cyclical; trends come and go. It is difficult to predict what brand or product will become fashionable ahead of time, but once it is becoming fashionable, the trajectory becomes entirely predictable as yesterday’s cool becomes tomorrow’s uncool. Whether through luck, judgement or a degree of well-timed investment in the brand, Permira’s purchase of the business coincided with Dr Martens’ footwear emerging from a long period of being considered unfashionable. From 2018 to late 2021, Google searches for the brand rose consistently, although its popularity was particularly pronounced in winter when people buy more boots.
In 2021 the tide turned, a fact easily inferred from Google Trends data, which is showing sequentially lower peaks in winter and lower troughs in summer. Moreover, fashion wanes with ubiquity and the inevitable consequence of a huge increase in sales is that there are a lot more people wearing the products. Things don’t become unfashionable overnight. It can take several seasons before something goes from being cool to becoming uncool, but once the process begins, it can be difficult to reverse. Dr Martens is in decline.
The consequences of becoming unfashionable are twofold. First, people buy far fewer products since the offering becomes just another pair of boots, which reduces sales volumes. Second, and potentially far more damaging, buyers become more motivated by the price than the style or brand. These less fashion-conscious shoppers are far more interested in the value of the product and are willing to shop for bargains or buy cheaper alternatives. This leaves a company with downward pressure on pricing and, with it, further falls in sales. As a result, when a previously fashionable brand is waning, sales can fall quickly. In these cases, operational gearing can be severe, so that a relatively small drop in sales can quickly wipe out any profits.
The most bullish scenario now is that this is indeed a temporary dip and the brand is on an upward trajectory of ever-greater popularity and sales. More likely, however, is that the brand is about to enter a prolonged period of being less fashionable, which could last for a decade or two, and the current value of the shares reflects that possibility. The group has an enterprise value of £1 billion. It holds £400 million in debt and other financial liabilities. The cost of servicing those liabilities is more than £30 million per year. Under a best-case scenario, the increase in sales outlets is indicative of an increase in sustainable sales. With the additional debt servicing, this would most probably leave the company able to generate £75 million or so in pre-tax profits and £55 million of net income. Applying a modest valuation of 12 times earnings would imply a value slightly below the current share price.
However, this might prove optimistic. A more pessimistic view would be that 11 years ago, the brand was unfashionable and worth £300 million, and it is becoming unfashionable again. Adjusting for inflation, £300 million in 2013 is £400 million today. A possible outcome, then, is that as the brand becomes less sought after, its value falls below the level of its debt. In this case, the shares are worthless and before long a highly dilutive rights issue is a possibility.
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