Date: Apr. 8, 2024
Fossil Group is a family-operated mid-market watch maker that faces significant operational challenges. The company's revenues have shrunk from $3.5B in 2014 to $1.4B in 2023, and by failing to gain market share in the smartwatch market, Fossil wiped out nearly $500M of shareholder capital through poor acquisitions, producing no excess cashflow in the last 5 years.
In 2021, Fossil issued $150M of 7% notes which are publicly traded under FOSLL. The debt is due November 2026 (roughly 2 1/2 years from now) which means that in addition to paying back the $150M in principal, Fossil will need to service roughly $26M of interest payments. The debt currently trades at 43 cents on the dollar ($10.75), yielding 16%—a true junk bond.
If Fossil is unable to pay the principal when it comes due, a bankruptcy proceeding is sure to take place. At this stage, all creditors (including businesses to whom Fossil owes payment for goods) will effectively be in control, and Fossil's remaining assets would be sold for parts. The question is whether there will be enough asset value left in this case to cover the principal, which I think is highly likely (for reasons outlined below).
If Fossil manages to roll over the debt or renegotiate terms with current lenders, breathtaking returns will ensue at current prices. Assuming full repayment at maturity, the principal would produce a 133% return on investment in addition to the 40% return through 2 1/2 years of interest, resulting in a total ROI of 173% and an annualized return of 49%. If the debt is renegotiated and maturity pushed out further and the principal then successfully repaid, the return should still be satisfactory, perhaps 30% annualized or more.
However, if Fossil enters bankruptcy before or at the maturity date, the balance sheet will be the primary focus for lenders. Perhaps to the chagrin of equity holders (but certainly to the benefit of the lenders) Fossil has gradually tapered its capital expenditures over the last decade, spending a total of $46M in CapEx over the last 5 years compared to $237M in the prior 5 years. If efforts to rightsize the company continue to fail, capital outlays are likely to shrink even further as the business liquidates unprofitable divisions, puts itself up for sale, or braces for bankruptcy.
In my view, it is unlikely that Fossil fails to repay the principal as management has a large personal stake in both the reputation of the business and the large potential increase in equity value if a turnaround is even moderately successful. If bankruptcy does take place, Fossil's current $117M of cash, $253M of inventory, and $188M of receivables ($558M total) are unlikely to evaporate between now and maturity in 2 1/2 years. A 383,000 sq. ft. distribution facility in Eggstätt, Germany may bring in roughly $40-80M in a fire sale assuming a price of €100-200 per sq. ft. The company may also find a new home for the debt, likely at higher rates.
In my view, the 7% notes (FOSLL) offer a substantially mispriced bet if held to maturity.