Despite the "retail winter" that Amazon (AMZN) has wrought on the industry, investors remain interested in finding defensible niches in the business. One meme that has gained some momentum is around "brands that control their product, distribution, and destiny." 

J. Jill (JILL) is a woman's clothing brand that started out as a catalog business in 1959. It was acquired by Talbots in 2006 for $517M. Just three years later it was "unloaded" in a sale to private equity firm Golden Gate Capital for $75M. Reports suggested that J. Jill lost $76M in 2008. Since then JILL has posted some growth (CAGR of 10%) and expanded their Adjusted EBITDA margins from 10% in 2012 to over 16% in 2016. As a result, EBITDA has doubled from $50M in 2013 to $105M for 2016.

JILL is a brand aimed at women who are over 35 and more professional. They company controls their brand, product and distribution with a combination of stores and direct (mostly online) distribution. This strategy has helped them "know their customer" and defend them from the destructive cycle of having excess inventory and constant markdowns.

Sales in 2016 are expected to be $639M (up 15% YoY) with most of the growth coming from e-commerce (up 25% to $245M) and retail stores still the largest segment at $363M. Catalog sales of $31M are the slowest growing segment and by our reckoning an unprofitable business that should be scaled back if not eliminated.

In terms of market opportunity, JILL believes they can expand stores from 275 to 375 over time which would generate $500M in that segment. They also target direct sales of 50% (versus the current 38%) which would add another $500M in total sales. So the long-term opportunity for JILL about $1B in sales (more if they can improve same-store results). They can probably improve margins a bit more over that time period where Adjusted EBITDA can approach 20% and FCF margins can be 10%+.

Some points on the deal

The company is offering 11.7M shares but they company won't receive any proceeds since they are coming from an existing stockholder. At the $15 mid-point the market capitalization will be $655M (43.7 million shares) with debt outstanding of $277M in the form of a term loan. That puts the EV/Sales ratio at 1.45x.

Based on the "aspirational" names like Kate Space (KATE), Duluth (DLTH) and Lululemon (LULU) the valuation looks very reasonable - the group trades at 2-4x sales. Other top names like Coach (COH) trade at 2x sales.

But many "successful" retailers trade at much lower ratios. We're reminded of names like Vera Bradley (VRA) which stormed out of the IPO gates. The stock reached $50/share in 2011 for a market cap of $1.7B on sales which was 4.6x sales. Higher growth (27%) was being driven by what turned out to be a minor trend toward very loud patterns for women - kind of like a Tommy Bahama meets Laura Ashley kind of thing. Now VRA is at $9.40/share and trades at 0.7x sales.

Positioning

It's not surprising that management selected the best (highest value) comparable companies - but how are they really positioned?

Unlike the unfortunate Vera Bradley, J. Jill is fairly neutral in their design style, low-key patterns and natural fabric choices. Their clothing is practically "anti-designer" with big shirts, stretchy pants, flowy sweaters and tops. The clothing is comfortable and casual but in some cases niche enough for professional (not corporate) environments. The closest competitor is another startup (1984) called Eileen Fisher which probably skews a little bit older and a little less sporty.

The one standout item for us on JILL is high margins. Combined with solid execution and consistent growth the high margin amplifies returns for shareholders. For example, gross margin expanded to an industry leading 68% in 2016 versus an already-high 63% in 2015.

Based on profitability and growth the deal looks solid at $15. We would be very cautious around the end of the lock-up period. TowerBrook is selling 11.7M shares in the IPO but will still have 25-26M shares "to go" when they are free to sell. Insiders may wish to take a little money off the table but with under 4M shares they won't have as much impact.

A few wrinkles

In the course of looking through the IPO roadshow slides, S-1 filing and our own transcript of the JILL roadshow, we noticed a few things:

1. The average customer spends $375/year which seems low. While that suggests multiple purchases - the total amount is less than one designer dress on sale. The company points out that "good customers" that buy through both stores and online spend more - about $800/year. Bull will say this gives the company room to increased revenue per customer but they have been around for decades.
2. Management has been well-compensated. Salaries look a little high. For example the CEO gets more than 1% of company revenues as a base. We'd like to a compensation mix with more variable compensation.
3. Retail is still challenging and not getting any better. There are routine reports from employees about poor working conditions in the stores, and outdated support systems. Customer reviews are somewhat scant since the J. Jill target customer tends not to be an avid user of sites like Yelp.

Conclusion

J. Jill is a solid if unexciting IPO. Investors may face some longer-term questions like what happens after the lockup expires and who would be the natural acquirer of this business as it grows toward their $1B goal?