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Crocs Inc. (NASDAQ:CROX), founded in 1999, is one of the leading American footwear brands with a focus on comfort and style. The stock has gained more than 100% this year, and unlike many companies whose price growth has been due to overblown optimism, Crocs' market success has been mainly due to its impressive financial performance.
Based in Broomfield, Colorado, Crocs is famous for its iconic yet simple clogs, but the company has grown to offer a wide variety of footwear products, including sandals, wedges, flips and slides, that cater to people of all ages. The company operates in three geographic regions - the Americas, Asia Pacific and EMEA - and sells products in more than 80 countries via wholesale, retail and e-commerce platforms.
On Dec. 23, Crocs announced a deal to acquire footwear brand Hey Dude for $2.5 billion, and this announcement sent Crocs shares lower as investors became skeptical of the companys growth strategy. A closer look at this deal, which would be Crocs' largest-ever acqusition, suggests that the company is on the right path to creating long-term shareholder wealth, in my view.
The terms of the deal
Founded in Italy in 2008, Hey Dude makes light and casual footwear such as slip-ons for all ages and genders, which are priced around $60. Despite being privately owned, the company has recorded impressive growth in revenue and profits in recent years.
Crocs announced on Dec. 23 that it will be adding the casual shoe brand to its portfolio through a $2.5 billion acquisition, which will be funded with $2.05 billion in cash and $450 million in shares. All proceeds of the deal will go to Hey Dude founder and CEO Alessandro Rosano.
Rosano will continue to lead innovative product development as Strategic Advisor and Creative Director. As part of this transaction, Rick Blackshaw, who has over 25 years of footwear experience and who most recently served as the CEO at CCM Hockey, will be hired as Hey Dudes Executive Vice President and Brand President. He will also be a member of the Crocs executive leadership team and report to CEO Andrew Rees.
The Hey Dude deal marks the largest acquisition for Crocs to date, turning Crocs into a multi-brand company for the first time. Moreover, the acquisition will add to its digital presence, as Hey Dude already has a strong online presence and generates around 43% of annual sales from its online business compared to 36.8% for Crocs. Hey Dude is expected to generate revenue of $570 million in 2021 and will operate as a standalone division after the transaction closes in the first quarter of 2022. Crocs plans to build Hey Dude into a $1 billion brand by 2024, which also complements the companys goal to achieve $5 billion in sales by 2026.
Crocs reported an impressive 73% year-over-year increase in revenue for the third quarter, and shares hit an all-time high in early November. Vietnamese factory closures and widespread disruption in global supply chains affected the business in the third quarter, but the company was still able to deliver handsome returns. Crocs reported revenue of $625.9 million for the quarter, with sales in the Americas growing 94.5%, the Asia Pacific region growing 21.2%, and the Europe, Middle East and Africa region up 42.8% on a constant currency basis versus the prior year. Digital sales, which became more balanced across all regions, grew 68.9% to represent 36.8% of revenue versus 37.7% and 32.2% of revenue in 2020 and 2019, respectively. All regions experienced double-digit growth in digital sales, which is a promising sign.
The gross margin of 63.9% was an increase of 670 basis points compared to the corresponding quarter last year. Selling, general and administrative expenses of $196.7 million was an increase of 46% from the last year, but as a percentage of revenue, fell from 37.2% to 31.4%. Diluted earnings per share came to $2.42 compared to 91 cents in the third quarter of 2022. All these numbers suggest Crocs is not only growing fast, but is also increasingly becoming more efficient, which has paved the way for higher profits.
Crocs ended the third quarter with long-term debt of $686 million, up from $386.4 million in the previous quarter. Since the company will be tapping into more debt financing to fund the Hey Dude acquisition, investors should expect a further deterioration of its balance sheet health in the coming quarters. This is the main reason why investors are concerned, since taking on too much debt can often weigh down growth.
Despite temporary disruptions, the management expects 2022 revenue to grow over 20% compared to full-year 2021, supported by the strong momentum seen in global markets. The acquisition of Hey Dude will also help Crocs in the New Year as this transaction is expected to be accretive immediately following the completion of the deal. Margins will be negatively affected by $8 to $10 million because of expenses related to distribution center investments, but these capital investments are necessary to sustain high operating margins in the future.
According to Mordor Intelligence, the global footwear market is expected to grow at a compound annual growth rate of 3.54% through 2025. The rising demand for fashionable, trendy, yet comfortable footwear across age groups is a key factor driving the global footwear industry, and Crocs is well-positioned to benefit from this trend. India and China, which account for almost a third of the global population, will maintain their leading position in the footwear market, and Crocs has already rolled out several strategies to ensure a higher penetration of these two important markets. The long-term success of Crocs will depend on its ability to gain traction in these markets while mitigating the risks posed by similar items that are popular in these regions. Brand investments are likely to be a key feature in the next five years, and it makes sense to me to sacrifice short-term earnings in favor of securing the sustainability of long-term earnings growth.
The acquisition of Hey Dude was not cheered by the market, but I believe Crocs is doing the right thing to expand its product portfolio with a view of penetrating more international markets. The financial performance of Crocs in 2022 will offer many insights into the long-term potential of the company as the global economy recovers; next year is when we will really see whether the company can keep its momentum going.
This article first appeared on GuruFocus.