Further, in the consumer industry, the licensee will often (but not always) pay a guaranteed minimum annual license fee which effectively sets a floor to the royalty revenue income that the licensor can expect to receive.

Most brands are housed in operating businesses where the focus is not exclusively on the brand itself (Mickey Mouse at Walt Disney being a good example). This is why specialised brand management companies, commonly referred to in the industry as ‘pure play’ brand licensing firms, have come about. These firms focus on maximising the value of a brand through product extensions, geographic and distribution channel extensions. These licensors will typically have a network of manufacturers, retailers and other key parties to line up as partners in each geography and/or product category.

The industry spreads across many types of consumer goods; however, by far the largest category in terms of revenues is character driven, e.g. Mickey Mouse. Walt Disney is the largest licensor in the world, accounting for over $40 billion in global annual licensing-related revenues. The largest ‘pure play’ brand licensor is a U.S. company called Iconix, which is now in the top 5 in terms of global licensing revenues.

Fashionable brands like Calvin Klein and Harley Davidson are major licensors (PVH representing Calvin Klein). As you can see from chart 1, apart from Mickey Mouse and other characters, the industry is dominated by fashion, sports goods and brand names. In terms of companies dedicated to this business model, Iconix is not alone. Names like Cherokee, Xcel Brands, Authentic Brands and Sequential Brands Group spring to mind. Between them, the top 10 ‘pure play’ licensors represent close to $20 billion in annual revenues.

Are we facing a recession?

This research paper has been written because we see certain indications that a cyclical slowdown – which may or may not lead to a recession – is imminent (as within 3-6 months). How would that likely affect a portfolio of consumer brands?

So why do we think a slowdown is around the corner? Because a number of indicators we track have turned negative. The yield curve is flattening – a sure sign of more difficult times to come. Credit spreads are widening – another sign of more problematic times ahead.    

Most importantly, the credit impulse – both in Europe and the U.S. – has turned quite bearish recently. The credit impulse is a term coined by Michael Biggs, then an economist at Deutsche Bank, when he in 2008 defined it as the change in new credit issued as a % of GDP. Biggs showed that, in most countries, private sector demand (C+I) correlates very highly with the credit impulse (chart 2).

As C+I is an integral part of GDP, it follows that the credit impulse can be expected to correlate highly with GDP. The lead time is usually 3-6 months. Biggs argued that the important credit variable in terms of forecasting GDP growth is the change in the flow of credit, not the change in the stock of credit. Looking at chart 2, it is hard to disagree with him.

The reason this is important as far as consumer goods are concerned is that the credit impulse has turned quite negative in many parts of the world more recently, noticeably in Europe and the U.S. (chart 3). This is indicative of a forthcoming slowdown in domestic demand in those countries, possibly even a mild cyclical recession.

A general assessment of consumer goods’ cyclicality

The problem facing investors is that consumer goods industries are far from homogenous. Industries such as pharmaceuticals, food, tobacco, personal services and retail (e.g. pharma, food and convenience stores) would typically be included in a list of the most recession-resistant (i.e. non-cyclical) industries around today. For obvious reasons, consumers would always want (and even need) items such as soap, toothpaste and food regardless of the state of the economic cycle.

Having said that, the range of non-cyclical industries is actually wider than many believe. For example, when the economic cycle turns down, most people will actually drink as much beer and wine as they did in the good times, and some will drink more (and a few a lot more).

Other industries will benefit outright from an economic downturn. The sale of certain types of pharmaceutical products are known to increase when the economic cycle turns down, and certain types of leisure industries also benefit. Cinemas, for example, tend to experience rising ticket sales during economic downturns, whereas other, and more expensive, leisure activities suffer.

It is therefore fair to say that one cannot generalise and assume that all consumer brands will behave the same in an economic downturn. The idiosyncratic nature of the brand in question becomes critical. Male apparel may prove moderately cyclical, if many young men suddenly find themselves unemployed, but if David Beckham is spotted wearing a particular brand, the cyclicality of that brand may rather strangely (strangely at least to the uninformed) turn into counter-cyclicality.

An example: lululemon is an upmarket retailer of yoga- and other gym-wear. The company was founded only 17 years ago, but has managed to establish a bit of a cult following. It has in fact been so successful in doing so that, when the great recession took its very sizeable toll amongst many retailers in 2008-09, lululemon managed to grow its revenues and keep its profits relatively steady (chart 4). lululemon provides a classic example that idiosyncrasy matters a great deal in consumer goods industries.

The other aspect worth mentioning in this context is that an investment in a portfolio of consumer brands wrapped into a closed-ended fund with flexible exit terms is likely to prove significantly less cyclical than an investment of the same kind in an open-ended fund. Most recessions last a year or less, and few have embraced the economy for more than two years. A closed-ended fund with flexible exit terms can therefore time its wind-down to stay clear of particularly adverse economic conditions.

Without entirely ignoring more traditional cyclical factors, it is therefore fair to say that, in terms of cyclicality, it very much depends on the idiosyncratic nature of the consumer brand in question, and one would need to approach the subject on a case by case basis.

The proof is in the pudding

There is a pattern, though. None of the listed ‘pure play’ licensors that we have looked at correlate particularly highly with GDP (chart 5). Although our analysis is based on stock prices rather than revenues and/or profits (which we don’t have access to), you would expect their stock prices to correlate quite closely with GDP, should their revenues and/or profits be adversely affected by an economic downturn. The low correlations suggested in chart 5 is therefore another indication that consumer brand licensing is not a particularly cyclical industry.

Adding to our growing list of arguments, we have also looked at how the largest U.S. apparel companies (TJX, Nike, Gap, etc.) correlate with the S&P500 and with U.S. GDP. Although the results are not shown in this paper, we can confirm that correlations are typically within -0.25 to +0.25 so, in neither case, is the correlation in the ‘danger’ zone.

Conclusion

We conclude that the nature of the brand and the industry in question matters, but that it is only part of the story in terms of assessing the cyclicality of an investment in consumer brands. An investment in a vintage car retailer would raise our eyebrows, as vintage cars are known to be amongst the most cyclical consumer goods, but the idiosyncratic nature of the brand in question is very important and may often change the picture quite dramatically.

An example: In 2007 – a year before the great recession - Nike sold the dormant brand Starter to Iconix for $60 million. Starter has done exceptionally well and, through distributional channel, product and geographical expansion, Nike now receives an estimated $30 million annually in royalty payments.  

In other words, based on the evidence we have looked at in preparation for this research paper, and subject to the product(s) in question, it is not at all unrealistic to expect consumer brand licensing to deliver growing revenues and profits during less benign economic times. Adding to that, licensors have the added advantage of being able to acquire brands more cheaply during times of adverse economic conditions.

Finally, we take great comfort from the fact that the investment in question would be in a closed-ended fund. The closed-ended nature in itself doesn’t alter the cyclical nature of the brand in question, but it provides the manager with considerable flexibility as far as the exit strategy is concerned – which the exit value should benefit from.

Niels C. Jensen

21 August 2015