What You Need to Know About This New Retail IPO

As the largest direct-to-consumer retailer of plus-size women’s clothing in the U.S, Torrid (NYSE:CURV) is looking to change the way consumers think about making clothing purchases. But is Torrid revolutionary or just rehashing the past? In this episode of Industry Focus: Consumer Goods, join Motley Fool Analysts Asit Sharma and Emily Flippen as they dive into this recent IPO.

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This video was recorded on July 27, 2021.

Emily Flippen: Welcome to Industry Focus, today is Tuesday, July 27th, and I’m the host of this episode, Emily Flippen. Today, I am joined by Motley Fool senior analyst Asit Sharma as we take a look at the largest direct-to-consumer retailer of plus-sized women’s clothing in the United States — that is a mouthful — Torrid. Asit, how are you doing today?

Asit Sharma: Emily, I’m fine. Good to be back with you on the show.

Flippen: Yeah it is. You had a week off.

Sharma: True.

Flippen: It’s good to have you back, and this was a business that we had talked about covering a couple of weeks ago. We ended up replacing it with Crocs. But it’s worth circling back around on, because when I was in the mall, as listeners will know, at the Crocs store a few weeks ago, there’s actually a store right across from it in my local mall called Torrid.

This is an interesting business. They actually recently went public. I think the market maybe didn’t quite give them the nod that other IPOs have gotten. It is a really interesting retail business. As I mentioned before, they have a really well-known direct-to-consumer brand that’s aimed at plus-sized women’s clothing in the United States. Certainly, an interesting and potentially really lucrative market.

Sharma: Yeah, and I think a key word here is “underserved.” Lately, Emily, I’ve had a fascination with markets that just have been ignored for one reason or another over the years and that now have more of a focus on them. Because, again, for those of you who maybe are newer to investing, one of the things you look for is a market that itself is growing and expanding. When you’re looking for investments that can return you great operating profits and a performing stock over a long period of time, and this certainly, I think, is one of those.

Flippen: Definitely. They claim to have very long-standing relationships with the intent of building up trust with the 90+ million plus-sized women in the United States. These are women who wear what they call size 10 or above.

I always have a bone to pick with women’s clothing retailers, because sizes in the United States for women’s clothing are not standardized. It’s a kind of meaningless number when you talk about size 10 or above. But it is aimed at people who, for traditional sizes, what they call straight sizes, haven’t quite worked. So like clothing that hasn’t been tailored to specific body types.

Torrid has found that for these 90+ million plus-sized women, their No. 1 priority is actually just fit. They want something that fits well. Torrid has really made this their extreme focus in developing their merchandising and product line.

Sharma: Yeah, fit is so important, and we’ll talk about the company’s CEO, Liz Munoz, in a second here. But you really identified something that she is fond of saying: “What do those customers who wear plus-size clothing want?” They want what the rest of us want: They want a good fit, and they want clothes that are comfortable, that are functional, but also stylish. “It’s not that hard to figure out” is what her message is.

At the same time, this is an overlooked part of the fashion retail industry. I think when we dig a little deeper into this company, you’ll see why it’s not a straight line to hit this part of the market and do it well. We’ll say it’s interesting.

Emily, you mentioned that sizing in the U.S. isn’t standardized, and you also mentioned the size 10 and above. Ten is like a symbolic size, I think, where you enter the limit of what it’s called straight-size clothing or traditional clothing into the larger-sized market. That seems to be a number, even though nothing is standardized, like a magic number. We’re going to talk about some sizes that are in excess of that today.

Flippen: Yes. And I will also say that Torrid, while trying to serve this market, they’re not trying to be fashion leaders, which I think is an interesting angle that Torrid has taken with their approach. What they’re trying to do is just internally design and develop their own products that they call vertical sourcing in order to provide just consistency, both consistency in the type of product but consistency in that fit.

With that 90+ million demographic, they’re only selling to about 3.2 million active customers, and they’re doing it via a mix of both e-commerce — which is obviously as we all discovered last year, but also, we’ve been alive for probably the past 10 years so we know the growth of e-commerce. But they’re matching it with in-store sales as well, which has been what some would argue, really critical for this demographic, because again, sizing is not standardized so going out and making a purchase online without having any sense, I guess, of what that size is going to feel like on you can be more challenging.

Marrying the e-commerce with the in-store experience has been really critical for Torrid to increase their sales, and what they found is that customers who have purchased both online and in-store make around eight purchases a year in comparison to just three purchases for people who only engage over a single channel.

Sharma: It’s very interesting that Torrid doesn’t describe itself as one type of retail or another. They call themselves a direct-to-consumer company. They even don’t like the term “omnichannel,” although they use it. What they prefer to think of their stores as is an experiential type place where the priority is, yes, to sell that piece of clothing, but to also make sure that the customer is comfortable and gets to the fitting room and can try on some sizes that she doesn’t have to buy today is the message that management has given in various interviews as the company was gearing up to go public.

It’s really about getting in touch with the brand, understanding that you’ve got a place to go if you do want to come in and try on the new look. But the emphasis isn’t on any single point in the channel. Although, as you mentioned, the e-commerce part right now is the predominantly or the biggest part, I should say, of the total revenue line.

Flippen: Yes, and that was certainly catalyzed by 2020. I think e-commerce was something like 70% of sales in 2020. But it was still very e-commerce-oriented even prior to the pandemic. I believe e-commerce was around 48% of sales in 2019. This is definitely something that management has been executing on far prior to just last year.

But I think it has catalyzed that omnichannel experience because now, people who have been engaging with Torrid maybe only in-store are aware that e-commerce is an option. They can increase their repurchasing rates.

I will say something you asked me before we started taping today, which was an interesting question, one I had to think about was, do I really own any retail businesses in my portfolio? And I think having some more minutes to reflect on my portfolio, I don’t think I do. I don’t think I own a single pure retailer. And I do think it has been because I have this perception of what a clothing retailer is, especially a business like Torrid, which has stores in strip malls and regular malls, I guess a model of customer experience and purchasing that I just view as outdated. But they’ve certainly been capitalizing on it well, and I guess expanding a demographic of consumers that has just been really underserved.

Sharma: I sprung this question on you a few minutes before taping and we were chatting beforehand. I would say, Emily, I can’t think myself of a retailer that I own. But I do own one, now that I’ve given myself some time to think about it, which is Canada Goose.

But the interesting thing is, Canada Goose is a niche retailer. They make these incredible parkas that start at $800 and go on up into the thousands. But they also have a store footprint that’s experiential. They’ve got rooms that simulate an Arctic environment. You can walk into a subzero room with their coat on in a shopping mall. This is more to be found in Canada, their flagship stores there, but a few here in the U.S. as well.

Yeah, I really think it’s a hard model, but when you get one that’s tilted toward e-commerce like this with the express purpose that that physical footprint is about the experience, it’s about the learning process so you can choose to buy in-store or out-of-store, a model like that can make sense. I feel that for myself personally, when markets really crash, it’s the time that I’m more interested in taking a look at companies like a Torrid or a Canada Goose or some of the more e-commerce direct-to-consumer companies that we’ve talked about recently, like a Poshmark or Revolve, these types of Internet fashion retailers.

Flippen: That’s a really good point to make: discretionary spending, in particular for retail businesses, especially those that have such a big retail footprint like Torrid does. They are more sensitive to those changes, and it can feel more compelling when maybe the economy is doing worse than it is right now.

I’d tell you about what will almost convert me on this business though; I got to see some metrics that I feel I haven’t seen broken out in such a clear way for a very long time, and that’s the lifetime value-to-customer acquisition cost. I think it’s pretty impressive.

I will say this is the 2015 cohort that Torrid is using when they talk about this number, so arguably one that’s potentially outdated. But the 2015 cohort had a five-year lifetime value-to-customer acquisition cost of around 7.4 times, meaning they’re making that much more money than it costs to acquire that customer over their life cycle. Ninety-five percent of their sales come from people who are members of at least one level of their loyalty program. That to me says that’s a lot of customers that really identify with this brand and will continue to make repeat purchasing.

Sharma: No. 1, Emily, I’m happy that they included those metrics, because I know you’ve been miffed. I think the last seven IPOs, you’ve been miffed by the lack of detail. What is going on with this customer acquisition costs? But I have learned from you in that space of time that it is really important to focus on those unit economics, because man, they play out in the financial statements. I was happy to see this too.

You mentioned when we were prepping for the show that the company has a Net Promoter score of 55. Now, a Net Promoter score is just a measure of advocates versus detractors in your business. We’re used to seeing companies tout a score of 70 or above on this metric. We look at a lot of tech companies where they are very focused on easy-to-understand products without a lot of variability and they can put a lot of money and time and resources into customer service.

Retail is a different industry. The return rates are really high. It’s a very subjective industry. When you buy a piece of clothing, sometimes you take it home and you realize it’s just not for you, and you return it, you’re not as satisfied. Sometimes, that’s on you.

And I have had this experience. I’m not the best-looking guy in the world, and sometimes I’ll put on a shirt and be like, “What are these people doing? My shoulders look so skinny in their shirt. What’s up with that?” The truth is, I studiously avoid going to the gym. This is really part of the equation I ignore. But my satisfaction with that clothing retailer dips a bit. It’s a really subjective experience.

You were saying, “Hey, 55? Not crazy.” But it’s pretty good for a retailer like that. And you were describing how that, you think, is really contributing to this repeat business that they are very good at and the customer loyalty which they seem to be developing as they grow as a brand.

Flippen: I tend to be critical when I see low Net Promoter scores because it can be gamed, I guess. The companies that report it tend to be an industry’s tier point that have a much easier time having somebody saying, “Yeah, of course, I’d recommend this to my friends.”

Retail is a different beast, and when I got into some of the, I guess, criticisms of Torrid, it was everything you’d expect from a retailer. Their return policies weren’t favorable. Some of their stuff fell apart. It took too long to ship. “I didn’t get my refund. The store credit card was challenging for me to use.” All of these, I would say, are legacy problems, as if they’re old, but in reality, they’re still challenging for retailers to this day.

That Net Promoter score, that NPS of 55, I think is not terribly notable, but it’s higher than most retailers, and when I combine it with the fact that 82% of sales in 2020 came from prior years’ customers, that to me says, the people who are promoters of this business, the people who are contributing to that 55 are the same people who are driving the majority of their revenue. I care less about the people who are having a hard time returning their shoes or some clothing that maybe didn’t fit the way they wanted to and more about just constantly getting more purchases from the people who are big promoters and lovers of the brand.

But I know that you mentioned the CEO at the start of the show. I spent very little time in today’s prep looking into her: Liz Munoz. I cannot pronounce her last name.

Sharma: I think it’s Munoz.

Flippen: Munoz, excuse me. I clearly didn’t spend enough time because I can’t pronounce her name correctly. But I saw when I jumped on our outline this morning that you had added a lot of really interesting information about her. In my attempt to maybe clear up my blind spot before we started taping, I did find her Instagram, and I wasted a good 20 minutes scrolling through her Instagram, and it made me feel really compelled about the leadership of this business.

Sharma: Such a great point, Emily. Liz Munoz has a really fun Instagram. She is very stylish. She is a Latina and has just a celebratory vibe about her. I too was impressed just scrolling through, and I think it’s important.

There’s so much to look at in a prospectus. I think you and I are less focused maybe then some at The Motley Fool on the requirement that a great business has to be founder led. Sometimes, that just doesn’t happen for one reason or another. Often, you will see a company that is doing well in its particular market helmed by a person who is really interesting and has a great backstory.

I think Liz Munoz has that. She has been with the company since 2010, has been leading it since 2018. In the press releases that the company puts out about Munoz periodically, she is a self-described — I’m putting this in quotes — “big girl,” and she’s got a very personal connection to this brand.

Her story is that in the 1980s as a teen, she sewed her own clothes because of a lack of clothing options for plus-size women in stores. In various interviews, she’s talked about the experience of going into the store and looking around to see if there is anyone else that she knows, because in years past, plus-size clothing was something that was associated with shame. She actually sewed her own prom and wedding dresses and started her career in the jeans business as a pattern maker. She worked her way up through the ranks of Torrid over a period of eight years. She was promoted to the CEO position in 2018.

The thing that I find so interesting about Munoz is that she is a product person. As she was working her way up through the company, she focused on fit. That was her big thing. From her experience as a teen, she loved patterning, she loved the way clothes fit. She had this team, they would spend 40 hours a week fitting between 140 and 175 professional models, live models, every day. The company says that over 3.5 years, she fitted 36,000 items of clothing on professional size 18 models. She even would fly customers overseas to the manufacturers of the company’s intimate lines so that the engineers could see the diverse bodies they were molding bras for.

I found this really similar to various experiences I’ve had in the tech industry, where you have a founder who started working as the designer of a product and then built a company around that. She didn’t build this company. But I think for this marketplace, the fact that the company describes its focus on fit as maniacal, I think it’s a source of competitive edge. I think they’re lucky to have a CEO in Munoz who just is so drilled in on this one aspect.

She says that the company has broken a lot of traditional fitting rules as it designed products for its customers. She’ll say, this is so interesting, once a fit for a certain garment is settled, at Torrid, you need an affidavit to change the fit. If you think about a shirt or a skirt or a pair of jeans that you will buy at any retailer within a year or a couple of years, that very same style may have a slightly different fit. Now, let’s exclude Levi‘s jeans, which seem to never change. They got the 501, 505s, those always have the same fit. But as you move up the fashion chain, this is a phenomenon of straight-size clothing. The manufacturers, the designers, don’t care that the fit never changes.

But in the plus-size industry, you want consistency, and she has pushed this as of the person who wears plus-size clothing herself. Munoz says, “You just cannot change in our company a fit once we establish it.” Now, they can introduce a new line of clothing or a new product, but that is something that as a loyal customer, you can buy again and again and again without having to worry that suddenly, “Wow, this doesn’t flatter me anymore. They changed the game on me.” I think that’s a competitive edge, as I said, as the company moves forward to try to grab more of this market.

Flippen: It’s very rare that 1% or one aspect of a business really changes my mind about it from the perspective of an investor. But in this case, I think Liz actually does.

I will say I did a bunch of research into their ownership. Sycamore, a big PE firm that has invested in a ton of different retailers, owns 75% of this business. They have controlling ownership. I, as a result of that, didn’t even think to look into the CEO, because in my mind, I thought to myself, well, it’s probably a CEO that Sycamore has put in place that cares not at all, I guess, about the mission of Torrid.

In my mind, I was thinking this is a marketing play. This is a business that is taking clothing and marketing it as clothing that has been especially tailored to fit a certain demographic, trying to play off of that marketing angle and make a pretty penny, but they’re rinsing and repeating this retail model.

I think I felt very skeptical about how revolutionary Torrid could be given its funding, given its mall presence, all these sorts of things. But I think Liz, if you just take five minutes to read about Liz, to your point, Asit, hear about her background, I think this is the perfect CEO for this business. I think she is obsessed with Torrid’s mission.

I actually think that this IPO and the potential cash-out from some of their PE ownership could put her in a position where she can actually make meaningful change in this business and really raise the stakes at Torrid from being just another plus-size women’s retailer to being the go-to plus-size women retailer in the United States. Actually, coming out of that, I changed my opinion a lot about the business purely because of the CEO.

Sharma: Well, Emily, let’s delve into that market opportunity to see if Liz Munoz and team can really exploit this.

It’s interesting that we’ve got this perception, many of us, that the plus-size market is a specialty market. But in the company’s prospectus, they point out that two-thirds of all U.S. women are actually sizes 10+ or plus-sized. That market, however, is only $85 billion a year in comparison to the $96 billion-a-year market for straight-size clothing. It is an underserved market with less spend.

But Torrid things that this underspend is a huge opportunity in and of itself. It’s on the order of $20 billion a year, which leads to a total addressable market of $104 billion. They think this market is going to grow itself annually at a 3% to 5% compounded annual growth rate.

In their prospectus, they have some really interesting stats that are convincing and make me think for a really long-term hold, this company has some appeal.

They note that there’s only one dedicated women’s plus-size apparel store for every 51 women, especially apparel stores. Just to break that into a different slice of statistics, there were approximately 78,000 plus-sized women for each dedicated women’s plus-size apparel store in a survey that they used, as compared to about 700 women for every other women’s specialty apparel store. That’s a huge differential, and it just shows you the opportunity in this market.

Now, the spend in the market is smaller, but the growth is there, and also the company’s small slice of this. It is interesting to note that it’s a fragmented market. As you would expect, Emily, there are a lot of smaller competitors. There are some bigger, well-known names like Lane Bryant.

But the biggest message here is that the average plus-size woman is underspending on apparel and intimates annually when you compare her to a non-plus-size peer. That’s where this company sees some revenue gains ahead, which should translate into higher profits and cash flow in years ahead.

Flippen: I think there is the argument that some will make that as well, maybe this demographic just isn’t as interested in buying clothing as the straight-sized market it is. You can make a social argument that even if we do have specialty retailers aimed at serving, they will never purchase at the same rate that the traditional straight-sized market will. I guess while we will answer that question, Torrid’s performance may answer that question for us. I tend to think that’s not the case.

For instance, I have very unusually large feet. When I walk into a store, there’s usually only a few selection of shoes that will be in my size. I often walk into a store wanting to buy a pair of shoes but leave without any pair of shoes because there were no cute ones in my size. I had three options, and I didn’t like any of them.

That experience is very similar for people who are not in a straight-sized market. They walk into an H&M, they walk into a Forever 21, just naming off some female retailers here. Straight-size shoppers can look over the entire store, but then people who are plus size have “Here’s your small section of the store that’s aimed at serving this demographic.” You walk over there and you’re like, “Well, I just don’t like any of these things. I don’t have the same selection or options that the majority of the store is laid out for.”

I think that is the reason for the underspend. I could be wrong, but if I had to bet, I would think that’s the reason for the underspend, not a lack of interest in making more purchases. I do tend to agree with management here that this is an underserved market for which the addressable market could expand. I think it’s probably going to grow at a faster rate than the straight-sized market is and probably going to increase the average spend with time.

Sharma: Yeah, I think you’ve put your finger on it, Emily. In fact, I remember reading Liz Munoz talk about this phenomenon. Her conclusion is that if you have this experience a couple of times, walking into a store and not find anything that suits you, what’s going to happen later? You’re just going to give up. What’s the incentive to keep going back into stores if you never find what suits you?

That’s why that part of the market maybe is quieter and will grow louder as attitudes change toward plus-size clothing and messages of diversity, of inclusiveness, changing aesthetics start to take hold in our society. I think that’s only positive in terms of choice that people have for apparel. I think it’s part of something else. It’s a positive trend in our society in general. As much as things often seem to be heading the wrong way, we as a society are widening our view of different things where we’ve had fixed opinions in the past. Again, this opens up new markets for investment so you can have your cake and eat it too in that sense.

But tell me something. Why wouldn’t a traditional retailer just jump into this market? What’s so difficult for traditional retailers to get about this and to participate?

Flippen: It’s been related to the cost and issues of running an entire second line for traditional retailers even serving the plus-size market, because most brands will start with what is a smaller model and then tweak those adjustments upward. The result of that is a fit that doesn’t really suit the sizes that they’re making it for.

What Torrid — and admittedly other retailers, Lane Bryant being another good example do — is they start with their average-sized customer, which, for Torrid, it’s typically around size 18, and then tweak from there. The clothing is made for their average demographic in a way that is really challenging for traditional retailers to adjust their entire product line to make those changes.

You can say, well, yes, the retailers are becoming more aware of this, and they are making these adjustments, taking on the cost, which some estimates have it at over half $1 million just to get into the plus-size apparel market. They’re taking on these costs to serve this market.

But if you look at the stats — and I love the stat from the NPD Group from 2019: Less than 20% of apparel is made in sizes 14 or larger, which represent 70% of women in the United States. Even with the awareness from traditional retailers that they need to target this demographic, they’re clearly not doing a great job because it’s not even just sales, it’s actual manufacturing of apparel that suits their needs is still significantly less than the total markets.

Sharma: It’s true. I think that the traditional straight-size retailers, they really struggle with both design and development, that whole process for plus-size, because it’s more intricate and it requires a lot of stuff that just aren’t as much of a consideration in straight-size clothing. You’ve got non-conventional placement of seams, you have strategic use of microfiber and stretchable fabrics, all kinds of design considerations.

In fact, there is a really great graphic in the company’s prospectus where they show different garments and how there are adjusted for the plus-size markets, such as boots with a wider calf and ankle, coats with super-stretchy, brushed fabric, so that gives you both a close fit, but it’s also comfortable.

How they manipulate the imagery to be on trend is something else we don’t think about. Traditional retailers, sometimes they feel they’ve made it to the finish line if they can just get the size right. Actual cool design becomes a secondary consideration. Again, if you look at Liz Munoz’s Instagram, their clothes are cool. There are clothes that you would want to wear, they’re fashionable, they’re on trend, but there’s so much into this.

I’ll just, before we move on, just mention that even their cotton is a proprietary cotton-spandex mix, which gives it more stretching capabilities versus a typical fabric. This type of clothing, if you can master it, can become its own edge in and of itself. It’s so hard to do.

Flippen: Let’s talk about their financials a little bit, because I think this is maybe where the arguments start to fall apart.

For me, their financial performance, despite having a really great breakdown of the lifetime value-to-customer acquisition costs, as I mentioned earlier, doesn’t really show up in terms of bottom-line profits or even just free cash flow generation.

There’s a few reasons for this. I think part of it is because they do rely a lot on third parties for manufacturing. Using third parties for distribution, that can tend to be a bit costly.

But they also just have a ton of money in long-term debt. I think Sycamore has really loaded them up. They used some of that debt to do stuff like pay Sycamore a nice, pretty dividend, something we see, unfortunately, pretty often with this type of PE involvement. But that’s really prevented the company from gaining a lot of actual earnings.

While they’re profitable, their net income has actually fallen pretty substantially from $87 million in 2018 to just $25 million over the last 12 months as of May 1st, 2021, despite the fact that their sales have grown, active customers have grown, adjusted EBITDA has grown. It made me a little bit nervous, I guess, in terms of just pure financial performance for this business.

Sharma: I agree. It was hard for me to get a gauge on the financials. Typically, when a new company comes to market, you get three to five years’ worth of financial performance, and you can pretty much draw out the trends. Now, once in a while, there will be a kink in the progression. You’ll see a couple of years of strong growth and then an off year and management explains it.

But here, we’ve got a company that had an off year, the next year was the pandemic year, and the progression of these really clouds exactly what’s going on. In the year that ended February of 2020, their fiscal 2020 year, they had a lot of trouble managing their growth. They had difficulties with their inventory. They brought on a new chief operating officer, and the COO reduced their stock-keeping units by 20%, instilled a lot of purchasing discipline.

But you know, while the company says that this was just a growing pain, this was the issue in that year, their marketing expense also jumped, and their interest expense jumped from $1 million in the prior year to $16.5 million that year as new debt was added to the balance sheet. And we will return to this point Emily mentioned in just a moment.

You follow up that year with a year in which no one was going into the stores because of COVID-19 and the top line drops by about 6% to $974 million. Net income drops again. We’re looking at progression again, $87 million in the year ended February of 2019. Then the $42 million that you mentioned is down to $25 million. You just have a declining trend, and we’ve got to give them a path for last year as we’ve given every other company that we’ve talked about, except a few that really catapulted their sales for various reasons during the pandemic. But it just gives one pause that the company hasn’t been able to manage its growth a little better.

Here we come to the role of Sycamore, which still owns, as you mentioned, a majority of the company. I will note that none of the proceeds from the IPO are going to the company’s coffers where it can use it for growth or R&D, product optimization, etc. This is really just Sycamore cashing out a portion of their investment. Nothing wrong with that, but still, you’ve got a third party that can call all the shots, and this becomes important when you think about the debt.

Emily, if you can describe for us the debt picture here — and I know you’ve got a couple of comments too — it’s crucial to understanding the rest of this story.

Flippen: At face value, the business has around $340 million now in long-term debt. That’s not including their lease obligations, which, you could argue, is a form of debt. But to me, the more concern is Sycamore’s role, I guess, and how levered this company has become. They recently increased their total financing, in part to pay down higher interest term loans, but also, to make a pretty hefty distribution to Sycamore.

I noted that out of the new term loan they took out, again increasing that debt to $240 million, there’s $130 million distribution to Sycamore. Then you mentioned that they actually had a cash distribution, I believe, of $170 million, if that’s correct, on top of that.

Sharma: On top of that. Essentially, they sent $300 million to Sycamore. Part of it was in this refinancing, but then they took about I think it was $168 million to $169 million, almost $170 million, off with their own balance sheet. The last balance sheet we have, the pro forma balance sheet which says, “Hey, after the IPO, this is pretty much what the balance sheet is going to look like, cash is down to $19 million.”

When we talk about cash-out, we’re talking about two things here. We’re talking about Sycamore being able to sell a portion of its shares as the company went onto the public markets, but also the combination of this distribution in the refinancing that you’re talking about, Emily, and this other distribution around the same time, right off the balance sheet.

This is the peril of a company. On the one side, we’ve got a really great story here. I think a market which is so interesting. The CEOs we’ve talked about are very dynamic, but you’ve got these private equity owners. — And we should mention here that they are also part owners, Sycamore is part owner, of competitor Lane Bryant, also Loft, Hot Topic, Talbot. other companies which also specialize in the plus-size market. I find that interesting as well.

But the bottom line here, just this thing out of the balance sheet, demonstrates what can happen when a big private investor can really influence what is happening with the resources that a company has to operate.

Flippen: Sycamore has definitely treated Torrid, especially recently, more like a piggy bank than a business that they think probably has the opportunity to aggressively grow. I think their distributions are a good example of that.

The only other fear I have is even before these big cash-outs under their previous term loan, they had issues just keeping up with the covenants of that. It required them to take a $20 million cash distribution from Sycamore to Torrid just to ensure that didn’t actually accidentally default on one of the terms of their prior credit agreement. And with this new agreement, that has a lot of the same caveats that the prior one did, for instance, to debt is floating rate, which does expose them to, I guess, interest expense if rates increase. But they also have provisions that require prepayment starting in 2022 based on a portion of free cash flow.

Despite the fact that we should give credit where credit is due in terms of the operating cash flow that Torrid does continuously generate, the free cash flow, I think, is more impacted as a result of these prepayment obligations under their term loans. It’s just that they’re heavily indebted that it makes me a bit nervous.

The only other thing, which I of course have to add. We talk about risks with businesses is a business that has material weaknesses which actually resulted and the necessary restatement of prior financial performance, which, to me just becomes that much more frustrating that we had a private equity firm that just underresourced, understaffed such a critical component of our business, especially that prior to an IPO. There’s, in terms of the balance sheet here and trust that I have with, I guess, Sycamore, it doesn’t excite me.

Sharma: Interesting. I agree with you. This is such a cloud over the investment thesis. I read that this was Sycamore’s first experience with actually taking one of these companies in this industry public, but the manner in which they did it really creates a lot of doubt going forward.

I actually am not worried about the debt obligations, because now they’ve got an owner whose value is in these public shares. They’ve sold out, and I forget the exact figure, 30%-odd of the company, but the majority still exists in the viability of this as a healthy company and a company whose share price will rise if they want to sell more shares in the future.

I can see, if push comes to shove, that Sycamore, like other companies we’ve seen where this relationship is prevalent. A lot of venture capital or private equity ownership accompanied with a certain amount of its float that’s public. The big-pocket owner step in and supply some cash on difficult terms, but the company’s phase of float.

More to the point though, is, I think what’s implicit in everything you just said, Emily: Where is the investment? Where is the parent company coming in and saying, “Hey, you guys are going public. We’re going to be able to cash out a little bit of our investment. We feel good about that, and we’re going to put some more money on your balance sheet because we want you to invest in research and development. We want you to market and to bust into those new opportunities that you have, we really believe in this business.”

The numbers don’t tell that story; the numbers tell a story of caution and trying to get out while the going is good. Which really undercuts the rest of this narrative that is there in the S-1, like the strong customer loyalty, that the very wide market, does the underserved market. The opportunity for it to grow at 3% to 5% and the company to grow at a faster rate than the market, this dynamic CEO who intimately knows how the product should work and has been able to grow the company through this relentless focus on fit for plus sizes.

All of this starts to fade when you look at how the true ownership of this company has utilized the resources in just the past three months, and it was a big negative for me. And maybe, Emily, that was what prompted me to ask you and myself the question right before we started taping, literally two minutes before we started taping, do you own any fashion retailers? It’s a hard business, and this is not the drag that you need going forward over the long term.

Flippen: I find myself really wanting Torrid to succeed. Reminds me of how I felt about Crocs when we talked a couple of weeks back, where I like the people who are running the show, I like the cult following both these businesses have, and I do want to believe that retailers, even those that are centralized in places like malls that have really large retail footprints, maybe have a bit of a traditional higher debt balance on their balance sheet, that they can succeed.

I say that while also being acutely aware of the fact that I’m probably not going to be buying shares in either of those businesses for the foreseeable future. I don’t see that happening for myself, and I guess how I prioritize the management of my portfolio.

It’s challenging. I don’t own any of these direct retailers. If I was, which I think I need to, there will be businesses… We mentioned Lululemon at the top of the show, but there will be businesses that I think would be in a much better position to really capitalize on that intersection between e-commerce and physical retail with building out loyal followings that have higher levels, I guess, of execution and comparison toward. For that reason, I’m probably not adding anytime soon, unfortunately.

Sharma: Well said. You can learn from companies. Not every company is an investment or a market for your hard-earned dollars, but you can certainly learn about the way industries work by studying these prospectuses. This one’s a pass for me, but I did learn a lot about an industry I wasn’t familiar with and it helped build my knowledge on the rest of the retailing industry.

I guess the message is: In this particular neck of the woods, set a high bar before you invest. It’s OK to take a pass there. There seems to be no end, anyway, of interesting consumer goods companies that are coming to market this year.

Flippen: Well, I hope not, because we have an entire year and infinite more shows to do, Asit.

Sharma: That’s right, people, give us work.

Flippen: Well, until next time, when we cover all of those fun businesses coming to public markets. Thank you so much for joining.

Sharma: Thank you for having me, Emily. Fun as always.

Flippen: Listeners, that does it for this episode of Industry Focus. If you have any questions or just want to reach out to say “Hi,” don’t be afraid to shoot us an email at [email protected], or tweet at us @MFIndustryFocus. As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against any stocks mentioned, so don’t buy or sell anything based solely on what you hear.

Thanks to Tim Sparks for working behind the screen today. For Asit Sharma, I’m Emily Flippen. Thanks for listening, and Fool on.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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