Digital Brands (DBGI) Positioning for a Private Takeover

Digital Brands (NASDAQ: DBGI) has been plagued by a number of dilutive financings, but there's light at the end of the tunnel thanks to some legitimate takeover talk. The CEO of DBGI, Hill Brandt, has been facing an uphill battle as investors continue to misprice the market cap of the company. On the earnings call he explained “the board is reviewing strategic alternatives given the continued dislocation between the public market value and the intrinsic value of the company.” The Q3 results soundly demonstrated the company no longer needed financing and was healthy enough to start paying down debt and accelerate the process into the first half in order to make the company look enticing as a private takeover target eyeing a multiple of at least 2 times sales or $36 million. This would equate to $20/share assuming a fully diluted 1.8 million shares in the O/S.

Earnings Call Summary

The CEO started the earnings call with a very confident tone that they had good visibility on the trajectory of revenue growth since they were half way through Q4 and closing out the wholesale orders for Q1. The acquisition of Sundry ended up being a big drag on company operations over the past year as it was expected to pull its weight and do the $20 million in sales it did in the prior year. This misfire along with the need to meet NASDAQ market requirements created a $5 million capital call during a period of weak market conditions. Although the acquisition didn’t pan out as advertised, DBGI’s management team was skilled enough to turn the tide on revenues by increasing the brand quality while decreasing the price which ultimately led to an explosion of new sales. The company tripled its wholesale bookings in Q1 from its August baseline.

The CEO stated “We have turned Sundry around. It set its bottom in August and has been on a steady increase since then.”

He evidenced that the Fall sweater line sold out so quickly that Anthropology asked for an exclusive sweater program for next Fall and Holiday. Then he added that other customers admitted they dramatically under ordered for fall and holiday given that they sold out on the floor within a couple of weeks. They also learned that another major retail chain and largest wholesale account sold through 57% of Sundry sweaters in just one week. These market wins positioned the wholesale accounts for significant revenue growth in the out quarters for next year as these wholesalers agreed to do a much deeper buy. .

EBITDA Neutral by Q1

The Q3 results encapsulated a turnaround in Sundry, an increase in sales from other brands, coupled with operating synergies to put them in a position whereby they are EBITDA neutral by Q1 assuming normalized e-commerce trends in their Direct to Consumer (DTC) business. The CEO explained that the DTC business was very promotional for a prolonged period during this holiday season yet they were still able to generate free positive cash flow in October which was being used to pay down old A/P and debt thereby strengthening the balance sheet.

Free Cash Flow Generation - Focus for Private Takeover

Private investors interested in buying the company value the free cash flow generation that enables the continued retirement of debt. There are structural increases in cash flow expected in April and October of 2024. The first initiative comes from the takeover of an existing outlet store generating revenue of $1.8 million annually or $150,000 per month. The monthly rent is $45,000 per month but they have millions in inventory from the Sundry acquisition to sell in the story at zero COGS to offset the rent costs. The rebranded outlet store is due to open March 1, 2024. This means in April of 2024 their free cash flow will increase by $100,000 /month assuming the same sales levels. In October 2024 the company will finish the catch up payments for rent in the amount of $60,000/month stemming from the COVID lockdowns.In Q1 the company is making structural changes that will cut approximately $500,000 in annual costs. The company estimates it expects to generate $6 million in internal free cash flow over 2024. According to the latest balance sheet the company has $4.9 million in promissory notes and $1.9 million in a note for a total debt of $6.8 million.

Wholesale Projections

The company is expecting 50% growth in revenues in Q1 and Q2 and 100% growth in revenues in Q3 and Q4. This translates into a $18 mill run rate based on wholesale business only. There is upside for DTC ecommerce sales, outlet store revenues, and licensing.

Financing Analysis

HC Wainwright did a $5.0 million financing with the Armistice fund. Fully diluted the deal will involve the issuance of 1,580,166 shares of common stock. Before the financing there were 578,502 shares. Fully diluted there will be 2,158,668 shares, but that would also bring another 2 additional rounds of financing that are unlikely to be exercised until the stock is over $12.50 or 30% over the strike price. On the final question the CEO explained that for the past couple of weeks the Armistice fund was exercising their funded warrants and selling into the market. This created wall for shareholders that were correctly speculating on a great quarter. He indicated they were very close to being done and based on the after hours reaction its likely that they are done.

Investment Summary

It's quite clear that the fear of dilution is one of the biggest variables that is impacting the stock stock price. The pre-funded warrant overhang has been causing the stock to stall over the past couple of weeks. The CEO pretty much stated that Armistice is done or close to done. The CEO has done so many rounds of dilution it's hard to fathom another, but much of the message board chatter is adamant that the CEO is going to dilute, taking the stock down yet again. There just isn’t any truth to that and it makes no business sense. While the CEO has not explicitly stated that he will not dilute any more, he's reduced the company burn and has achieved a cash flow neutral status. It's unlikely that he or the board would entertain another dilutive financing when they are operating at cash flow neutral or have follow-on warrants in place should they need funding. The earnings call was a reality check to investors that the company was heavily positioning itself to go private. They are taking the free cash flow from the business and paying off A/P and debt so they look more attractive to the private financiers they are courting instead of going out and finding new brands to buy. Investors really need to wake up here because the quarterly revenue with 77% gross margins was higher than the market cap of the company. With the thin float this stock could really soar on a fundamental basis. For investors interested in a turnaround story this is one of the best values in NASDAQ and could easily justify $20/share. The CEO seems very focused to get the company privatized or drive the public market valuation higher to justify its existence. The company was also toying with the idea of selling its NASDAQ listing in the go private bid because they are worth millions of dollars more than the existing market cap of the company.

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