Crocs Inc Current Context Crocs Thesis

Excerpt from Thesis :

The fourth element is the company's currency policy. Crocs has some limited operations. The firm began by utilizing technology from a Canadian firm, which was later absorbed into the company. They have undertaken some overseas production, including in Brazil, Mexico, Romania and China. Crocs has indicated that they have aggressive international expansion plans, as evidenced by their applying for patent protections in over 36 countries worldwide (Reeves, 2006).

Crocs sells in over 70 countries, with international expansion beginning in earnest in 2006. After just one year, international sales had increased from $8.2 million in 2005 to $78.4 million in 2006 and accounted for around one-third of the company's total sales (Pierce, 2007). This growth has been facilitated by setting up distribution centers where manufacturing takes place. This tactic -- the operating hedge -- has become the cornerstone of Crocs' foreign currency policy.

The company had, until last year (Blick, 2008), an operating hedge in its Quebec City facility. This offset its largest foreign currency exposure, the Canadian dollar. Crocs also matches manufacturing facilities with sales in Mexico and China. Otherwise, their production is U.S.-dollar denominated, eliminating the need for hedges. Aside from the operating hedges, Crocs does not actively hedge its foreign currency exposure at this time.

It is unknown if this is a deliberate policy undertaken after careful analysis of trends in currency markets, or an incidental policy resulting from a lack of analysis of the issue. Both are possibilities given the youth and inexperience of the firm. The firm's foreign currency exposure is growing, and it will not be able to set up operating hedges in every country. Indeed, it remains to be seen how Crocs will hedge its Canadian dollar exposure now that it has closed the Quebec City facility. In terms of financing, Crocs obtains all of its financing domestically. They tapped the NASDAQ for equity financing and their line of credit is also U.S.-based. It remains to be seen if they will abandon this strategy as their exposure to foreign markets grows.

The fifth element is the firm's preference for financial innovation. The use of exotic financing instruments can reflect management's creativity and opportunistic tendencies. With respect to Crocs, there is little financial innovation. The firm's main sources of capital at this point are its line of credit and its equity financing. Both are vanilla. This reflects two important points. One is that there is little complexity to Crocs' operations at this point. The company's operations are, in general, fairly vanilla. The second point that this reflects is the inexperience of the Crocs management team. This team is essentially comprised of the same entrepreneurs who launched the company in the first place. They are learning on the job, and are therefore averse to exotic financial instruments. The new CEO as of 2008 is Russell C. Hammer, a former finance executive at Motorola (Forbes, 2009). As he brings more experience to the finance team, it will be interesting to see if there is a shift towards increased use of financial exotica, but there is no indication of this to date.

The sixth element is external control. Equity in Crocs still lies with the founding shareholders. In 2006, 9900 shares were issues publicly, but these represent less than 15% of the total public shares even today. That year also saw the exercise of 31,726 preferred shares into common shares. This gave these shareholders increased say over the company's operations. Since then, further shares have been issued, albeit mainly to management.

With respect to debt, 2008 saw consistent increase in outside control. Crocs was found in a few instances to have been in compliance with financial covenants of its revolving credit facility agreement. This cost the company fees, and the bank had them lower the amount of borrowing. Further amendments in 2008 reduced the amount borrowed in exchange for the removal of all remaining covenants.

The revolving credit facility is an example of Crocs management asserting control over its situation. The creditor, Union Bank, had enforced covenants against Crocs. This caused the company to reduce its obligations to Union Bank, so that management could reduce this external control. This indicates that Crocs has now taken the stance of defending against external control.

The seventh element is distribution. This reflects the way that the company markets its securities and delivers value to its investors. These decisions reflect management's beliefs about the future of the company. The only form of public capital that Crocs has is its common stock. At present, the firm has been hesitant to leverage itself, indicating the management possibly believes their business to be sufficiently risky as it is, and that taking on more risk would potentially lead the firm to ruin,

Crocs does not issue dividends, preferring to deliver value via capital gains. This policy is consistent with young, growing companies. This policy indicates several beliefs on the part of management. One is that they believe the company's cash flows are not sufficiently established and stable as to justify paying a dividend. The other is that the company's management believes that reinvesting capital in the form of retained earnings will allow the company to build up its operations, generating greater profit in the future for shareholders. Crocs was growing rapidly until 2008, growth stagnated last year. This resulted in steep declines not just in profitability but in shareholder value as the stock price plummeted from $75 in the fall of 2007 to $0.79 during the depths of the global economic crisis. This 99% loss of value will make it difficult for the company to raise further equity capital, which is going to be a constraint to the company's growth prospects going forward.

These seven elements make up the description component of Crocs' finances. For the most part, these elements are consistent with what would be expected of a small, young and rapidly growing company. Management has an aversion to debt, which may serve them well going forward since they may be forced to rely on debt financing (thus it is good they are not overleveraged yet). The firm remains subject to high volatility as well, which means that they have benefited from their relatively conservative financial outlook.

Analysis of Financial Policy: Diagnosis

The diagnosis section is where the firm's strategies as outline in the description are analyzed for fit. The fit takes three different dimensions. The first is the degree to which the policies create value. The second is the degree to which the policies create competitive advantage. The third is the degree to which the policies sustain senior management's vision. This next section will analyze these three issues in detail.

The first dimension is the degree to which the policies create value. Value is analyzed along the following dimensions -- shareholder wealth, market value of the firm, and cost of capital. The current market conditions would indicate that these policies have not created shareholder wealth. The company's stock value (and therefore market cap) have declined around 99% since the autumn of 2007. This would indicate that the company's policies have not created the wealth that was anticipated with the shares were issued at $21 each.

However, we should analyze this issue within two contexts. One is the overall market context; the other is the opportunity cost. The market is in terrible condition. It is not only shares in Crocs that have declined substantially since November 2007, but the market overall. The inherent volatility of Crocs stock is high (? = 1.89), which is normal for a young firm in its position. Thus, to the extent that shareholder value in the overall market has eroded, the erosion of value at Crocs was predictable. There is a degree, however, to which the decline in Crocs exceeded that which would have been expected had CAPM held. The additional decline in shareholder wealth potentially can be explained by the lack of faith that the market has in the long-term viability of the company. Crocs is a one-product company and that product is considered by some to be a fad product. It is therefore easy for an investor to conclude that not all of the revenue declines in 2008 are attributable to declines in the general market. It is therefore not financial policy that has contributed to the strong reduction in shareholder wealth but rather market perception about the long-term viability of the core product.

Given this, the opportunity cost of the financial policy should be considered. Crocs management in general has eschewed debt financing, and even reduced their credit facility when they realized the degree to which they would cede control via restrictive covenants. If we consider, however, what Crocs' situation might be had they held a sizeable portion of long-term debt, we realize the position that the company is in. If Crocs had substantial debt, those obligations could have crippled the company. Remember that Crocs lost $185 million last year. This ultimately came…

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