ASOS plc: A Buy(Out) At This Price?

clothesThe share price of ASOS (LSE: ASC) has dropped 30% this year. Only a couple of weeks ago, it was down more than 40%. Taking a bet on the online fashion retailer at £42-£45 would make a lot of sense for an investor whose portfolio is properly diversified. It currently trades at the high-end of that range.

Still Growing Fast

ASOS turns over almost £900m from the UK (36% of the group’s sales), Europe (20%), the US (10%) as well as the rest of the world, but is expected to generate £1.6bn by the end of 2016. Emerging market exposure will increase over time.

Its top-line has grown at an impressive 30%-plus annual rate in the last couple of years, and forecasts are for a similar performance into 2016. Even if it grows, say, at 20% annually, it’ll be able to outperform most rivals. Growth is needed to shore up the retailer’s equity valuation, and management know that.

The retailer’s net cash position is £36m and minority interests are negligible, so its enterprise value (EV) is in line with its market cap, which means that debt can be raised to fund shareholder-friendly activity.

Short-Term Pain For Long-Term Gains?

This is a 14-year-old business valued at £3.7bn. Earlier this year, when its stock hit a record high of about £71, its market cap stood just a tad below £6bn.

ASOS trades at 4x EV/sales, which is a rich trading multiple for any business, but not for ASOS if management continue to deliver. The pressing question is whether ASOS will be able to remain profitable in future in the same way it has been in recent years.

ASOS got hammered in March as management informed analysts that a combination of lower growth and higher investment would hinder profitability. Just a few days earlier, its valuation had reached a peaked of 7 times sales and 85 times earnings before interest, taxes, depreciation, and amortisation (EBITDA).

Is this a case of short-term pain for long-term gains?

The stock hasn’t recovered since, although in the last couple of weeks it has recouped some of its lost value. There are signs that investors are building long positions.  

Deal Or No Deal

ASOS needs growth, and lots of it, to justify a higher valuation – or, alternatively, a takeover. While there’s no certainty that an offer will materialise, suitors are certainly monitoring how the valuation of the British group is impacted by less favourable trading conditions.

The free float of ASOS is 62%. Denmark’s Bestseller owns about 27% of the company; the Danish clothing retailer could certainly make an attempt at buying out ASOS. A debt-free balance sheet means that private equity may also be involved, but the chief candidate for a takeover is Amazon, whose stock is down 21% this year.

Meanwhile, interest from food retailers in the UK should not be ruled out. The ailing sector needs options and all the main players could be attracted to ASOS’s business model and its market-beating growth prospects. 

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Alessandro doesn't own shares in any of the companies mentioned. The Motley Fool has recommended shares in ASOS.