New Issue: Restoration Hardware (RH) $300 Million Convertible Senior Notes

The Convert

Restoration Hardware's proposed deal looks good enough, or maybe even a bit better. We're particularly drawn to the relatively small deal size given the company's market capitalization. The $300 million deal, even with a shoe, will be only 10% of the equity. That's twice the new-issue cushion we look for. This name looks highly tradeable, with proven volatility in the 40% range and average daily volume of around $100 million. It may not be Tesla, but it'll more than do.
The company is showing substantial confidence (maybe a bit too much) by entering into a call spread to take the effective conversion premium up from the low 30's to 100%. Still, we like the willingness to tap a rich convertible market eschewed by so many good candidates. Smart decisions tend to beget other smart decisions.
Given the legitimate volatility, we're backing out a credit spread of around 400, which seems to leave just enough room for tightening on a name like this. We expect the deal to do well, especially given the recent momentum in the stock.

The Company

Restoration Hardware is a retailer of premium household furnishings sold through a multi-distribution channel platform including retail stores and a direct channel comprised of  catalogs and a website. The company operates 69 retail stores in upscale malls and stand alone buildings in the US & Canada as well as 17 outlets. The stores include 61 galleries averaging 7,400 sq. ft., 5 full-line design galleries averaging 21,600 sq. ft. and 3 Baby & Child galleries. In 2013, the company distributed 12.3 million catalog books (known for its extensive volume up to 3,300 pages) and had 22.2 million unique visits on its websites. In 2013, the stores represented 53% of total sales with the direct channel accounting for the 47% balance. The company is focused on expanding its full-line design galleries to about 70 future locations.

RH is highly focused on providing coherent, high quality product lines introduced to the market with minimum development lead times.  The company uses product teams with representatives from product development, sourcing, merchandising, inventory and creative which develop strategy across all distribution channels. These teams work closely with artisan partners and RH has built the RH Center of Innovation and Product Leadership to standardize the process across all product lines. The company believes that this structure has disintermediated the typical wholesale mark-up found at other retailers.

RH common shares closed at $71 one year ago and were as low as $55 in February, but broke out on June 12 with better than expected quarterly results and improved guidance. It currently trades at $85/share. RH reported net income per share of $0.18/share for Q1 2014, beating its own previous guidance of $0.09 to $0.11/share. Revenues for the quarter were $366.2 million, up 22% Y-O-Y. Retail store sales grew 19% and direct channel sales grew 24%. The company increased its 2014 revenue growth target from 18% - 20% to 20% - 22% which would put 2014 total revenues between $1.86 billion to $1.89 billion.

The company has also racked up strong long-term growth numbers as well. In 2013, brand revenue was up 31%, marking the fourth consecutive year of growth in excess of 25%. Total annual revenues have doubled to $1.55 billion in fiscal 2013 from $772.8 million in fiscal 2011.