Limited Brands

Current Price: 15.77 Amy Chen

Target Price: 30 (90%) achen09@gsb.columbia.edu

Investment Summary
• Significant corporate changes are NOT fully appreciated in the street’s valuation
• 911 worst scenario: brand name specialty retailer, sustainable growth within franchise - consistent higher than
industry sales per store, sales per square foot, high OPM and high ROIC
• Management increase shareholder value, massive stock repurchase and insider buying
• Bottom line - Limited downside, huge upside, large margin of safety

Company Overview
Limited Brands Inc. is a specialty franchise retailer of women’s apparel, lingerie, and personal care and beauty products.
The company’s major brands are Victoria’s Secret and Body & Bath Works. The company is currently trading at 8.5 times
the earning last year, below industry average of 17x. During the past 12 month, S&P 500 dropped 8%, S&P Retailing
Industry Index dropped 25%, and LTD dropped 40%.

Investment Thesis - “fallen angel turnaround”

1. For the past six years, the company’s revenue grew at 5% CAGR, with average profit margin of 10%. After break
down the operating metrics of each division, I found the company’s growth and profit margin have been seriously
dragged down by its Apparel division, which has a five year CAGR of -3% with profit margin of 1%. (see graph
below) Given the significant evidence here, I conclude that the Apparel division is a value destroyer. During the 3Q
last year, the company divested 75% ownership its Apparel division to Golden Gate Capital and Sun Capital for a net
pre-tax gain of 230 million. Without the apparel division, the company will achieve a growth rate of 9% (400 bps
higher) with an operating margin of 18% (800 bps higher), far above other retailers, such as ANF and GPS. However,
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by looking at the stock performance last year, the street’s valuation has not digested this spectacular value driver. I
believe this is a perfect time to buy and my target price is $30 per share, 90% upside.

Revenue Growth Rate

20.0%

15.0%

10.0%
VS growth
5.0% BBW growth
Apparel growth
0.0%
2001 2002 2003 2004 2005 2006
(5.0%)

(10.0%)

Operating Margin

25.0%

20.0%

15.0%
Victoria's Secret
10.0%
Bath & Body Works
5.0%
Apparel Business
0.0%
2001 2002 2003 2004 2005 2006
(5.0%)

(10.0%)

Average Sales / Sq. ft.

800
700
600
500 Victoria's Secret
400 Bath & Body Works
300 Apparel Business
200
100
0
2001 2002 2003 2004 2005 2006

ROA

0.50

0.40

0.30
Victoria's Secret
0.20
Bath & Body Works
0.10
Apparel Business
-
2002 2003 2004 2005 2006
(0.10)

(0.20)

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Sales Breakdown
(in millions) 2001 2002 2003 2004 2005 2006 Avg.
Victoria's Secret
Victoria's Secret Stores 2,403 2,647 2,822 3,113 3,222 3,700
La Senza 23
Victoria's Secret Direct 869 939 995 1,119 1,226 1,416
Total 3,272 3,586 3,817 4,232 4,448 5,139
VS growth (0.9%) 9.6% 6.4% 10.9% 5.1% 15.5% 9.4%

Bath & Body Works 1,747 1,781 1,934 2,169 2,285 2,556
BBW growth (2.1%) 1.9% 8.6% 12.2% 5.3% 11.9% 7.9%
Apparel Business
Express 2,044 2,073 2,071 1,913 1,749 1,749
Limited 618 638 626 577 545 493
Total 2,662 2,711 2,697 2,490 2,294 2,242
Apparel growth (6.1%) 1.8% (0.5%) (7.7%) (7.9%) (2.3%) (3.4%)
Other 742 367 486 517 627 734
Total net sales 8,423 8,445 8,934 9,408 9,699 10,671
Total Growth (7.2%) 0.3% 5.8% 5.3% 3.1% 10.0% 4.8%

Victoria's Secret 454 614 711 799 886 958

Bath & Body Works 347 300 355 400 403 456
Apparel Business 55 115 91 16 (92) 27
Other 40 (191) (194) (188) (211) (265)
Total operating income 896 838 963 1,027 986 1,176

Victoria's Secret 13.9% 17.1% 18.6% 19.4% 18.6% 17.1% 17.4%

Bath & Body Works 19.9% 16.8% 18.4% 19.3% 15.9% 16.4% 17.8%
Apparel Business 2.1% 4.2% 3.4% 1.4% (5.5%) (0.0%) 0.9%
Other (17.5%) (42.7%) (39.8%) (36.3%) (16.3%) (16.5%)
Operating margin 8.6% 10.3% 10.8% 11.6% 9.9% 11.0% 10.4%

Victoria's Secret 4,458 4,663 4,735 4,868 5,001 5,126

Bath & Body Works 3,463 3,568 3,542 3,556 3,570 3,604
Apparel Business 12,190 8,031 7,726 7,340 6,724 6,004
Other 35 35 35 37 37 37
Total Selling sq. ft. 20,146 16,297 16,038 15,801 15,332 14,771

Victoria's Secret 539 568 596 639 644 722

Bath & Body Works 504 499 546 610 640 709
Apparel Business 218 338 349 339 341 373
Average Sales /Sq. ft. 338 438 465 492 509 575

Victoria's Secret 1,991 2,018 2,140 2,173 3,221

Bath & Body Works 1,477 1,404 1,487 1,438 1,516
Apparel Business 685 665 666 616 622
Other 3,093 3,793 1,796 2,119 1,734
Total Assets 7,246 7,880 6,089 6,346 7,093

Victoria's Secret 0.31 0.35 0.37 0.41 0.30

Bath & Body Works 0.20 0.25 0.27 0.28 0.30
Apparel Business 0.17 0.14 0.02 (0.15) 0.04
Other (0.06) (0.05) (0.10) (0.10) (0.15)
Average ROA 0.12 0.12 0.17 0.16 0.17

2. Victoria’s Secret is a brand name retailer occupies 20% of the market share. The company’s leased stores mostly
operate at shopping malls. Due to the economic downturn, the mall traffic is negatively affected temporarily, as it
happened after September 11 recession period. With brand name and captive customer, the company’s revenue

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 rebound quickly after the recession, achieving an amazing growth rate of 10% (Victoria’s Secret) the next year.
Currently the company’s same store sale decreased by 2%, less severe than the drop 3.5% in 2001. I believe the
company’s resilience to survive the recession to reverse to an average growth rate of 9% next year.

Year 2000 2001 2002 2003 2004 2005 2006 2007

Total Revenue, million $9,080 $8,423 $8,445 $8,934 $9,408 $9,699 $10,671 $10,134
% Change (7.0%) (7.2%) 0.3% 5.8% 5.3% 2.8% 10.4% (5.5%)
% Same-store 4.5% (3.5%) 3.0% 4.0% 4.0% (1.0%) 7.0% (2.0%)

3. Massive stock repurchases and insider transaction reflects the management’s confidence in the company’s future.
During 2007, the company repurchased 45million shares for about 1.3 billion dollars. Total insider holding increased
10% (from 51M to 56M shares) during last three month.

4. The company has built a new distribution center for Victoria Online, which accounts for one third of the Victoria sales.
The company will continue the momentum for Body & Bath Works Direct, which has a revenue growth of 85% last
year. On January 12, 2007, the company completed acquisition of La Senza Corporation, a Canadian retailer of
lingerie and sleepwear for 600 million. Le Senza has more than 300 licensed stores across 34 other countries. The
acquisition enhanced the company’s core competence and its capability to pursue strategic growth internationally.
More efficient distribution channel will expand profit margin, as the company closed un-profitable stores and
increased capital investment in technology. From 2003 to 2007 the company reduces retail stores from 4000 to less
than 3000. Last year’s results shows 1% decrease in the SG&A expenses. The more efficient business model also
reflects in the increases of sales per store and sales per square foot. (see graph above)

Valuation

Given the negative macro economy environment, consumer spending slowdown, dollar depreciation and increases of oil
price and outsourcing cost, I expect the company to maintain operating margins of 16%, 2% lower than the past six year
average, and revenue growth rate of 9% over the next eight years and a sustainable growth of 4% into the future. Based on

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that, my target price is $30. The investment carries an upside is 90%. Even during the worst case scenario, with an
average growth of 5% and operating margin of 12%, the stock price would worth about $13 per share.
Year 2007 2008E 2009E 2010E 2011E 2012E 2013E 2014E 2015E 2016E
t 1 2 3 4 5 6 7 8 9
Total Revenue $10,134 $9,000 $9,810 $10,693 $11,655 $12,704 $13,848 $15,094 $16,452 $17,110
Growth Over Prior Year -5.0% -11% 9% 9% 9% 9% 9% 9% 9% 4%

EBIT 880 1440.0 1569.6 1710.9 1864.8 2032.7 2215.6 2415.0 2632.4
Operating margin 8.7% 16.0% 16.0% 16.0% 16.0% 16.0% 16.0% 16.0% 16.0%

NOPAT 469 864 942 1,027 1,119 1,220 1,329 1,449 1,579
effective tax rate 46.68% 40% 40% 40% 40% 40% 40% 40% 40%

change in working capital (180) (42) (45) (49) (54) (59) (64) (70) (76)
Capital expenditure (700) (460) (501) (546) (595) (649) (707) (771) (840)
Depreciation 386 309 336 367 400 436 475 518 564

Free Cash Flow (25) 671 732 798 869 948 1,033 1,126 1,227
Discount factor 0.91 0.83 0.75 0.68 0.62 0.56 0.51 0.47 0.42
PV(FCF) 610 605 599 594 588 583 578 573
RV, perpetual growth 21,273
PV(FCF) 4,730.15
+ PV(RV) 9,022
= Enterprise Value 13,752
- Net Debt 2,905
= Equity Value 10,847
/ Shares outstanding 353.1
= Share Price 30.72

Sensitivity Analysis (sales growth and operating margin)

30.72 12% 13% 14% 15% 16% 17% 18%
5% 13.13 15.66 18.19 20.73 23.26 25.79 28.32
6% 14.30 16.97 19.64 22.31 24.98 27.65 30.32
7% 15.53 18.35 21.16 23.98 26.80 29.61 32.43
8% 16.82 19.80 22.77 25.74 28.71 31.68 34.65
9% 18.19 21.32 24.46 27.59 30.72 33.85 36.99
10% 19.63 22.93 26.23 29.54 32.84 36.14 39.45

Worst Average Better Best

Prob. 10% Prob. 40% Prob. 40% Prob. 10%
op. margin 12% op. margin 14% op. margin 16% op. margin 18%
rev. growth 6% rev. growth 8% rev. growth 9% rev. growth 10%
share price 14.30 share price 22.77 share price 30.72 share price 39.45

Price estimate 26.77

Share Price $16.21

x Shares Out. 353
= Market Capitalization 5,724

- Cash & Short Term Investments 218

+ Total Debt 2,908
+ Pref. Equity -
+ Total Minority Interest 61
= Total Enterprise Value (TEV) 8,475

Book Value of Common Equity 2,077

+ Pref. Equity -
+ Total Minority Interest 61
+ Total Debt 2,908
= Total Capital 5,046

EV/EBITDA 7.0
EBIT/EV 10%

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Investment Risks
1. The unfavorable economy environment causes consumer discretionary contraction and decreases in mall traffic
2. Credit crunch makes it difficult for the company to borrow money to expand.
3. Increases in oil prices, foreign exchange rate and outsourcing expenses will hurt profit margin
4. Worries about fashion trends will lead to inventory clearance, discount and markdowns
5. People believe the US intimate apparel market is saturated.

Multiple Analyses

Year 2000 2001 2002 2003 2004 2005 2006 2007 Avg.
Total Revenue, million $9,080 $8,423 $8,445 $8,934 $9,408 $9,699 $10,671 $10,134 9,349
% Change (7.0%) (7.2%) 0.3% 5.8% 5.3% 2.8% 10.4% (5.5%)
% Same-store 4.5% (3.5%) 3.0% 4.0% 4.0% (1.0%) 7.0% (2.0%)
EBITDA 1,113 1,003 1,148 1,251 1,421 1,254 1,492 1,213 1,237
EBIT 842 726 872 963 1,027 978 1,176 880 933
Net Income 428 519 503 717 704 683 676 718 618

Equity 2,316 2,744 4,860 5,266 2,335 2,471 2,955 2,220

Debt 400 400 547 648 1,646 1,677 1,683 2,905
Invested Capital 2,716 3,144 5,407 5,914 3,981 4,148 4,638 5,124

ROA 8.6% 8.2% 8.1% 7.2% 7.1% 6.6% 7.8% 5.2% 7.4%
ROE 34.0% 29.0% 25.0% 14.3% 13.8% 29.3% 33.7% 20.9% 25.0%
ROIC 15.7% 16.5% 9.3% 12.1% 17.7% 16.5% 14.6% 14.0% 14.6%

Gross Margin 35.1% 35.8% 36.6% 35.4% 36.1% 35.9% 37.6% 35.0% 35.9%
EBITDA Margin % 12.3% 11.9% 13.6% 14.0% 15.1% 12.9% 14.0% 12.0% 13.2%
EBIT Margin % 9.3% 8.6% 10.3% 10.8% 10.9% 10.1% 11.0% 8.7% 10.0%
Net Income Margin % 4.7% 6.2% 6.0% 8.0% 7.5% 7.0% 6.3% 7.1% 6.6%

Debt to Capital rate 14.7% 12.7% 10.1% 11.0% 41.3% 40.4% 36.3% 56.7%

Industry Comparables

Market Dividend Operating Sales/Sq.

Cap,billion Sales Price/Book P/E Yield Margin ft.
Limited Brands (LTD) 5.58 10.13 2.7 8.8 4.30% 10.0% 650
Abercrombie & Fitch Co. (ANF) 6.29 3.75 3.9 14.7 1.00% 12.7% 360
American Eagle Outfitters (AEO) 3.57 3.06 2.7 9.6 2.30% 13.1% 412
Anntaylor Inc (ANN) 1.33 2.4 1.5 14.6 n/a 4.1% 471
Aeropostale Inc (ARO) 1.71 1.59 8.7 15.3 n/a 8.1% 526