Alante Musings: Why the Levi's IPO matters

March 22, 2019

Hello friends and colleagues,

Karla and I had been waiting with interest for last week’s Levi’s IPO – over the last year and a half we’ve loved getting to know a variety of people at the company passionate about embedding social and environmental sustainability holistically into their business (many other companies, too! But none in the midst of an IPO). People started asking us for our thoughts, so we felt compelled to put fingers to the keyboard and share...

Naturally, being the capital markets + sustainability nerd that I am, I see any SEC filing for a company that claims to care about sustainability as an opportunity for them to demonstrate their alignment with the Sustainable Development Goals… and more importantly, lay out where they see material risks and opportunities for their business as driven by environmental and social factors. This nerd is thrilled to see that Levi’s leaned right on in.

One might ask “what does an equity offering of a $6.6bn ($8.2bn as of Friday’s close!) market cap brand have to do with venture capital?”. We think quite a bit. A substantial driver of our approach at Alante is founded in our conviction that sustainable innovation is critical for large, incumbent brands to continue to exist. While some of that innovation is proprietary to apparel companies like Levi’s, increasingly, groups like Bart’s (see above) are seeking to move more quickly and nimbly through industry collaboration and partnerships with startups. That’s where we come in.

Going through the offering doc, I loved seeing all the strategic areas that our thesis at Alante touches, and it feels like a very tangible demonstration of why the types of innovation we’re focused on is important to both profitability and sustainability… so I thought I’d share with some of you that might also find this of interest.

Because it is hard to talk about the E(nvironmental) & S(ocial) without the G(overnance), I’m compelled to note that the offering creates dual share classes with the insider shares carrying 10 votes to a public shares’ one. This is something that tech companies tend to do to maintain decision making with “visionary” founders, but in this case, it keeps it in the family. Levi Strauss’s decedents are still the controlling shareholders of the company, and they will maintain the communication structure they have developed with management to understand and lead the business (an official family council). Of the 11 members of the BoD, 10 are non-employee, 2 of whom are directly related to the family of Levi Strauss.

Now for a quick overview….

 Out of the gates, they start out by positioning themselves as a mission-driven company – they call their approach “profits through principles”. This boils down to ensuring that the people who make their products are treated fairly, that they source responsibly, and they invest in innovative and more sustainable ways to make products. Furthermore, it involves a commitment to using their influence as a successful business with global reach and powerful brands to advocate for social good and to give back to our communities. All on page 1 of the summary.

They also talk upfront about their Eureka Innovation Lab - an in-house creative space in San Francisco dedicated to research, design, creative development and advanced product prototypes, responsible for delivering cutting-edge advancements for the company and the industry, with an emphasis on fit, finish and fabric. The Innovation Lab led Project F.L.X. (Future-led Execution), which is Levi’s strategic initiative for customized denim finishing (if you want to know more, keep reading), and touches topics near and dear to our hearts like on-demand manufacturing and removing toxic chemicals from finishing solutions.

Bart (the guy who runs Eureka, pictured above) and several of his colleagues we know have been a major force in imbedding sustainability at the company, seeing the opportunity that lives in the overlap of the Venn Diagram of sustainability and profitability. And they aren’t the only ones - there are people like them driving strategy at all major apparel companies.

Above all, the thing that both gave me chills while also thrilling me was this risk factor… “Climate change and related regulatory responses may adversely impact our business”. I’ll give some color to why it’s a big deal below. I truly believe (and hope) this one little sentence might set a precedent for the entire industry.

Below, you’ll find some of the relevant bits and pieces that I found compelling summarized, with some commentary on why it all circles back to how we think about industrial systems change at Alante (because I must: this does not constitute investment advice or a recommendation to purchase or sell any securities, just a collection of my thoughts).

Business

1)     Operating infrastructure - Efficiency is enabled by technology

In 2018, Levi’s announced Project F.L.X. (Future-Led Execution), an approach that uses lasers in a new way to reduce finishing time and increase our operational agility, reducing lead time from more than six months to as fast as weeks or days in some cases. 

Flexible supply chain and global operating infrastructure enables quick response to consumer and customer demands, scaled operations across diverse geographies and sales channels, shortened product development cycles and adaptation to changing economic and political conditions, including new trade policies.

Our take: Reduced lead times and flexible supply chains mean greater agility, and the ability to right-size production to demand. All of these things require integration of technology and digitization to execute effectively.

2)     Operational excellence, efficiencies and agility

Reducing inefficiency increases profitability. Driving supply chain savings, effective inventory management, better understanding geographic market demand, etc. drove a 329 basis point increase in Levi’s gross margin FY 2015 – FY 2018. The company believes implementation of a new Enterprise Resource Planning system to improve data and analysis capabilities will drive further savings.

Flexibility and response to fashion and consumer trends is critical to maintaining profitability – the goal is to put systems in place that lead to higher sell through rates and less marked down product. Project F.L.X. is an example of technology that allows the company to more dynamically respond to customer demand.

Our take: We believe one of the biggest opportunity areas to drive sustainability in the industry is not making things that won’t be sold. Levi’s is calling out how they use technology to enable them to be more responsive to customer demand, and ensure they have the digital backbone in place to inform meaningful business decisions around production.

3)     Integrating corporate citizenship into the business model – beyond philanthropy

Project F.L.X. enabled the elimination of thousands of chemical formulations from the supply chain. Levi’s was named to Fortune magazine’s “Change the World” list in 2017 and 2018 as a result of initiatives to improve worker well-being and reduce the use of chemicals in finishing processes, respectively.

Our take: Rethinking production methods to remove harmful chemicals is critical to healthy supply chains and sustaining rather than harming that the communities where production occurs.

Risk Factors

1)     Levi’s believes climate change is real enough to call it that!

For a bit of color – other listed apparel companies allude to the same types of events that can result from climate change as risk factors for their business. By way of example, Gap, Inc. phrases their version of this as “natural disasters, negative climate patterns or other catastrophic events”, VF states that their business “may be adversely affected by weather conditions”, Nike uses “extreme weather conditions and natural disasters”.  

Levi’s does something a little different and calls it climate change, and even recognizes the resulting regulatory environment and global complexities. It mentions an impact on the types of apparel products their consumers purchase, which could be interpreted in a variety of ways, including consumer preference for clothing that does not contribute to climate change.

 Like I mentioned, I believe this sets a precedent that the whole industry will have to begin addressing in a more direct way. I’m cutting and pasting the whole glorious bit here because whatever associate wrote this deserves a gold star and drinks on me.

Climate change and related regulatory responses may adversely impact our business.

There is increasing concern that a gradual increase in global average temperatures due to increased concentration of carbon dioxide and other greenhouse gases in the atmosphere will cause significant changes in weather patterns around the globe and an increase in the frequency and severity of natural disasters. Changes in weather patterns and an increased frequency, intensity and duration of extreme weather conditions could, among other things, adversely impact the cultivation of cotton, which is a key resource in the production of our products, disrupt the operation of our supply chain and the productivity of our contract manufacturers, increase our product costs and impact the types of apparel products that consumers purchase. As a result, the effects of climate change could have a long-term adverse impact on our business and results of operations.

In many of the countries in which we operate, governmental bodies are increasingly enacting legislation and regulations in response to the potential impacts of climate change. These laws and regulations, which may be mandatory, have the potential to impact our operations directly or indirectly as a result of required compliance by us, our suppliers and our contract manufacturers. In addition, we may choose to take voluntary steps to mitigate our impact on climate change. As a result, we may experience increases in energy, production, transportation and raw material costs, capital expenditures or insurance premiums and deductibles. Inconsistency of legislation and regulations among jurisdictions may also affect the costs of compliance with such laws and regulations. Any assessment of the potential impact of future climate change legislation, regulations or industry standards, as well as any international treaties and accords, is uncertain given the wide scope of potential regulatory change in the countries in which we operate. 

2)     Costs of inputs – climate change again!!

Increases in the price of raw materials or wage rates could increase our cost of goods and negatively impact our financial results.

Here they lay out what goes into making their products (cotton, blends, synthetics, wools), reliance on market prices, and factors that cause fluctuations in market prices. And then they go so far as to state…Any and all of these factors may be exacerbated by global climate change.

3)     Brand Value

 Most big brands are now including a line on customer perception of their production policies as having the potential to affect brand value. Gap, for example, includes a reference to perception of sustainability policies. Levi’s is no different but does go further in saying that their corporate integrity and culture are a critical factor to their brand value. That word integrity makes this bigger than reputation. What Levi’s says: 

Our success depends on our ability to maintain the value and reputation of our brands.

Brand value depends on the ability to maintain a positive consumer perception of our corporate integrity and culture. Negative claims or publicity involving us or our products, or the production methods of any of our suppliers or contract manufacturers, could seriously damage our reputation and brand image, regardless of whether such claims or publicity are accurate.

Management Discussion & Analysis

Most of the relevant aspects here are understandably around sourcing and supply chain costs, and the need to find new efficiencies while remaining within the framework for their sourcing practices / code of conduct – which they include in the document.

The proliferation of e-commerce, changing retail buying patterns, and increased pricing transparency enabled by technology are clearly top of mind as they seek growth in a fiercely competitive environment.

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In conclusion, we were excited to see so many of the topics directly relevant to what drives us every day as a major part of a $6.6bn market cap company’s strategic vision and mission. They aren’t the only ones, and there are many like Bart in other large apparel companies.  That said, I feel it is one thing to know people are working on ideas in an organization because of your relationships, and another to see them laid out in documents like this for their investors and the world to see.

We hope it is exciting for you, too.

Leslie & Karla

Alante is a venture capital fund investing in innovative companies that radically improve environmental or social sustainability within the textile & apparel industry.

Over the past decade, clothing prices have hit record lows while production continues to soar, resulting in an exponential increase in environmental & social costs. The challenges of managing opaque supply chains have allowed for forced labor, unsafe working conditions & toxic dumping to be outcomes of the clothes we wear. Companies are actively developing & integrating new solutions to make the lifecycle of apparel safer, cleaner, & more sustainable.

We intend to help them do it.

Brand & consumer demand, alongside supply chain pressures, are rapidly driving a shift towards sustainable apparel. Alante partners with brands to understand their sustainability bottlenecks & requirements, informing our process to invest in companies that provide viable solutions.

Investing across the lifecycle of apparel in innovations in production, distribution and waste recovery, we seek scalable solutions that leave lasting, positive impacts on people & the planet. We aim to increase ethical sourcing in the apparel industry by helping to bridge the gap between the newest innovations and the largest brands on the market. At Alante, we make it easier for brands of all sizes to produce and sell the ethical apparel that consumers are increasingly demanding.