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About six months ago I seriously considered purchasing ANF and ran it through the old Cash-King criteria. Overall, the company passed with flying colors. However, I decided not to buy at the time for a couple of reasons. First, while ANF's numbers in isolation look great, there is a big gorilla out there called the Gap. What would happen if the Gap decided to compete head to head with ANF? Imagine all those Old Navy commercials being replaced by Gap ANF knock-off product commercials. Second, where is ANF's moat that protects it from competition? Coca-Cola has is brand identity; Pfizer has its patents; and Intel has the ability to produce chips cheaper than its competitors. Arguably, ANF has a brand name but does it compare to Coke's? Moreover, will it be able to keep pace with changing fashion trends? For these two reasons, I did not think that ANF was a stock that one could simple buy and forget about. Now, that doesn't mean it wouldn't be a good investment but probably one that should be watched more closely.

The third and most important reason (to me) why I didn't invest in the company at that time: I don't have the financials in front of me but when ANF was spun-off of the Limited, it assumed part of the Limited's debt (the amount I believe was in the tens of millions). ANF quickly paid off this debt through cash generated from retained earnings and the issuance of additional stock. While I didn't back out the numbers to see if ANF met the cash-king criteria before paying off the debt, I didn't like to see the company diluting the share base in order to pay off the debt (even in small amounts). Further, I don't think that a small amount of debt is a bad thing. Modest amounts of debt at low interest rates with good management can be a catalyst for growth. ANF had a sold ROE and the interest rate on the debt I believe was about 7%. Further, much of ANF's growth is coming from opening new stores. With its healthy margins and solid ROE, I assumed that ANF would earn more than 7% on the funds that it reinvests in itself. In addition, the financial statements did not explain why the company decided to pay off the debt rather than to continue to finance it.

Having said all that, I don't mean to bash ANF. I really did like a lot of what I saw and I do like the clothes. I continue to watch the stock and may still purchase it in the future. However, the dilution of the share base to pay off the debt made me question what the management was doing. In light of alternative investments that were out there (Cisco), combined with the fact that ANF has no real "moat" made me take a wait and see approach.

Greg

P.S. I am really enjoying reading the great research and analysis that you Fools are posting. Thx.
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