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Inside Zara

This article is more than 10 years old.

With Inditex, the reclusive Amancio Ortega has built a phenomenal fashion retailing success.
But is it worth $8 billion?

And so a new name enters the ranks of the world's superwealthy. On May 23, Spain's Amancio Ortega Gaona will sell 26% of Industria de Diseno Textil (Inditex), his textile and fashion retailing empire, to public investors. The IPO will value Inditex at $8 billion (9 billion Euro).

None of the almost $2 billion in cash proceeds from the IPO will go to the company. It will flow entirely into Ortega's pockets and those of a few close relatives. When the dust settles, the secretive Ortega clan and its holding companies will still own 70% of Inditex, a stake worth nearly $6 billion (the other 4% will be owned by management and employees). Add in his other assets and Amancio Ortega is Spain's richest individual by far. He started with nothing.

If Amancio Ortega is one of the world's wealthiest people, he is also one of its most low-key and reclusive. Inditex is located in Arteixo-La Coruña in northwest Galicia, far from gossipy Madrid. There are no Ortega media interviews; no photo shoots; no big launch parties. Not even his age is disclosed in the company's IPO prospectus. (He is 65.)

During a recent visit to Inditex's spanking new headquarters, a mix of open Scandinavian forms (lots of glass) and a Mediterranean stucco look, FORBES GLOBAL bumped into Ortega by accident in the employee canteen. A bouncy, pleasant-looking, short and slightly paunchy fellow dressed in slacks and a shirt open at the throat, he made charming small talk for a few minutes. Then he quickly disappeared.

But make no mistake. In barely a quarter of a century this Galician entrepreneur has become a force to be reckoned with in the cutthroat world of fashion retailing. Last year Inditex earned $230 million aftertax on revenues of $2.3 billion, tripling in five years. Cash flow (earnings before interest, taxes, depreciation and amortization) margin: 20%. Net aftertax margin: 10%. Even its archrival, Sweden's Hennes & Mauritz (H&M), nets only 8.4 cents per dollar of goods sold. The U.S.' Gap nets 6.4 cents.

You may never have heard of Inditex, but you have probably passed by or shopped in one of its 1,080 stores (908 owned, 172 franchised) scattered across 33 countries. Taking a page from the book of The Limited's Leslie Wexner, Ortega has segmented these stores into five branded chains (a sixth, a new lingerie chain called Oysho, is scheduled for launch later this year).

The best known by far is the Zara brand. Now competing head-to-head with H&M in the U.S., Denmark, Germany, the Netherlands, the U.K. and Spain, Zara stores number 450 in 29 countries (220 in Spain). With new stores typically 1,200 square meters in size, the Zara stores sell 10,000 men's, women's and children's apparel models created every year under Ortega's watchful eye at Inditex at Arteixo-La Coruña.

Zara is known for its stylish designs, many with a resemblance to the offerings of famous Italian fashion houses and all moderately priced. A well-cut woman's leather jacket runs $43 in a Spanish Zara, $47 in Portugal, and $65 in Lebanon. A blouse with a staid flowered pattern of mostly synthetic fabric goes for $27 in Spain, $27 in Portugal and $41 in the United Arab Emirates. "If you want a classic, Italianate look in tune with current styles and at a reasonable price go to Zara," says Lotte Freddie, a former model who is now the fashion editor of Berlingske Tidende, a daily newspaper in Copenhagen.

Zara accounted for 77% of Inditex's sales last year, an average of $4 million per unit. After Zara come the lesser brands. The 198 Massimo Dutti stores (8% of sales) peddle quietly traditional, midprice clothes for older men and women. The 229 Pull & Bear stores (7%) sell Gap-like youthwear. The 100 Stradivarius outlets and the 104 Bershka stores (8% of sales between them) present hip apparel for young women ages 15 to 25.

The reclusive Ortega was born in León into a family of moderate means in 1936. He came to Galicia as a teenager with his family in the early 1950s. In 1963 he quit his clerk's job with a La Coruña apparel retailer and, with 5,000 pesetas ($25 at that time) in hand, started a business manufacturing lingerie, pajamas and nighties. A few years later, he branched into retailing. He opened the first Zara store, in La Coruña, in 1975.

Like most successful entrepreneurs, Ortega is a control freak. To guarantee the quality of his fabric, he integrated backward early on, investing heavily in textile finishing operations in Spain's industrialized north. Today there are 18 Inditex textile-design and finishing operations, plus some in-house apparel production. Almost 10% of Inditex's 24,000 employees work in manufacturing.

If Ortega had an operating title, it would be design czar. Under his constant direction, Inditex's apparel designers develop a flood of new models-10,000 a year for Zara alone-that are cut from the fabrics finished and treated at the Inditex mills.

"He is very hands-on about the designs," says Martín Varsavsky, founder of Spain's Jazztel telecom operation, who recently spent a day with Ortega in La Coruña. "Everything creative is passed on by him." He also tends to show up unannounced at any Inditex trouble spot. An Inditex loading clerk in Arteixo-La Coruña quizzed by FORBES GLOBAL confirmed this: "Ortega's not afraid to get his hands dirty."

No executive understands fashion design and retailing better than Domenico De Sole, the CEO of Gucci (a board member of forbes.com). De Sole says of Ortega and Inditex: "What always strikes me is the very high quality of their store presentation. I respect people who know how to present their product. Their stores, and particularly their windows, are very elegant."

This doesn't just happen. Walk through the lower reaches of Inditex's headquarters building. Deep underground is a display unit. Some 25 full-size store windows complete with display platforms with variable lighting are set up there. They enable Ortega (who's constantly in and out of the display unit) and his team to see what their real store windows will look like at night and on dim days and bright. In this laboratory Inditex window designers create the retailing look and feel that they desire.

Once approved, the window presentation designs are sent out to the stores. Do the Zara store windows in Paris, New York, Munich and elsewhere have to look exactly like the presentations created in La Coruña? We asked our guide, María García. She laughed, rolled her eyes and replied: "They'd better."

Inditex's mills finish the fabrics and its headquarters staff design the products and dictate how they're displayed. Who actually makes the goods? Therein lies an important secret behind Inditex's success-and a risk for investors in its stock.

Ignore those press clippings that say Zara manufactures all its own products. The facts are much more interesting.

Inditex claims, in its prospectus, that it produces, "in-house," 50% of Zara's "merchandise by sales price." The remainder (leather goods, for example, or fragrances and some apparel) is manufactured by third parties. But, says the prospectus, "Zara's in-house production model includes a closely monitored outsourced portion in which products are sewn by external workshops located primarily in Spain and Portugal. Zara has maintained a long and stable relationship with such workshops."

Here's how it works: Once Ortega has approved a design for a new Zara blouse, say, or skirt, fabric is cut into pieces and distributed to a network of small workshops mostly in Galicia and in northern Portugal. Similar to the laboratori clustered around Florence that are the backbone of the Italian rag trade, these 350 workshops between them employ some 11,000 gray-economy workers. None of these workshops are owned by Inditex. Most of the informal economy workers the workshops employ are mothers, grandmothers and teenage girls looking to supplement their household incomes in the hardscrabble towns and villages where they live.

Supplied with precut pieces and easy-to-follow instructions, the workers stitch the pieces into finished products that flow in a continuous stream to the Zara distribution center at Arteixo-La Coruña.

How much are the workers paid? Hard to say with any precision, and Inditex's IPO prospectus discloses very little about this crucial aspect of Zara's operations and high level of profitability. But last year the average monthly salary of a Spanish industrial worker was about 250,000 pesetas-$1,300 a month, excluding the state's 30.8% charge for social contributions. The workshops may or may not pay the social charges. We estimate that if they're lucky, the seamstresses probably get something less than half the average industrial wage, maybe $500 a month.

Whatever the typical seamstress in Inditex's workshop network earns, it is competitive with wages in many of the Third World countries where Hennes & Mauritz, Gap, and most of Inditex's other competitors outsource their production.

The workshop network gives Inditex something even more important than low wage costs: a high degree of production flexibility. Such competitors as H&M and the Gap must begin producing their lines from three to five months before the goods are to be delivered to stores; Inditex requires just three weeks. It hasn't even begun to turn out the goods for its collection for this fall and the winter of 2001-02, due for delivery in the middle of August. Designs, moreover, can be altered or new designs created as the season moves along. No model is kept on sale for more than four weeks no matter how well it's selling.

This unparalleled turnaround time between approval of a design and delivery of finished goods slashes Inditex's inventory needs to a bare minimum. At the end of last year, Inditex had on hand finished goods inventories equal to just 7% of revenues. At the very well managed Hennes & Mauritz, the figure was 13%. Bottom line: every peseta of Inditex's working capital sweats extra hard.

Again, this kind of performance doesn't just happen. Ortega has invested heavily in advanced information systems technology. Spearheading this crucial investment has been José María Castellano, 53, Inditex's CEO since 1984. A native of La Coruña, Castellano was formerly the head of information technology for Aegon España and the CFO for the Spanish subsidiary of Conagra. Ortega has rewarded him with 3.8 million shares of stock, now worth $48 million.

It's hard to exaggerate the degree to which Castellano has modernized Inditex's systems. We happened to be in a big Zara outlet in Madrid as it was closing. As final sales were rung up and customers were being shooed out of the store, salespersons equipped with wireless handsets were communicating inventory levels to the store manager, who in turn was using his internet-connected phone line to pass the numbers on to both the design/order and distribution departments in La Coruña. The same thing happens at closing time at all the other 449 Zara stores.

Zara's 500,000-square-meter distribution center features 211 kilometers of moving rails. The unit is built on two levels, one for folded apparel, boxed in cardboard cartons, and the other for plastic-covered garments on hangers. Zara checks each delivered piece twice for quality.

The garments, either folded or on hangers, then continue on to the appropriate belt systems. Routing personnel, using automated devices, are directed by a group sitting in a control room. Each lot is labeled by its ultimate destination. Apparel is moved out to loading docks, where fleets of trucks await it. For overseas deliveries, the trucks drive to nearby airports, primarily the one at Santiago di Compostela.

There is no question that Amancio Ortega has built a fashion phenomenon. But should you buy Inditex's stock at its likely IPO price of $12.70? That price values the business at 35 times last year's earnings and 3.5 times revenues. This is a modest discount from the slightly less profitable Hennes & Mauritz, which currently trades at 42 times earnings and 4.7 times sales, but a sizable premium to such U.S. retailers as Nordstrom (p/e of 17) and Gap (28).

A little bit of bad retail news could result in a big hit to Inditex's unseasoned shares. Nor is it clear that investors will strongly support an IPO whose proceeds will go not to the business but to the selling shareholders. Our advice: Wait for the stock to settle after the inevitable IPO hype.

Another, longer-term risk lies in one of Inditex's key sources of strength, its workshop outsourcing system. These workshops are not strongly dedicated to withholding income taxes or paying social benefit charges. But Spain is modernizing rapidly, and European Union bureaucrats are cracking down on Europe's informal economies with all manner of costly labor market directives. And don't forget that Spanish wages are below the eu average. Will Inditex continue to enjoy the twin benefits of low wages and high labor-market flexibility? That remains to be seen.

This much is certain. The $2 billion in cash that he and his kin are likely to receive from the IPO will not change Amancio Ortega's lifestyle. He already has a few toys, including a Falcon 900 executive jet and and reportedly a big stake in Deportivo La Coruña, last year's Spanish League soccer champions. True, he'll have to watch out for Spain's bloodthirsty Basque terrorists; in late March, the Spanish government announced the crushing of an effort by ETA to inaugurate a campaign of terror in Galicia.

Expect Ortega, who has no retirement plans, to keep his hands in all aspects of Inditex's operations. An Inditex designer summed up her boss's dedication to the business when she looked up from her computer screen and proudly declared: "He okayed these [designs for children's wear] just last week."