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In a still brittle economy, investors’ patience can be tested as companies wait for revamps to show results, pressuring near-term earnings. It can make sense for retailers to go private while giving new business models time to develop.
As M&A in specialty retail picks up, Destination Maternity Corp. could be a potential target, said William Susman, president and chief operating officer at retail investment bank Financo Inc.
Others in focus include teen fashion retailer Aeropostale Inc., women’s apparel retailer Chico’s FAS Inc. and children’s wear retailer Children’s Place Inc., said Betty Chen, who covers specialty apparel at Wedbush Securities.
“Retail is a sector where there’s likely to be a lot of fall-outs and there’ll be winners and losers over the next couple of months,” said David Bassuk, managing director of the global retail practice at business advisory firm AlixPartners.
He said it was difficult to predict how many deals could be struck, but he forecast private equity deals would be double what they have been doing.
Deals from private equity firms have risen sharply in recent months, with funds under pressure to spend funds they raised from investors before the financial crunch. As of late September, such deals totaled $140.5 billion, more than double the year-earlier volume.
Shares in Destination Maternity, which sells clothes and accessories to pregnant women, trade at 13.7 times forecast earnings, nearly half the industry average of around 25.
“Aeropostale and Chico’s have a lot of cash flow generation, both have new concepts that could grow in the future, and they are also trading at discounted valuations,” said Chen, referring to Aeropostale’s PS line and Chico’s White House Black Market and SOMA Intimates chains.
Aeropostale is trading at below 10x forward earnings, while Chico’s is at about 17x.
Clothes retailers catering to kids, teens and other niche groups usually have low working capital and good potential for strong earnings, which typically generates strong cash flow.
Cheap valuations add to their attraction.
The Gymboree deal, valued at 7-8x EBITDA, could set a benchmark for similar buyouts.
“I think this will likely set the tone for future negotiations,” said Chen, adding that any bids for Aeropostale, Children’s Place and Chico’s would likely be around those valuations.
“Those companies are actually trading at a big discount to those multiples, so for them to get a valuation in a 7-9x range implies a 30-50 percent premium, which is pretty significant, and similar to what Gymboree was able to get,” said Chen.
“There’s a lot of capital in private equity that needs to be deployed or not be utilized at all,” said Michael Dart, senior Partner at Kurt Salmon Associates.
“And I think people are looking and saying, with valuations where they are now and the dynamics we’re seeing, this is a good time to try and put that capital to use,” said Dart, who is in charge of the firm’s private equity practice.
Last month, private equity buyouts in retail were boosted by a $3.26 billion deal for Burger King Holdings Inc.
“The retail environment, although not as vibrant as it once was, is not particularly unstable. We have stabilized at a significant percentage of people with jobs, and they still go to the mall and spend money,” said Lawrence Creatura, portfolio manager at Federated Clover Investment Advisors.
As deals are discussed, brand equity and value are most likely to govern takeover decisions.
“Deals will be large and small. … Size doesn’t matter,” said Financo’s Susman, but he added buyers may hold fire until they can see year-end results.
“Many of the rumored ones are possible, but we suggest caution,” he said. “Radio Shack tried to get itself sold, and nothing has been done until now.”
Nivedita Bhattacharjee is a Reuters correspondent in Bangalore.