Forget November’s Black Friday as the kick-off for the shopping season. The retailers have apparently decided March is a much better month to buy and sell.
Consider the wave of activity last month. Toys R’ Us was sold in an $8.8 billion deal. Neiman Marcus, Casual Corner and UK retailer Joseph all recently went on the auction block. Apax Partners is engaged in a dogfight to acquire Woolworths plc. And Swander Pace Capital just unloaded Reef Holdings to VF Corp. Add the announced merger between Federated and May Department Stores and the upcoming Kmart / Sears union, and it’s clear that the face of the retail is undergoing a massive change.
“Retail companies are going to have to bulk up if they want to be relevant,” said Mark Vidergauz , founder and CEO of Sage Group. “The U.S. still has too many of the same type of stores, so I think you’re going to continue to see a consolidation process.”
As the retail space continues to churn out deals, private equity firms are finding that the strategic buyers have returned. In the Neiman Marcus auction, for instance, firms such as Apollo Management, Leonard Green & Partners and others are reportedly competing with the likes of Nordstrom and LVMH Moet Hennessy Louis Vuitton. Joseph, meanwhile, will likely be shopped to such names as Bear Stearns Merchant Banking and Trimaran Capital Partners on the private equity side, and Jones Apparel Group, Phillips Van Heusen and Liz Claiborne on the strategic side.
The arrival of the corporates has pushed valuations higher, but that does not necessarily preclude private equity firms from participating in the auctions. Moreover, they seem intent on staying competitive in these deals. “We’ve certainly seen valuations increase and private equity firms are making bids with multiples in the double digits 10x EBITDA and higher,” Vidergauz said, adding such prices were “unheard of” just a couple years ago.
Indeed, the Toys R’ Us acquisition had an enterprise value of 13x the company’s EBITDA, according to a Bear Stearns research note, which is high compared with the 6.5x times EBITDA Cerberus Capital Management and Sun Capital Partners paid for Mervyn’s just seven months earlier. Meanwhile, the Kmart acquisition of Sears was valued at 6.10x EBITDA, while the Federated purchase of May Department Stores came in at 9x EBITDA. But as the aborted Eddie Bauer auction from last year demonstrated, there are limits. Spiegel, the retailer’s parent company, was reportedly seeking as much as $1 billion-well above the $600 million to $700 million PE bidders had been offering.
Looking at the past three years, the recent activity is coming after somewhat of a dry spell for private equity retail deals. In 2002 and 2003 combined, there were only 18 retail acquisitions, worth a combined $3.94 billion in disclosed values, with Texas Pacific Group’s acquisition of Debenhams (a UK retailer) accounting for $2.96 billion of that total. Last year, however, retail assumed a more prominent position on the private equity radar, with 31 deals completed worth a total of $5.43 billion. This year, the Toys R’ Us deal alone will shatter last year’s disclosed total for the sector, and pros expect more deals to follow.
So why are buyout firms so interested in this space? For one, recent successes have made the sector more appealing. To cite one example, Bear Stearns generated a 12x return on paper through its 2002 investment in New York & Co. Another factor is that consolidation begets more consolidation. Sellers see the high multiples that are being achieved and decide the time is right to gain liquidity, while the buyers, especially the strategic players, feel pressured to react to the growing competition.
And the trend even trickles down to the manufacturers. The recent acquisition of Bennett Footwear by Brown Shoe was an example of this. Jones Apparel Group started the rush to consolidate with acquisitions of Maxwell Shoe Co. and then Barney’s New York, Inc. Soon after Rocky Shoes & Boots acquired EJ Footwear Group from Strategic Industries (a portfolio company of Citigroup Venture Capital). But it was the announced merger between Federated and May that ultimately sent shockwaves through the industry, and now manufacturers are scrambling to keep pace with the growing retail companies. Brown Shoe, on the defensive, had to react to bolster its standing among the retailers, and acquired Bennett in order to grow its marketshare (see story, page 14). Publicly held apparel company Cherokee is another company that has recognized this need to consolidate and recently hired UBS to explore its options.
Even as retail enjoys this surge of M&A interest, the sector does present hurdles. For one, transactions in the sector have been historically difficult to leverage given the sporadic cash flow trends. Large jumps during the holiday and back-to-school seasons can account for as much as 50% of a company’s sales. In the case of Toys R’ Us, for instance, holiday sales account for almost 40% of the company’s total revenue. Disappointment in the month of December can often translate into a disappointing year and that kind of pressure can dissuade some financial sponsors.
The new ownership at Toys R’ Us knows this all too well. Bain Capital, which along with KKR now controls the toy giant, suffered some of its worst losses after the acquisition of KB Toys in December, 2000, a $305 million deal that ended in bankruptcy for the former Toys R’ Us competitor.
Looking ahead, with interest rates rising, it could be even more difficult to leverage retail businesses, especially at the prices companies are going for. But one pro active in the space noted that the sector is large enough and diverse enough to continue to attract sponsor interest. “It’s such a big sector that we never lack things to do,” he says. “It’s hard to believe that these headline deals will continue, but there are a lot of opportunities out there.”
On the sell side, there is no doubt that the window is open to pursue a sale. The source confirmed that for sponsors prescient enough to invest in retail in past years, the recent frenzy could prove propitious. “Generally speaking, it is probably a good time to sell,” he said.