With so much froth and capital in the market these days, it’s no surprise that seemingly every sector and industry is seeing increased play. But even so, the retail and consumer products sector has managed to stay in the spotlight for some time now, and most expect it to stay in favor now and in 2007. “We had a strong wave of activity last year, and although the retail deals this year haven’t topped those deals, the sector is still enjoying a pretty good winning streak,” said one pro. Indeed, last year saw private equity firms buy big-name companies like Toys “R” Us, Neiman Marcus and the Casual Corner.
In the first quarter alone, there were 20 deals totaling $4 billion in the retail and consumer space, including Apollo Management’s $1.3 billion buyout of Linens n’ Things. Last year saw 56 deals worth $18 billion completed. 2004 saw 51 such deals completed for a total of $8 billion, while 2002 and 2003 combined saw only 18 retail and consumer product acquisitions completed worth about $4 billion.
“Investors are interested in the sector because it’s large and dynamic. There’s been a lot of activity lately as a number of folks are looking at the deals in the space who weren’t [looking] before,” says David Landau, a founder of LNK Partners, a White Plains, N.Y.-based fund that plans to invest only in consumer and retail. The firm just capped its first fund at $400 million in March. “There are a lot of opportunities in the consumer space, and premier businesses in the space are getting premier multiples. The trouble is mediocre businesses are getting higher multiples as well.”
According to industry sources, solid companies in the sector can easily command a purchase price multiple of 10x EBITDA, especially if banks keep lending at 5x to 6x cash flow, as many in the sector have been seeing.
“This sector is benefiting from the overall deal market, but consumer spending certainly hasn’t slowed down even though there was talk of that. 2006 is going well so far,” says James Frommelt, a managing director with Goldsmith Agio Helms. “Our consumer sector was pretty active even when things were bad because consumers are never going to go away, but we expect this year to continue to be very strong.”
A rash of recent deals, including some profitable exits, have certainly kept the sector in the spotlight. Department store chain Debenhams will return to the stock market next month in a flotation expected to value it at about £3 billion. The IPO comes two-and-a-half years after Debenhams was taken off the market in a deal that valued the business at £1.72 billion. The private equity firms that bought it—CVC Capital Partners, Texas Pacific Group and Merrill Lynch Private Equity—are expected to double their money in the latest deal.
More than half the company’s shares will be sold in the flotation, although the private equity firms will retain an interest.
Citigroup, Credit Suisse, Merrill Lynch and Morgan Stanley will handle the sale.
“People are seeing some of the big-name deals and perceiving that there is a lot more out there. The number of deals hasn’t grown that much, there’s just many more high-profile mega deals,” says Landau.
It’s The Real Estate, Stupid
While hefty exits and large deals certainly keep consumer products and retail businesses in the forefront, the fact that many of these deals have prime real estate helps.
“Real estate is definitely a force at work here,” says Frommelt. “Lots of times the real estate in these types of deals is worth close to the deal value, so there is no downside, because even if the businesses don’t turn out to be what is was supposed to be, the real estate can always be sold.”
Sun Capital Partners or Bain embrace this model, but are smart enough not to go it alone. When Sun bought Mervyn’s in 2004 it teamed up with Cerberus Capital Management to gain real estate knowledge. Similarly Bain and KKR teamed up with Vornado Reality Trust on the Toys “R” Us deal for the same reasons.
“It just makes sense for private equity firms to work with a REIT or someone that can help them navigate that aspect,” says Frommelt.
Linsalata Capital, a private equity firm, admits it likes the retail and consumer product space, but doesn’t want anything to do with real estate. “We don’t like deals that are based on locations and long-term leases. It doesn’t give you any room to react to problems,” says Eric Bacon, a managing director with Linsalata Capital. “With stores you also have to put out what’s going to move. You can’t focus on anything that’s not mainstream. I prefer a narrower focus.”
Linsalata is not alone in its dislike of brick and mortar deals. This has given the catalog space a tremendous push. Just recently Spire Capital bought Sky Mall catalogs and Linsalata Capital sold Potpourri catalogs to American Capital. “Private equity groups are all over the catalog business as well. While catalogs may not be as trendy right now as real estate amd retail, they are still quite profitable. These deals are also starting to approach double-digit sale prices,” says Frommelt.