Vintage 2006 Retail Deals Ripe For Exits

Private equity portfolios are glutted with aging investments in the retail sector that could present attractive buying opportunities, a Buyouts analysis has found.

Of the 86 retail companies U.S.-based sponsors backed in 2006, 45, or more than half, are still under the same ownership, the analysis found. These include big-name companies easily recognizable by mall shoppers, including mattress retailer Mattress Giant, backed by Freeman Spogli & Co.; department store Lord & Taylor, backed by NRDC Equity Partners LLC; and toasty sandwich chain Quiznos, backed by CCMP Capital Advisers LLC, which is preparing to raise its next buyout fund, seeking $3.5 billion. See a comprehensive table including all 45 companies on page XX.

Theoretically, these companies should be ripe for a sale or an initial public offering, considering that private equity firms typically hold their investments three to five years. Further, many of these owners need to provide liquidity to investors as they prepare to raise new funds—CCMP Capital, for example, is preparing to raise its next fund, seeking $3.5 billion. Meanwhile, potential buyers loom, as buyout firms still sit on mounds of capital, much of it raised in the boom years, that they need to put to work.

Recent data suggests appetite for retail deals among sponsors may be on the rise, if still somewhat depressed. As of Dec. 5, U.S.-based sponsors had invested in 45 companies globally in the retail sector this year, compared with just 27 in all of 2009 and 2010 combined. Consumer confidence, meanwhile, is strengthening: Private research firm The Conference Board said its consumer confidence index climbed 15 points in November—its largest gain since 2003—to 56.0, though it is still far below 90, the level that suggests an economy is growing at a healthy pace. And finally, several companies have sold this year at multiples in excess of 9x EBITDA, according to a banking source, including Sur Le Table, which Freeman Spogli sold to Investcorp; Garden Ridge Corp., which AEA Investors LP bought from Three Cities Research for approximately $720 million; and Academy Sports + Outdoors, bought by Kohlberg Kravis Roberts & Co..

“I actually believe we are entering a good cycle for retail M&A,” Steve Tricarico, a managing director and head of retail and apparel investment banking at Jefferies & Co., told Buyouts in an e-mail. “Consumer spending remains good despite [the] macro economy.”

Food & Beverage

Of the 45 vintage-2006 retail companies still owned by the same sponsor or sponsor group, the food & beverage category accounted for almost half, with 21 companies.

Long holds in this sector could be attributed to several factors, said John Howard, CEO of Irving Place Capital, a mid-market firm that invests in the retail sector but avoided it in 2006 because it thought prices were too high. For one, many consumers cut down on eating out amid a severe recession coupled with periods of high gas prices. And rising prices for cheese, corn and other commodities cut into profits. “They’ve all been tested and compromised in this environment, so they’re working their way through things,” Howard said.

Notable companies bought in 2006 in this sub-sector include Schlotzsky’s Ltd., the deli-restaurant chain backed by Roark Capital Group, a firm focused on the franchise, food and restaurant and specialty retail sectors, among others, that closed its most recent fund with $1 billion in commitments in 2008. Schlotzsky’s is now under Roark Capital’s FOCUS Brands umbrella, which puts Roark Capital in a position to exit FOCUS in one fell swoop or to sell off Schlotzsky’s and its well known sister companies Auntie Anne’s, Carvel, Cinnabon and Moe’s Southwest Grill piecemeal. Roark Capital typically invests $15 million to $350 million to buy companies with EBITDA of $10 million to $100 million.

Other food and beverage assets from 2006 include Orchid Pubs Ltd. The sixth largest pub-and-restaurant chain in the United Kingdom has completed several divestitures and add-on acquisitions since GI Partners bought it in a deal valued at more than $1 billion in 2006, suggesting the company has shed less profitable locations while pursuing growth elsewhere. GI Partners, which invests $50 million to $250 million per deal in a variety of sectors including retail, closed its third fund with $1.9 billion in commitments in 2009.

The there’s Checkers Drive In Restaurants Inc. Backed by Wellspring Capital Management LLC, the burger drive-in chain has more than 800 franchised and company-operated locations across 27 states—which suggests growth options in other states for a would-be buyer. The company generates more than $620 million in sales, according to the company’s Web site. It also operates outside the beleaguered casual dining segment, which has suffered greatly in recent years. In 2009, Checkers opened 35 new restaurants, a 70 percent increase over 2008. Wellspring Capital closed its fifth fund with $1.2 billion in commitments in early 2010. The New York City-based generalist invests in North American companies with values of at least $75 million, usually cutting checks for $75 million to $150 million per transaction.

Ranking sponsors by their holdings of vintage-2006 retail companies, Boca Raton, Fla-based turnaround firm Sun Capital Partners, which focuses on companies with $50 million to $5 billion in sales, continues to hold, with four. These are Marsh Supermarkets Inc., which in March named a new CEO charged with reestablishing the company’s growth (see table for more detail on Marsh and other companies, page XX); Fazoli’s Restaurants Inc., an operator of 224 quick-service Italian restaurants; Uniform City Corp., a retailer of health care apparel; and CanGro Foods Inc., a supplier of canned fruit and vegetables that changed its name in January to Del Monte Canada.

Scott Edwards, a principal with Sun Capital, said sales at three of the companies above are up since the firm bought it—one has tripled its sales under Sun Capital ownership, he said—while sales at one are flat. (He declined to attribute the numbers to specific companies or to comment on when Sun Capital might try to exit them). The market for selling retail companies is a lot better than it was a few years ago, he added. “We tend to have longer hold periods,” Edwards said. “First, we need to prove out a turnaround. Once we do that, we hold it long enough to prove we can grow the company.”

Other firms still holding a few retail companies from 2006 include Leonard Green & Partners and Bain Capital, with three companies each; and The Blackstone Group, Bruckmann Rosser Sherrill & Co. and Incline Equity Partners (formerly PNC Equity Partners), with two companies each. Executives at Bain, Blackstone, Bruckmann Rosser Sherrill and Incline Equity either declined to comment or did not respond to requests for comment (see companies in table on p. XX).

Stock Market Chill

One reason sponsors are holding retail companies longer, sources said, stems from turmoil in the equity markets, which makes it hard to lock-down a solid IPO price.

“Right now, the IPO environment—which for us was one way to exit—is so volatile. We don’t feel enough market stability to take these companies public at this time,” Peter Nolan, a managing director with Leonard Green, told Buyouts. “It’s creating buying opportunities, but it makes predicting exits challenging.”

Case in point: In October, NRDC Equity-backed Hudson’s Bay Trading Co., the parent of Lord & Taylor and other retailers, postponed plans for an IPO in part because of volatile global equity markets, according to reports.

That said, Tricarico, of Jefferies, said the IPO market is open for retail companies that have a differentiated niche; the ability to grow their store base 10 to 15 percent a year; that can drive earnings in excess of 20 percent over the next five years; and that wouldn’t carry debt in excess of 3.5x EBITDA as a public company.

Shares in women’s apparel boutique Francesca’s Holdings Corp., for example, backed by CCMP Capital, had popped 63 percent after a week of trading following its July 22 debut at $17 a share (though it has since come back to Earth, closing at $15.36 a share on Dec. 1). The company reportedly plans to expand its base of boutique stores by about 900 in the United States over the next decade.

Shares in nutritional product retailer GNC Holdings Inc., backed by Ares Management LLC and the Ontario Teachers’ Pension Plan Board, have been trading up since its Aug. 30 debut, as have shares for Mattress Firm Holding Corp., a Mattress Giant rival backed by J.W. Childs Associates LP, which closed Dec. 1 at about $22 a share, up 15.8 percent from its debut price of $19 a share.

Continued love shown retailers by the public equity markets would be sure to signal a return to a healthy exit market for sponsor-backed retailers.