Wet Seal is Clinton Group's new hobby horse

Not everyone on Wall Street agrees with Clinton Group Co.'s belief that teen apparel retailer Wet Seal Inc. is undervalued and ripe for a sale, but it's hard to argue with the New York hedge fund's M&A instincts.

Clinton Group, which led activist fights involving bedmaker Select Comfort Corp. and fast-food franchiser Red Robin International Inc., pressed toymaker Jakks Pacific Inc. in March to explore a sale. On Aug. 24, Los Angeles private equity firm Oaktree Capital Management LP made a new, undisclosed bid for Jakks.

The hedge fund, which holds just under 4% of Wet Seal's shares, thinks the retailer, too, can draw PE interest. But it sees possibilities for corporate acquirers as well.

"From a strategic-buyer perspective, the company has a fantastic footprint -- it's in the best malls and has the best locations inside the malls," said Greg Taxin, Clinton Group's managing director.

On July 23, Clinton Group senior portfolio manager Joseph De Perio suggested in a report that Wet Seal could fetch $5 to $8 per share -- a healthy leap from its current $2.80 per share stock price.

Taxin said the company could be a bargain for a PE buyer. "We also believe there is and will continue to be private equity interest -- the business used to do $60 million of Ebitda, but it's underperformed lately," he said.

Wet Seal suffered a net loss of $12.4 million in the second quarter, ended July 28, and on Aug. 21, it disclosed that it was considering its strategic options. The company also said it had adopted a poison pill to discourage investors from owning 10% or more in shares, in order to take its time to study multiple options. Wet Seal didn't return calls for comment.

But given the $148 million in cash Wet Seal has on its balance sheet, Clinton Group didn't stand pat. Three days later, it said it would put up a slate of nominees for Wet Seal's board. Those nominees are Lynda Davey, Raphael Benaroya, Dorrit Bern, Mindy Meads and John Mills.

Besides the cash, what Clinton Group sees is a well-known brand name, one that other clothing manufacturers could run more efficiently by using existing sourcing and management expertise, Taxin explained.

Over the past year, the company has suffered, in part, from a decision to design its own clothes rather than adopt the "fast fashion" model of picking on-trend clothing from existing designers. As a result, its business may be less attractive, said Stephanie Wissink, an analyst at Piper Jaffray & Co.

"We respect management's attempt to reposition Wet Seal back to its heritage as a fast fashion retailer," Wissink said in an Aug. 22 report. "But we also recognize that there may be irreparable damage to the brand that will prevent core operations from returning to prior productivity and profitability levels."

Demand for fast fashion, too, may be starting to fall, Wissink added.

Because of the risk inherent in Wet Seal, Wissink changed her price target model from one that relies primarily on the company's current share price to one that focuses on the company's return on investment. Even still, she values Wet Seal at $177.2 million, or $2 per share.

Wissink, however, stresses that this valuation only looks at Wet Seal's fundamentals, and she readily acknowledged that a buyer could end up paying more.

"There's always a premium on depressed fundamentals for take-out prospects," she wrote. "A strategic buyer would value the business on a pro forma basis for what they think would be the normalized business. A financial buyer would evaluate the prospects based on the ability to financially reengineer the capital structure, regardless of the underlying business trend."

Indeed, under the right management, Taxin believes Wet Seal could see healthy Ebitda numbers again. It's a belief shared by some interested buyers -- Taxin said he's heard from a few, though he wouldn't name them.