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Abercrombie not fit for an LBO

by Richard Collings | Published March 23, 2012 at 2:34 PM

Though it reportedly hired Deutsche Bank AG to assist in a review of strategic alternatives, teen apparel retailer Abercrombie & Fitch Co. does not constitute a strong leveraged buyout candidate, said several industry sources.

The New Albany, Ohio-based apparel retailer disappointed investors in November, when it missed analysts expectations for a rise in earnings. Its net income was nearly flat at about $51 million for the quarter ending Oct. 29, 2011, compared to $50 million for the same period a year earlier. Its income remained flat despite a 21.5% rise in quarterly revenues to about $1.08 billion, according to a Dec. 6 filing with the Securities and Exchange Commission.

Abercrombie's shares tumbled from $76.81 on Oct. 28 to $44.65 by Nov. 25.

Fourth quarter results for the period ending Jan. 28, 2012 show the company's continued deteriorating condition. Abercrombie's net income shrunk to $19.6 million, compared to $92.6 million for the same period a year earlier, while revenues increased 16% to about $1.33 billion from $1.15 billion. Same store sales were flat. The company attributed the drop in earnings to steep markdowns during the holiday season.

An industry banker quipped rhetorically, "To get in front of a credit committee" and present that kind of performance to obtain financing for a leveraged buyout? "Good luck with that."

The banker said Abercrombie is not well-positioned to take on a lot of leverage, explaining that it would be difficult to saddle the company with debt that exceeds the multiple it is currently trading at.

According to Paul Lejuez, a retail analyst at Normura Securities International Inc., Abercrombie is trading at 6-times the forward Ebitda it is expected to generate for its fiscal year ending Jan. 31, 2013.

"A debt investor will not lever a business over its current market cap," the banker said.

While financing is available, debt terms are typically not as generous for retailers like Abercrombie. That being the case, a private equity buyer would have to put up between $500 million and $800 million in equity to buy out Abercrombie, said a private equity source

To acquire Abercrombie at a 30% premium to its Friday stock price of $51.20 per share, a buyer would have to pay roughly $5 billion. Such a price would be large relative to recent similar transactions, said Lejuez. Retail deals over the past year include the $1.6 billion buyout of discounter 99 Cents Only Stores Inc. by Ares Management LLC and Canada Pension Plan Investment Board, announced Oct. 11; and the June 29 buyout of BJ's Wholesale Club Inc. for $2.8 billion by Leonard Green & Partners LP and CVC Capital Partners Ltd.

Lejuez said in an interview that Abercrombie is trading at 6 times forward Ebitda of $661 million it is expected to generate for its fiscal year ending Jan. 31, 2013, and 5.5 times forward Ebitda of $725 million for the fiscal year ending Jan. 31, 2014. If Abercrombie were bought by a private equity firm, the analyst said, it would be the largest LBO of a specialty apparel retailer, a sector the private equity industry has not historically been fond of.

The industry banker said analysts pushing the idea of a leveraged buyout of Abercrombie do not appreciate how much the retailer has swung in terms of financial performance over the last few years. Those analysts include R.J. Hottovy, director of consumer research at Morningstar Inc. and John Kernan at Cowen and Co. LLC, who were cited in an article by Bloomberg marking Abercrombie as a strong LBO candidate.

Kernan said he agreed that the probability of a transaction occurring was low and two major obstacles to an LBO would be obtaining the debt financing and that Abercrombie's management is not pre-disposed to such a deal. He said the aim of his report was to emphasize that the economics behind a potential deal made sense in terms of Abercrombie's Ebitda, growth and balance sheet. It's his belief that the company could support debt of up to 5 times Ebitda. Abercrombie would likely be an acquisition candidate in perhaps five years, he added.

Hottovy did not respond to queries seeking comment.

Reports are "too simplistic in how much sense this deal makes now," Lejuez said. There was a time in the past, he said, when Abercrombie's stock was cheaper and its potential internationally unknown when he would have been more bullish on a sale of the company.

Lejuez also cited factors in his report such as long leases on Abercrombie's European stores that are generating negative comparable store sales growth, a highly competitive teen apparel segment, and private equity's aversion to the volatility of specialty apparel retail. The analyst pointed to the LBOs of J.Crew Group Inc. and Gymboree Corp. as being disappointments for their respective buyers.

In November 2010, TPG Capital LP and Leonard Green & Partners LP, along with management, agreed to take J. Crew Group private in a deal valued at about $2.86 billion. Bain Capital LLC reached a deal to acquire Gymboree for $1.8 billion in October 2010.

The banker said that in hindsight, considering that there were no competing bidders, Leonard Green and TPG Capital ended up paying a very full-price for J.Crew, about 10 times to 12 times Ebitda.

Recently, fears of high commodity prices impacting earnings have subsided, and companies are now priced closer to "perfection," the banker said, making it unlikely private equity firms will find any bargains.

Another deal impediment is Abercrombie chief executive Michael Jeffries, Lejuez said, who is key to the retailer's future success. Jeffries is likely is not in favor of a buyout as he prefers to be in control of the company. A private equity firm would have to have a healthy relationship with Jeffries to make a deal likely, the analyst agreed.

Abercrombie declined to comment for this story.

The banker said that the only retail target under serious consideration for a leveraged buyout currently is Collective Brands Inc., with perhaps one other smaller opportunity in terms of valuation up for grabs. On Aug. 24, 2011, Collective Brands announced it had retained Perella Weinberg Partners LP and consulting firm Kurt Salmon Associates to advise on strategic alternatives including a sale.

Another private equity source pointed to firms that paid high prices for retailers in 2006 and 2007, and ended up recording losses on some of those deals. Most notably, the $1.3 billion buyout by Apollo Management LP, NRDC Real Estate Advisors I LLC and Silver Point Capital Fund Investments LLC of Linens 'n Things Inc. in Novemer 2005, ended in disaster when Linens filed for Chapter 11 protection in May 2008. The investors sunk $633 million into the retailer.

A private equity source said not only are firms practicing restraint, but sellers are expecting generous multiples, and if they don't receive the expected valuation, they are pulling their companies off the auction block.

Other private companies such as Tumi Inc., which filed for an IPO on Dec. 13, recognize the valuations being achieved by publicly-held companies such as Michael Kors Holdings Ltd., and are choosing initial public offerings instead. After pricing at $20 per share in its Dec. 15 stock market debut, Michael Kors traded Friday at $47.59.

Instead of chasing mega-deals, private equity buyers are likely to consider bidding for assets put on the auction block by publicly held apparel conglomerates such as PVH Corp., Liz Claiborne Inc. and VF Corp., sources said. For example, PVH's heritage business could be a worthwhile acquisition at a fair valuation, said the private equity source.

PVH's chief executive Emmanuel Chirico told The Deal in early January that it is considering divesting its Heritage Brands business consisting of Van Heusen, Izod, Arrow and Bass brands.

Even VF, a source indicated, in now focused on action sports and businesses that "move the needle," so a divestiture of brands that don't fit into that description such as Splendid and Ella Moss or even Seven For All Mankind could be possible.

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Tags: Abercrombie | Deutsche Bank | leveraged buyouts | sec | securities and exchange commission

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Abercrombie not fit for an LBO

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