Boom and Gloom

The economy swung all over the place, from the stumbles of Wal-Mart and the subprime mortgage crisis to the continued strength of the luxury market and a flood of private equity money in search of fashion properties in which to invest.

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WWD Year In Fashion issue 12/11/2007

The economy swung all over the place, from the stumbles of Wal-Mart and the subprime mortgage crisis to the continued strength of the luxury market and a flood of private equity money in search of fashion properties in which to invest.

From the business and financial perspectives of retail and fashion, this was a year of transition.

This story first appeared in the December 11, 2007 issue of WWD.  Subscribe Today.

View the full coverage of  WWD Year in Fashion 2007 at

Among the bigger macroeconomic developments was a tectonic shift in the global M&A market. Dramatic swings in consumer spending and confidence also marked the year, as did rising energy and raw material costs as well as hints that the aspirational luxury consumer could be pulling back after five years of robust spending.

And, due to the collapse of the adjustable-rate mortgage market, 2007 included rabid volatility on Wall Street, with many retail stocks setting 52-week lows in the second half, as well as the ongoing devaluation of the dollar against other currencies, especially the euro. On the bright side, the weak dollar brought hordes of shoppers and investors to these shores, trawling for bargains.

Some surprises included VF Corp.’s selling of its founding namesake intimates business and a string of investments in the designer world. A report surfaced last summer that KKR might be interested in acquiring Macy’s Inc., and Barneys New York became caught in a bidding war. Subprime market woes forced KKR to reconsider its strategies, while Middle Eastern investment firm Istithmar beat out Fast Retailing for Barneys. Fast later vowed to hunt for other targets.

Here’s a wrap-up of the booms and busts that characterized 2007.

M&A Mania Slows, Shifts

The implosion of the credit markets due to soaring foreclosures from homeowners unable to keep up with rising adjustable-rate mortgages had a chilling effect on the global M&A market. Private equity firms, faced with tightened lending from banks, rethought their acquisition strategies. The result was a halt to three solid years of leveraged buyouts that involved high multiples of eight and nine times pretax earnings.

But within several sectors, such as technology, communications and retail, companies continued to be bought and sold, although premiums were generally lower. The size of deals also changed, and the era of the “megadeal” of prior years came to an end. While there were exceptions, analysts and bankers believe it will be some time before the industry sees a multibillion-dollar deal again.

In the current fourth quarter, there’s been a lot of activity in the retail/apparel/fashion sectors. A weak dollar is making targets look attractive to overseas investors. For example, Icelandic firm Baugur Group is chasing Saks, last month hiring NM Rothschild and Financo Inc. as its U.S. advisers.

Other M&A players include TSM Capital, founded by retail veteran Marvin Traub along with Mortimer Singer and Aslaug Magnusdottir, and The Atelier Fund, which was launched this year by Marty Wikstrom and Dawn Mello with partial backing from Compagnie Financière Richemont. Bluestar Alliance also made some moves, and Fast Retailing, owner of Theory, Helmut Lang and Uniqlo, said it had earmarked $3.5 billion for “overseas acquisitions.”

Li & Fung USA bought some of the moderate brands being sold by Liz Claiborne Inc., and acquired private label vendor Regatta Pacific Alliance this year. NRDC Equity Partners, parent of Lord & Taylor, formed NRDC Acquisition Corp. in October with an initial public offering to raise $360 million for the “possible purchase of one or more operating companies.” NRDC also bought Peter Som Inc.

Among the most talked-about deals since the credit market meltdown was Clorox’s $925 million acquisition of Burt’s Bees in November. The 18.5 percent pretax earnings multiple paid for the lip balm and natural beauty products maker surprised the market. “Everyone would have loved a piece of that deal,” said one investment banker.

Another hotly discussed deal involved a high premium from a strategic player: the VF Corp. acquisition of Seven For All Mankind for about $775 million. VF also grabbed Lucy Activewear for $110 million. The two businesses were combined to form a new division, VF Contemporary Brands, with estimated annual revenues of $350 million. In January, VF sold its $800 million intimate apparel business to Warren Buffett’s Fruit of the Loom Inc. for $350 million in cash. For Buffett, the deal was seen as a way for Fruit to bolster its position in the mass market.

On the designer front, some notable deals this year included TSM Capital’s investment in Matthew William and its “significant” minority stake in Rachel Roy, in November. The infusion is seen as a way for the label to expand into new categories and with freestanding stores. At the time of the deal, Roy said the transaction was a way of expanding the brand “and building it into something I wouldn’t be able to do on my own because funds wouldn’t have come as quickly.”

In July, Prada SpA inked a deal to sell all of Azzedine Alaïa SAS back to the namesake founder for an undisclosed price. Prada had developed a strategic alliance with the Paris-based designer in 2000. Then, in an October surprise, Alaïa said it had a new financial backer: Richemont.

During the summer, just as the credit market collapse gave private equity firms pause, Betsey Johnson sold a controlling interest in her firm to Boston-based private equity investor Castanea Partners. Echoing Rachel Roy, Chantel Bacon, Johnson’s chief executive officer, said, “For the past 30 years, we’ve really established a brand, and with their help, we’re going to take it to the next level.”

Other notable deals include NexCen Brands Inc.’s $54.6 million deal for Bill Blass Holding Co. Inc., and Liz Claiborne’s 50 percent stake in Narciso Rodriguez last May. In June, Claiborne named Janice Sullivan president of Rodriguez.

In March, WWD learned that the Weinstein Co. and Hilco Consumer Capital LLC were set to acquire the Halston brand from Neema Clothing Ltd. In November, Harvey Weinstein, speaking at the WWD/DNR CEO Summit, said, “Some people have asked me about my plans for revitalizing the brand. What I really can say is that I found Roy Halston and all the books I read fascinating….And I’m now just considering doing a documentary about his life….I want to introduce Halston’s life to a world of playwrights and authors, actors and filmmakers. I want them to be inspired. Maybe somebody will make a movie about that time period.”

Perhaps the most intriguing deal of 2007 was the sale of Barneys New York. Over the summer, two firms — Fast Retailing Co. of Japan and Dubai-based investment fund Istithmar — were locked into a bidding war for the retailer. After several exchanges, Istithmar won out after Fast dropped out. Istithmar paid Jones Apparel Group, Barneys’ parent, $942.3 million in an all-cash deal.

How 2008 plays out in the M&A market hinges on the shakeout of the credit markets. M&A firms hope the economy brightens and that big banks loosen up lending. Deals, meanwhile, are likely to continue. Private equity firms remain flush with cash, so if they are not buying companies outright, at the very least they will be investing in the sector.

The Street’s Wild Ride

Wall Street in 2007 was as volatile as it’s been in years. The Dow Jones Industrial Average soared to new heights, only to lose the gains as the subprime market woes forced investors to flee.

Liquidity issues triggered a heavy sell-off in retail that began in August and continued for several months. Concerns over consumer spending, the impact of the housing slump and a weaker-than-expected same-store sales report for July sent the market in a tizzy for several weeks in the late summer. The Federal Reserve tried to quell the concerns by adding $4 billion of liquidity to the financial markets.

What investors tended to key into most were same-store sales and consumer confidence. The back-to-school season was a dud, and some retailers were saddled with leftover spring and summer inventory by September — not a good position. The inventory glut was a challenge, as retailers knew steep markdowns were needed, even at the expense of lower gross margins. The result was a highly promotional fall.

Meanwhile, consumer confidence was riding high until August — it even reached a six-year high in July.

“The rebound in consumer confidence has catapulted the Index to its highest reading in nearly six years….An improvement in business conditions and the job market has lifted consumers’ spirits in July,” said Lynn Franco, director of the Conference Board Consumer Research Center. “Looking ahead, consumers are more upbeat about short-term economic prospects. This rebound suggests economic activity may gather a little momentum in the coming months.”

The party didn’t last, though. August’s reading fell over macroeconomic conditions triggered by the subprime collapse, softening in business and labor market conditions, volatility in financial markets and continued subprime housing woes.

Over the next four months, consumer confidence — and retail stocks — would continue to spiral downward. The S&P Retail Index is down about 14 percent since the beginning of the year.

Wal-Mart’s Watershed Year

Before the subprime credit mess hit, Wal-Mart Stores Inc. made a move back to its core strategy of offering “everyday low prices,” or EDLP. The timing was perfect, and several analysts praised the decision as consumers grew more price-sensitive during the fall and holiday shopping seasons.

At the annual shareholders’ meeting, Wal-Mart chief financial officer Tom Schoewe said the retailer was reducing the number of new Supercenters to 190 to 200 from a previously planned 265 to 270. President and ceo H. Lee Scott also reiterated the “mantra of EDLP is the company’s core strategy.”

Analysts and investors said Wal-Mart had stumbled in recent years as it attempted to move upscale and compete with Target and other retailers. Wal-Mart’s stock price was stagnant and its apparel sales suffered as it introduced such fashion-driven lines as Metro 7.

“Our customer knows Wal-Mart is the price leader and Wal-Mart will stay the price leader. Period,” Scott said during the shareholder meeting.

By August, Wal-Mart was hit by the big economic picture. It lowered its outlook despite delivering second-quarter profits that rose 49 percent.

“In the Wal-Mart U.S. segment, we certainly have made improvements in some areas, most notably grocery, pharmacy and entertainment. Having said that, merchandising overall is still not where it needs to be….At the same time, U.S. consumers continue to be under difficult pressure economically,” Scott said in a prerecorded call at the time.

By October, Wal-Mart said sales growth would slow over the next few years as it trims U.S. expansion to make long-term investments overseas. It said it would build fewer stores in the U.S., reduce corporate expenses and overhaul its merchandising, human resources and financial software systems.

In a challenging stock valuation climate, it is difficult to assess how well Wal-Mart’s strategy is paying off. But shares of the retailer have been up about 4.5 percent since the beginning of the year.

Luxury Still Tops — For Now

Momentum in the luxury segment continues to remain vibrant. LVMH Moët Hennessy Louis Vuitton, Gucci Group, Richemont, Hermès and others have posted strong results over the past few months, and high-end retailers appear to be bullish for the holiday shopping season. In the U.S., foreign tourists are propelling sales while domestic top spenders continue to buy. Analysts, however, expect some pullback on the segment, but it likely will be from the aspirational shopper who is already moving downstream.

Michael J. Silverstein, senior partner at Boston Consulting Group, said during the Black Friday weekend that the strength in the high-end market comes from the top 40 percent of U.S. earners. This demographic is in a growth mode, and retail sales likely will come in better than expected for the fourth quarter. He said the top 40 percent accounts for 65 percent of total U.S. consumption, and the group has a median income of $175,000, which is growing in real terms.

Brands are banking more on growth in the U.S. — evidenced by Dolce & Gabbana opening an expanded New York flagship on Madison Avenue earlier this month at a cost of $10 million — as the Japanese luxury market continues to stagnate. There, companies from Armani to Bulgari and Bottega Veneta this year joined the rush to open megastores in Ginza in an attempt to drive customer traffic.

Still, there are concerns — and opportunities. Johann Rupert, executive chairman of Richemont, said in November that the company would weather the current storm in financial markets. “Access to easy money has dried up for some market participants, and I am not sure that we are necessarily over the worst. The luxury business, whilst not immune to external disruption, has historically shown itself to be relatively resilient. There are many opportunities for our businesses to grow…in established as well as new markets, which are opening up to luxury products.”

Either way, 2008 will be challenging across the board. Some analysts are warning of a U.S. recession, perhaps short-lived, in the first half of the year and the weakness of the dollar and yen has European executives concerned. Consumer confidence remains low in the U.S., and higher energy costs are impacting the costs of raw materials. The good news is that apparel retailers are looking forward to spring, which promises a broader color and print palette — something fresh to lure back the shoppers.

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