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Choose Your Partner: Fashion’s Ownership Shuffle

Why fashion and finance often clash.

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WWD Accessory issue 08/15/2011

Earlier this year, two groups of fashion executives were gleeful after their companies were flipped by private equity owners—and not just because of the personal financial windfall. In both cases, those companies—Jimmy Choo and Kurt Geiger—were sold to trade buyers, Labelux Group and The Jones Group Inc., respectively. By severing their ties with private equity, their companies were now in the hands of investors who speak their language.

“I feel like Jimmy Choo has found the right home now,” Tamara Mellon, founder and chief creative officer of the famous shoe house, said at the time. Choo had been in various private equity hands for a decade. TowerBrook Capital LLP was its most recent investor. “Labelux has a completely different vision from private equity—brand building versus financial engineering,” added Mellon, whose company swelled from 20 million pounds ($28.8 million at average exchange) to 549 million pounds ($900 million at current exchange) in those 10 years, and whose personal net worth is estimated at 150 million pounds ($246 million), according to the Sunday Times Rich List.

Like Mellon, Neil Clifford, chief executive officer and a shareholder in Kurt Geiger, expressed relief that Europe’s largest luxury shoe retailer was no longer in private equity hands, although it was he who led a 95 million pound ($175 million at average exchange) management buy-out in 2008 with backing from Graphite Capital. Hours after Kurt Geiger’s sale to Jones for a cool $350 million in cash, he said, “It’s been a brilliant journey with private equity, but we instinctively knew it could not continue forever because you’re watching your debt grow, and you’re looking at a sale every few years. And because of that, you end up focusing on the wrong things.”

So were Mellon and Clifford biting the hands that made them rich, or expressing some uncomfortable truths about the often-prickly relationship between fashion labels and their financial investors? It’s no secret that fashion and luxury companies need a steady flow of financing over an extended period of time. “It takes at least 30 years for a luxury brand to mature, and you need a lot of nurturing and investment in that time,” said Mellon after the sale. “Jimmy Choo is still only 15.”

Samples must be produced, launch parties thrown, and runway shows or presentations, the former often in the six- or seven-figures range, staged multiple times a year. Unless a brand generates a steady flow of cash that can be pumped straight back into the business—or has access to a bottomless trust fund—it will, at some point, need an investor. And that’s when the misunderstandings and the dramas begin. Many financial types, whether venture capitalists, private equity or angel investors, are wholly unfamiliar with the rhythms and quirks of the fashion business. They may love their front-row perch at fashion shows, the look of the ad campaigns, and the prospect of endless discounted merchandise, but they can be woefully unprepared for what lies ahead. Often, they’ll assume that a fashion company works just like a pet supplies or pub chain, a software business or a camping equipment distributor. “It’s very hard for the average venture capital firm to get its head around fashion, the emotion, the creativity, the designers’ diva behavior,” says one accessories executive who requested anonymity. “And from a cash point of view, it’s just crazy: For nine months, the investor has to foot huge bills—for fabrics, samples, runway shows, manufacturing and shipping—before they even seen any cash back. And by then, they already have to invest in the next season.”

Many financial folk also have great difficulty placing a numeric value on a “brand,” that precious entity that designers and executives hold close, protect—and in many cases fetish-ize. Nick Hood, head of external affairs at Company Watch, which tracks and rates the financial health of firms worldwide, said that a brand—and any value that it might carry—is a slippery notion to many investors. “Underlying the whole relationship [between fashion companies and venture capital investors] is the reality that the investors’ end reward will be governed by that most indefinable of assets: The value of the brand,” he says. “In fact, with many fashion businesses that’s pretty much all the company is. In the fashion game, brand volatility is both extreme and constant. There’s a very good reason why most credit risk calculations discount brand value either heavily or eliminate it altogether.”

Indeed, brand value is a major point of contention that can poison relationships early on. Hood believes the problems between fashion businesses and their private equity partners start early, even before the investors take their stake. “Relationships between venture capital investors and fashion companies often start badly over the thorny issue of valuation, which leads to the original owners feeling that they’ve been ripped off by the outside investor, whom they think has demanded too high a share of the equity,” he says. To add to many fashion companies’ stress levels, financial investors will usually look to build up their investment and then sell it off in three to five years. Financial companies are under pressure from their shareholders to make investments, and then to exit those investments in a timely way—or suffer penalties.

“The very reason private equity exists—to buy low, leverage as much as it can, and then sell high—conflicts with long-term brand-building,” says Chris Spira, a veteran fashion executive whose New Spirit Group, a consulting and investment business in the premium sector, has a stake in the British footwear brand Nicholas Kirkwood. “There’s a tension that has to be resolved.” Spira, who has worked closely with such brands as Escada and Julien Macdonald, and who sits on the board of Lulu Guinness, says a particular sticking point between companies and their investors is brand-building. “Events, marketing, and p.r. are often a massive bone of contention because there is no measurable return for the investor. They find it difficult to understand how important those things are in building a brand.”

Spira notes other intangibles that require investment—such as a designer’s research for a collection—can also be incomprehensible to someone with his or her eye on the balance sheet.

 

“The designer would argue that he or she needs to visit amazing factories, to travel to art shows and museums for inspiration. The private equity person sees that as an excuse for a holiday, and wonders why the designer can’t just sit at a computer and Google,” says Spira. “I’m sure there’s a bit of truth on both sides, but what needs to happen is that the private equity guys need to understand the value of fashion’s ‘processes’ and to build a framework where the designer feels free to create.”

When that happens—and it sometimes does—the brand can flourish. Anya Hindmarch, Jack Wills, Agent Provocateur, Georg Jensen and, until its recent acquisition by Phillips-Van Heusen, Tommy Hilfiger have all thrived under private equity ownership, as did Choo and Geiger.

“Private equity can get you fast from point B to point C, but with that comes decision making,” says Michelle Feeney, who served as ceo of St. Tropez, the skin care and self-tanning company, when it was owned by the private equity house Lloyds TSB Development Capital. “Private equity brings you discipline and forces you to set short-term goals. And you have to remember it’s not your company. You have to find a middle ground with your investors,” adds Feeney, who ramped up St. Tropez’s U.S. retail distribution with private equity investment. She is now ceo of PZ Cussons Beauty, whose parent, the publicly listed PZ Cussons purchased St. Tropez from Lloyds last September for 62.5 million pounds ($96.9 million at the time).

Steve Petrow, a managing director at Change Capital Partners, says that when a partnership is right, magic happens. Last year, Change sold the British multibrand denim retailer Republic for an undisclosed sum after doubling its turnover to 200 million pounds ($310 million) and tripling its earnings before interest, taxes, depreciation, and amortization. This past July, Change bought a 70 percent stake in the French fashion brand Paule Ka for an undisclosed sum, and plans to accelerate the brand’s international expansion.

“You need to get your capital structure right from the start,” he says. “And then let your design team and management do what they do well. Don’t try to put them in a box. These relationships should be a respectful partnership, and if that partnership is right, it will enable the management to build confidence, take risks, and add value to the company.”

Petrow says that before the credit crunch, a lot of private equity companies failed to get their capital structure right: “They took a large amount of debt into the companies they purchased, then when the credit crunch came—and sales declined—they had the banks breathing down their backs, and the fashion managers bore the brunt of that. They were the ones who were asked to make cutbacks, and that can be soul-destroying for a manager.”

Petrow also believes the three-to-five- year window is an ideal time frame in which to grow a fashion business: “It’s a very positive thing, and it’s why the private equity model performs so well. It’s a long enough horizon to accomplish things and to focus management, but not long enough for people to get complacent. There is no other model that creates that kind of value for a company.”

Despite the potentially explosive nature of relations between fashion and finance—and the inherent risk that both sides run when they form a partnership—there’s still a lot of competition for the most attractive candidates on both sides of the deal. “We’re finding that people are actually seeking us out because they can see the value we add,” says Petrow. “It’s a really good time for us, and we are flat out with work.”

Graphite, meanwhile, which sold Kurt Geiger to Jones, has a different take on the future of fashion financing, now that banks are tighter with their lending and post-crunch debt has become expensive to service. “I think we caught luxury at the right time. The weakening currency meant that an influx of foreign tourists was able to buy the brand at places like Harrods and Selfridges. It really worked out, timing-wise,” says Markus Golser, senior partner at Graphite. He adds that going forward it will be difficult for private equity to compete with trade buyers—such as Labelux, PPR, Jones, and LVMH Moët Hennessy Louis Vuitton—on the fashion and luxury deals. “It will be harder for private equity because of the lack of leverage. Trade buyers still pay a premium to have these brands, so it will make competing for them more difficult,” he says.

Trade buyers, meanwhile, believe they are ones best suited to own fashion and luxury brands.“The success of a private equity investment is dependent on operational performance and financial engineering, and the timing of buying and selling,” says Berndt Hauptkorn, ceo of Bally, which belongs to Labelux. “The trade buyer prepares a luxury company for the next generation of ownership. Private equity buys to sell, whereas individual trade investors buy to build.”

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