WWD.com/business-news/business-features/j-crews-challenge-whats-it-worth-7712627/
government-trade
government-trade

J. Crew’s Challenge: What’s It Worth?

J. Crew Group Inc.’s owners face a Millard “Mickey” Drexler conundrum as they consider cashing out.

What might be J. Crew Group’s greatest asset — the exacting and merchandising-infused leadership of Millard “Mickey” Drexler — has become something of a complication for the company’s private equity owners as they consider selling the retailer.

This story first appeared in the June 5, 2014 issue of WWD.  Subscribe Today.

Drexler, the driving force behind Gap Inc.’s success in the Nineties, is the rare executive who’s seen as having the magic touch by both Wall Street and the fashion crowd. His hands-on approach and ability to pick product helped put J. Crew back on the map when he took the helm as chief executive officer and chairman in 2003. And he will be a very difficult man to replace when he decides to step down.

Especially now that the company is experiencing a period of slower growth. Late Wednesday, J. Crew said refinancing costs pushed it to a loss in the first quarter, while adjusted earnings fell and comparable company sales declined 2 percent (after 5 percent growth a year earlier).

It was J. Crew’s promise under Drexler that attracted deep-pocketed investors TPG and Leonard Green & Partners, who teamed up with the ceo to take the retailer private in 2011 for $3 billion — a price that reflected what might be called a “Mickey Premium.” They bought not only the company, but Drexler’s stewardship and aura. Drexler, 69, got a bigger piece of the action as his stake in the business grew to an estimated 20 percent, according to sources.

“Is Mickey Drexler to J. Crew what Steve Jobs was to Apple?” asked one retail observer, noting the answer was a definite, “yes.” “What Mickey Drexler is, is vision.”

But how much is that vision worth when Drexler might only remain in his role for a few more years after a sale?

The Japanese parent of Uniqlo, Fast Retailing Co. Ltd., had been in early talks to buy J. Crew, but reportedly balked at the $5 billion price tag proposed by TPG and Leonard Green. And Fast is one of only a few retailers in a position to buy J. Crew.

There have been rumors that Zara parent Inditex was interested in J. Crew, but a source familiar with the matter said Inditex, if it were to make any acquisition, would rather buy a fixer-upper and does not want to pay top dollar for a successful business that it would then have to rework to fit its vertical operating platform.

Although anything can happen, that more or less clears the field of obvious strategic acquirers for J. Crew, leaving TPG and Leonard Green the option to take the company public yet again. Part of that process would likely involve a promise that Drexler would be on board for some period of time. Or the investors could lose the Mickey Premium they paid and hold on to the investment longer. That would give them time to have Drexler train a new ceo as the company seeks to boost profitability with its overseas expansion and further development of the Madewell brand.

Late Wednesday, J. Crew reported a net loss of $30.1 million for the first quarter ended May 3, down from earnings of $29.3 million a year earlier. The deficit in the most-recent quarter reflected $36 million in losses, net of tax, that were tied to a refinancing package that is ultimately expected to produce annual interest expense savings of $16 million. Adjusted earnings before interest, taxes, depreciation and amortization, or EBITDA, fell to $64.8 million from $101 million. Revenues increased 5 percent to $592 million.

This is a continuation of a general financial trend for J. Crew, which like other retailers finds it confronting a consumer who’s stretched thin.

In 2013, J. Crew’s EBITDA grew about 2.9 percent to $370.2 million, a slowdown from growth of 27.4 percent, to $359.6 million, the year earlier.

One private equity player noted the company’s owners have “huge valuation expectations” and that “the market is soft in apparel in the U.S. The earnings growth [at J. Crew] really isn’t all that impressive. And you’re kind of cashing out to some degree on a world famous merchant-ceo who’s not going to be there all that much longer, so it’s kind of tough to really justify.”

J. Crew and TPG declined to comment about the company’s succession plans on Wednesday. Leonard Green could not be reached.

Jenna Lyons is the best-known executive at the company behind Drexler and although she’s taken on a more operational role as president and executive creative director, she’s an unknown quantity to many investors. Plus she would be seen more as a creative type than the merchandising-financial combo that makes Drexler stand out.

Still, Elaine Hughes, president of executive search firm E.A. Hughes & Co., said Lyons should not be overlooked.

“The investment community needs to get over their infatuation with the single-genius theory,” she said. “Mickey Drexler’s success with J. Crew is well documented and at some point would be a great case study for students interested in a fashion career. However, Mickey is one of the few executives who has created succession planning at J. Crew with the unique partnership of Jenna Lyons and Libby Wadle. Jenna being the president and executive creative director and Libby as brand president. It is the marriage of art and science, or actually design and merchandising.”

Hughes said Drexler “stuck his neck out” by making a designer president. “In this case, the designer, Jenna has been able to permeate the organization with creativity on all levels while maintain the business-savvy to have equal responsibility to manage the operations, real estate, etc.,” she said.

Drexler seemed to allude to Lyons as a possible successor shortly after J. Crew was taken private. In an interview with Bloomberg Television, the ceo was asked if Lyons could possibly take over for him one day. “Well how could you say no, right? I mean, I don’t know if she’s going to be watching this or not, but sure,” he said.

In that interview, Drexler addressed the issue of a succession plan, saying, “I can’t speculate on that. We’re a team that’s been together. The only reason we did this is because of the team. The team got us here. The team will get us to where we’re going. But I think everyone has to think about a succession plan. And I think about that, too.”

Others are more skeptical that Drexler — whose micromanaging is the stuff of legend — is the person to develop his own successor.

“His style, I’m not sure if it’s conducive to molding and shaping ceo talent,” the private equity source said. “He kind of controls most everything. This is detail management and he’s just all over it.”

One banker summed up the situation this way: “Mickey likes to talk about succession and having succession, but I don’t think he really wants succession.”

TPG and Leonard Green are only three years into the investment and can simply wait and grow the business — adding more stores overseas and potentially developing a business under the name J. Crew Mercantile, which the company trademarked last year.

“They don’t need to [exit the investment] right now, so they’re sitting tight,” the banker said. “Long term, they do have a Mickey problem.”