By  on March 26, 2007

Private equity firms that are flush with cash and a strong economic backdrop, coupled with low borrowing rates, should keep leveraged buyout activity robust this year, according to a recent report from Citigroup Global Markets.

The report also rated companies that would make good acquisition candidates, and listed Liz Claiborne, Hot Topic, Tween Brands, Abercrombie & Fitch and Children"s Place as the most attractive.

Citigroup equity analyst Deborah Weinswig said in the report that LBOs accounted for 31 percent of all the mergers and acquisition volume last year. And, despite the bullish outlook for 2007, LBO activity this year could be hampered by a tightening of the credit markets.

Private equity investors likely will be on the prowl for targets in the retail sector, according to the Citigroup report, because the sector offers strong cash flow. The analysis of acquisition targets included rating firms on cash flow generation, low debt levels and room for margin expansion, among other criteria.

With Liz Claiborne, the report said if the company is taken private, "we believe $50 [per share] could be a reasonable takeout value for the company. We estimate this could be an attractive value for private equity because, based on our analysis, the sponsor"s internal rate of return is 18 percent. We believe Liz could be a deal with a lower level of risk due to its strong cash flow, diverse portfolio of brands and strong management team."

The stock has been trading around $43.

Citigroup analyst Kate Mc­Shane has Liz Claiborne pegged with a "buy with a high risk" rating. "We think the company"s diverse portfolio of brands, its proactive strategy to increase its retail presence and its strong balance sheet enable the company to capture future growth opportunities," the analyst said in the LBO report. "Furthermore, our proprietary valuation analysis indicates there is room for multiple expansion due to the company"s strategy to expand its retail business."

Liz Claiborne"s retail business accounted for 16 percent of revenues in 2000, McShane noted, and grew to 24 percent of revenues by the close of 2005. "Based on our estimate of the company"s store expansion for the next two years both domestically and internationally, we think the retail business could be close to 30 percent of the company"s overall revenues by the end of 2007," the analyst said.Of the potential LBOs in the specialty retailers tracked by Citigroup equity analyst Kimberly Greenberger, the sub-sector may not be as attractive to private equity.

"Although we highlight Hot Topic, Tween Brands, Abercrombie & Fitch and Children"s Place as the most attractive privatization candidates in our coverage universe, we believe the softlines sector overall is the least attractive retail sector to private equity investors," Greenberger said. "Specifically, the specialty retailers have no underlying asset value (specialty apparel retailers lease their stores, they do not own them), high-fashion risk and volatile operating margins and cash flow relative to other sectors, which makes these companies relatively less appealing as a target for a leveraged buyout in our view."

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