By  on March 7, 2013

Sycamore Partners has tapped into two — maybe three — hot topics with its latest deal.

The private equity firm’s $600 million agreement to take Hot Topic Inc. private, which was unveiled Thursday, underscored both the untapped potential of the plus-size market and the opportunities seen in revamping the mall-based specialty store model.

Analysts said it is not the 618-door Goth-inspired Hot Topic chain that’s the prize of the deal, but the 190-door Torrid business, which targets younger plus-size consumers with trendy fashions.

“The plus-size female consumer, the younger set is begging for someone to give them a lifestyle destination to shop,” said Thomas Filandro, analyst at Susquehanna Financial Group, noting the brand fills that niche and is just starting to gain traction.

“You’ve got white space growth with Torrid,” Filandro said. “You get an opportunity to build Torrid potentially outside the U.S. You’ve got the Hot Topic business established well with its edgy positioning but growing fashion apparel. Combining all those with systems implementations, they can take the [profit] margin structure up substantially.”

For the nine months ended Oct. 27, Hot Topic posted net earnings of $7.4 million, versus a loss a year earlier, on sales of $508.8 million. Gross margins stood at 35.3 percent of sales.

Private equity companies often look to buy companies that need some fixing up but also have clear growth opportunities and, in some cases, could benefit from time away from the public spotlight.

Hot Topic ticks all those boxes.

The deal values the retailer at $14 a share, a roughly 30 percent premium over Wednesday’s close. “Sycamore Partners will provide great resources and expertise to us as we operate as a private company,” said Lisa Harper, chief executive officer and chairman of Hot Topic.

A spokeswoman for the retailer said Harper would continue to head the business.

Hot Topic was not looking for a deal, the spokeswoman said, “But once the offer was received, the board determined that it was at a premium worthy of consideration. The company explored alternate competing proposals and determined that the Sycamore proposal was the best way to maximize value for shareholders.”

Jeff Van Sinderen, an analyst at B. Riley & Co., said the offer price represents “a pretty average multiple” at about 8.1 times his estimate for the company’s annual earnings before interest, taxes, depreciation and amortization.

Van Sinderen said he would not be shocked if another bidder emerged before the deal closes.

“Given the growth potential of the company and its unique concepts, we could see an acquirer agreeing to pay somewhere in between $14 and $16.40 [a share],” he said.

If the acquisition does go through, it might also help Sycamore maximize its own portfolio, which includes The Talbots Inc. and apparel sourcing firm Mast Global Fashions. Mast is already one of Hot Topic’s vendors. A spokesman for Sycamore declined to comment on the deal.

“[Hot Topic] is going to be able to move faster as a private entity,” said Janet Kloppenburg, analyst at JJK Research, who sees Torrid and the company’s budding five-door Blackheart lingerie concept as growth opportunities for Sycamore.

A decade ago, mall-based specialty stores had seemingly endless expansion ahead of them and the comparable-store sales of Hot Topic and others made them darlings of Wall Street. But with mall growth slowing to a crawl and more consumers going online, specialty stores are reinventing themselves. That along with relatively low stock prices have helped draw would-be acquirers to the channel.

“They need to leverage secondary concepts,” said Kloppenburg, of specialty stores. “They need to optimize international opportunities. They need to build out the e-commerce space.”

They also have to compete against the likes of Uniqlo, Joe Fresh, Zara, H&M and others.

“It doesn’t mean you’re dead,” Kloppenburg said. “It means you have to look at the new channels of growth for your brand and penetrate them as well as you’ve penetrated the malls. That’s what the message of this Hot Topic acquisition by Sycamore is.”

Bank of America Merrill Lynch served as financial adviser to Sycamore, while Guggenheim Securities represented Hot Topic.

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