The M&A market is simmering. The question is when it might hit full boil.
This story first appeared in the April 6, 2010 issue of WWD. Subscribe Today.
Phillips-Van Heusen Corp.’s $3 billion deal to buy Tommy Hilfiger from Apax Partners has industry executives, private equity players and financial firms speculating on what deal will be next, and whether the floodgates are about to open on mergers and acquisitions activity given the rebounding economy. Those firms that hoarded cash in the downturn are now looking to spend it, while those who were irreparably weakened by the recession are hoping for a lifeline.
“With the way that capital markets have come back over the last few months, without a fundamental change in the macro economy, people are now tempted to sell,” observed Ajay Khaitan, founder and chief executive officer of Emerisque Brands UK Ltd. Emerisque, along with SKNL North America B.V., last year acquired Hartmarx Corp. when it was mired in bankruptcy proceedings. Emerisque is one of those firms on the prowl to buy more.
M&A activity overall in the first quarter of 2010 has been centered mainly in Asia, with those transactions helping to increase the value of global M&A deals 6.1 percent to $442.1 billion, including a 92.5 percent increase to $89.4 billion in Asia-Pacific excluding Japan, according to data from Mergermarket.
M&A analysis from investment banking firm Robert W. Baird & Co. on the U.S. consumer products sector, which includes beauty and recreational firms but not fashion companies or retailers, indicated the number of deals for which terms were disclosed during the first two months of the year declined to four from seven a year ago. However, their aggregate value tripled to $2.42 billion from $807 million. In 2009, the value of middle-market M&A deals, or those valued under $1 billion, in the retail, apparel, footwear and restaurant sectors rose 32.5 percent to $9.29 billion from $7.02 billion in 2008, even though the number of deals fell 20.9 percent to 91 from 115, Baird said.
So far this year, Kellwood Co. in January closed on its acquisition of women’s outdoor performance brand Isis, and has said it is on the hunt to acquire more brands. In the same month, Sanyo Shokai Ltd. said it would buy Tokyo-based apparel retailer Kai Lani. In March, apparel catalogue firm Casual Living USA was sold to Boston Apparel Group, a portfolio company of Monomoy Capital Partners that includes Chadwick’s and Metrostyle, and on April 1, Compagnie Financière Richemont SA took a giant step into the e-commerce arena with the purchase of Net-a-Porter.com, the online fashion retailer it has valued at 350 million pounds, or $532 million.
Firms such as G-III Apparel Group Ltd., Steven Madden Ltd., Delta Apparel Inc., Perry Ellis International Inc. and Oxford Industries Inc. have said on conference calls to Wall Street analysts that they are looking for acquisitions. Madden completed its purchase of Big Buddha Inc., a marketer of fashion-forward handbags, in January.
Last month, Morris Goldfarb, chairman and ceo of G-III Apparel Group Inc., said on a conference call to Wall Street analysts, “For our company, integration of acquired businesses has become a core skill set. Every company we’ve acquired over the past few years is proving to be accretive. We believe we’ve never been better positioned to continue to take advantage of acquisitions on an opportunistic basis.”
Earlier acquisitions include Andrew Marc and many of the assets of Wilsons The Leather Experts Inc.
Also in competition for brands are the perennial consolidators that are often on the prowl or are rumored to be, such as VF Corp., Kellwood Co. and Warnaco Group Inc.
“What the PVH deal has done is take one of the natural predators off the market,” said Esteban Bowles, principal in the retail practice of A.T. Kearney. “When you look at the apparel space, only a handful can do something this significant because of the health of the balance sheet.”
It had been more than seven years since PVH had acquired Calvin Klein Inc., a deal that fundamentally transformed PVH.
Bowles also said VF Corp. is another well-capitalized firm with a healthy balance sheet, known for growth via acquisitions.
“Warnaco is a big owner of brands, but its challenge continues to be that it has a higher debt load and lower cash levels [than either a VF or PVH],” Bowles said, noting other potential acquirers such as Perry Ellis and G-III Apparel are in a similar position with respect to their balance sheet.
So far the branded firms he’s worked with have sought to improve their operational structure, trying to make it through the downturn and emerge in a better position to grow.
How healthy some of these brands really are depends on the “individual strength of the brands, and the financial health, especially the cash flow generated [by the business],” Bowles said.
While brands are hot properties these days, Bowles doesn’t rule out interest in some specialty retailers, even though the chains right now don’t seem to be actively prowling for a cash infusion.
“I also see some attractive companies [such as] Lululemon and others that [buyers] could be eyeing. I think these retailers will largely remain independent, growing organically. There are dozens of them, all high-profile, such as Under Armour Inc. and Forever 21,” he said.
Lululemon Athletica Inc. and Under Armour are publicly held, while Forever 21 is private.
Paul Charron, senior adviser for Warburg Pincus and an accomplished dealmaker himself during his tenure as chairman and ceo of Liz Claiborne Inc., isn’t ruling out action by financial buyers in the world of private equity.
“Private equity is clearly interested in apparel and fashion. Fashion, retail and apparel are never out of vogue,” he said after a presentation at a recent Retail Marketing Society meeting.
Charron noted the lending environment now seems to be opening up. He added that while there can be “risk in fashion when you let your emotions overwhelm you,” he believes there’s been more recent interest from financial buyers because “years ago it was harder to do these deals. There was no financing, and firms had to put their own money into a deal.”
Matthew Katz, managing director and head of the retail practice at global business-advisory firm AlixPartners, expects to see activity from both financial and strategic buyers.
“After a period of belt-tightening and cautiousness, it certainly feels like there is increased activity,” said Katz. “The private equity folks were on the sidelines a bit, and there’s now renewed interest. Retail companies, when run correctly, throw off a lot of cash and are attractive to sponsors. The strategics are looking for market share plays and growth opportunities, and their interest also seems to be piqued.”
According to Katz, firms that have not altered their business model to meet today’s consumer mind-set could spell prime opportunities for potential buyers, who can provide them with financial flexibility and help them recapture their former momentum. He noted the PVH-Hilfiger deal is a “wonderful story about how Apax and the management team at Tommy did a phenomenal job in creating value and in repositioning the business.”
The recession has made prospective buyers more cautious. Katz said while due diligence is still intense, there are sharper questions that are “more focused on the risk profile of the business as opposed to the upside of the business.”
Yet not everyone is convinced the retail and apparel sector is about to see an M&A boom.
“I’m a bit of a skeptic,” said James Grayer, a partner at law firm Kramer Levin’s corporate practice. “I think it has turned a corner to some extent, but it is not like the floodgates have opened to new transactions.”
Generally, there’s still a disconnect between what buyers want to pay and what sellers think companies are worth, the attorney concluded. He also noted that buyers are looking at deals differently than before, particularly in terms of the risk they’re willing to undertake. He explained that has impacted how a firm’s business operations are drawing closer scrutiny compared with a few years ago, as well as changes in how deals are being structured.
“People are looking for cleaner companies, and walking away from firms that have an issue,” Grayer said. “When someone comes to me to talk about getting a business ready to be sold, I tell them to do some due diligence on themselves beforehand.”
As buyers test the waters of M&A once again, they’re less likely to dole out all the money in the deal at once, holding something back to make sure the business performs the way the sellers had warranted. Grayer noted that one way buyers are doing this is by drafting sales agreements that keep sellers “on the hook” for a longer period of time. The provisions include tighter representations and warranties; increased use of earnouts to bridge valuation gaps; special indemnification protections if diligence issues arise, and holdbacks on a portion of the purchase price for a set time as reserves for indemnity claims.
David A. Galper, managing director for retail and apparel in the consumer and retail investment banking division of KeyBanc Capital Markets Inc., said, “There is hope that the Tommy acquisition will break the ice and that a number of deals will follow. We know of several companies that are hunting for acquisition targets. In many cases, acquiring complementary brands, product categories and-or distribution channels can be more efficient than building them” from the ground up.
He said there is a general loosening of credit markets, with pricing and spreads continuing to improve. “Lower rated credits have greater access to capital now than before. In the secondary market, we’ve seen pricing about 20 basis points lower than it was in January.
Some financial sources estimate that the PVH-Tommy transaction was at a 4.0 times multiple of EBITDA, or earnings before interest, taxes, depreciation and amortization, the norm in the market these days.
“Leverage levels on retail and apparel deals are not stratospheric, as they once were,” Galper said. “One can expect to see total leverage in the 4.0-times to 4.5-times EBITDA range,” Galper said. He explained that financing a deal at 4.5-times EBITDA could consist of senior debt at 3.5-times EBITDA, with subordinated debt or mezzanine financing for the balance at 1.0-time EBITDA.
He sees more activity in the smaller- to middle-market arena: “As we emerge from the recession, the competitive landscape is favorable for strategics. [Target] companies that lack scale may have a harder time getting distribution in an environment where retailers have been consolidating vendor relationships. Strategics are looking as aggressively as ever, feeling that the worst is behind them. While they want to acquire something that can really move the needle, many are looking at modest-size deals that will not put their core businesses at risk.”
According to Galper, “At KeyBanc, we’re typically closing leveraged finance transactions in about 60 days. The structure of deals is reasonably conservative, with established covenants and healthier leverage levels. Gone are the days of ‘covenant lites.’”
Richard Kestenbaum, a partner at Triangle Capital, cautioned that the risk he’s seen is where, in conducting diligence, firms fail to evaluate the cultures of the acquiring and selling firms. “If you’re not perceiving the gap in culture values [of each firm], you can miss a potential failure in the transaction.”
Still, the next salvo on the M&A front will likely be a move by a strategic buyer zeroing in on a brand.
“There are lots of brands out there now open for discussion, more so than a year-and-a-half ago,” said Andreas Kurz, former head of Diesel USA and Seven For All Mankind, and now president and owner of fashion consultancy Akari Enterprises LLC.
Kurz said he’s seen more activity and interest in the first three months of 2010 than in all of 2009, particularly since “last year was tough for many firms. They didn’t talk with potential strategic or financial partners last year, but are now welcoming discussions for help in the back office and [eyeing] financial investments so they can focus on design.”
He noted when companies were doing well in the days prior to 2008, it was easy on the operational front for the successes to hide mistakes. “After the slowdown in 2008 and 2009, the whole world was shaken and many found they were ahead in design, but not in operations; nor were they very high-tech in systems.”
He said brands are even more important now, noting a department store buyer two years ago had 25 denim resources to choose from, a number that’s now essentially been halved.
“There’s less focus now on a branded lifestyle approach and more on trying to build a business in the core operation. Before the brand was too much of ‘How I want to be Ralph Lauren,’ and they all tried to imitate that. Now it is about what the brand really stands for, where is the credibility. The focus is on brand meaning and then how to develop it around the world adding licenses to the brand for growth and looking at what categories are feasible for expansion,” concluded Kurz.