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Buy, buy, buy — or should that be sell, sell, sell?
This story first appeared in the March 11, 2014 issue of WWD. Subscribe Today.
Investment professionals expect 2014 will be an active mergers and acquisitions market for retail and apparel, compared with the levels of 2013. And given current deal flow activity, executives at companies prowling for good assets to acquire say the year is shaping up to be a seller’s market. Competition is expected to be keen from both strategic and financial buyers, as well as high-net-worth individuals and sovereign wealth funds.
Research firm Preqin estimated that private equity firms alone, on a global basis, ended 2013 with $1.07 trillion available for deals this year, a combination of the $554 billion raised last year plus the uninvested capital from prior years.
Adding to the competition for good assets is the continued open window for initial public offerings, allowing owners of assets available for sale to consider testing the IPO waters instead. Last year, global annual IPO proceeds rose 37.5 percent to $137 billion, the largest gain since 2004, when U.S. IPOs had annual proceeds totaling $51.9 billion, according to IPO investment advisory firm Renaissance Capital.
Peter Comisar, vice chairman and head of West Coast Investment Banking at Guggenheim Partners, said the M&A market in 2014 will be driven by continued active participation by private equity investors, availability of favorably priced debt and more complex deal structure. Comisar also noted “strategic buyers have become more engaged, as have international players fueling competition for compelling assets.”
“Over the past few years leading retailers and branded apparel companies have delevered their balance sheets, focused on execution and cost-cutting, and now are looking for portfolio additions to drive growth and valuation. The right M&A transaction [allows for] a relevering of the balance sheet with attractive debt capital. Further, the spectre of activist investors have chief executive officers and boards thinking much more actively about mitigating vulnerabilities such as large cash balances or debt-free capital structures,” the banker said.
Gilbert Harrison, chairman of investment banking firm Financo Inc., added, “What is creating this surge is the combination of easy access to money and the feeling as we come out of the recession that many things are significantly undervalued.”
For Mark Vidergauz, ceo of investment banking firm Sage Group, “contemporary brands are very attractive as acquisition candidates, and we’re seeing increased activity in the beauty space. There are a lot of larger firms looking at smaller deals, which we haven’t seen that much of historically.”
Professionals from the private equity side are also seeing a rise in activity on the M&A front despite some potential global risks to the macroeconomic backdrop.
According to Jason H. Neimark, managing director at Sun Capital Partners, whose firm’s portfolio includes turnarounds and special situations, “The economic outlook for 2014, given the current macro picture, we believe will remain broadly the same as it was in 2013, reflecting a low to no growth environment.”
Sun Capital’s U.S. operations across different sectors and that of its European advisor, Sun European Partners, completed 18 acquisitions in 2013, along with eight exits and two IPOs via contemporary brand Vince in the U.S. and women’s brand Bonmarché in London. “We expect 2014 to be active on both the buy and sell sides, given the robust M&A market and continued strength in financing in the IPO market.” At this point in time, Neimark sees nothing on the horizon that could constrict access to the credit markets, which should help to continue to fuel M&A activity.
“There’s been a significant change in the M&A environment since the first of the year,” said Josh Olshansky, a managing director at Golden Gate Capital whose primary focus is on the retail and restaurant sectors. Olshansky said volume in the retail sector was depressed in 2013, noting that after the beginning of the year a “switch got flipped and things picked up.” Easy access to credit financing, even with Fed tapering, has resulted in a significant amount of confidence that things are getting better. That in turn has helped to fuel M&A activity.
According to Olshansky, conditions over the past 12 months have leaned toward a seller’s market where there aren’t a lot of assets available in comparison with the number of buyers out there trolling for an acquisition. That’s in comparison with conditions in 2008 during the economic downturn. Then companies that needed liquidity put up assets for sale, and the few buyers who had the cash to put to work found little in the way of competition.
The opportunity for deals isn’t limited just to the U.S.
Ariel Ohana, founder of Paris-based investment banking firm Ohana & Co., said there’s been an uptick in cross-border transactions in comparison with before when consolidation, particularly in Europe, used to be localized. Companies in China are both acquiring brands at home and looking at brands in the U.S., while South Korean and Japanese firms are eyeing companies in Europe.
Elsa Berry, founder of investment banking firm Vendôme Global Partners, said, “Clearly the big thesis in the luxury sector is that there are so many different types of buyers, and so much money available for acquisitions, that there’s not enough good-quality companies available [for purchase].…To say that the buyers are strategic or private equity is overly simplistic. There’s also interest from high-net-worth individuals, family offices and sovereign wealth funds. We also see interest from Korea, Japan, China, Brazil and Qatar, as well as the U.S. Most traditional private equity firms aren’t geared toward luxury purchases given today’s shortened [investment] time horizon. Many of these luxury purchases are a 10-year investment in time and money.”
There’s definitely been an increasing focus on the consumer sector from both sides of the Atlantic.
John Coyle, a partner at Permira, who heads up the firm’s New York office, said, “Historically, the consumer sector hasn’t been as big an opportunity for Permira in the U.S. because consumer preferences did not share much in common with Europe. However, in the age of instant gratification, social and digital media, brands that are popular in one country are now often popular in another, making the opportunity much bigger and more global than before.”
While he continues to see huge opportunity in the consumer sector on the international front where the firm has invested in luxury brands, Permira has also increased its footprint in the search for investment ideas, with an emphasis on the U.S.
“That the consumer products sector is gaining interest is a natural evolution from the recession,” Coyle said. “In a recession, a lot of private equity firms had hesitated to increase their exposure to the consumer sector. For us, brands are really the crucial factor. As long as you’re buying good brands, you will do well, but you have to execute on that potential.”
In general, for private equity deals of $400 million and greater, valuations have been at a multiple of 9 times earnings before interest, taxes, depreciation and amortization in 2011 and 2012 on average, and in 2013, closer to 9.4 times, Coyle said.
In the case of J. Crew Group Inc., which is said to be in talks with Japan’s Fast Retailing Co. Ltd., a deal at $5 billion represents 13.5 times adjusted EBITDA for 2013.
Tricia Patrick, a principal at Bain Capital, which invested in Canada Goose and Bob’s Discount Furniture last year, said it seemed that valuations for some public and private companies were rising higher given that consumer sentiment has been on the rise and retailers have recently been trading up. She cautioned that the increase is not a reflection that every business is overvalued. “The risk level goes up at these sort of valuations from the investor’s point of view, but there are still attractive deals in the market. And of course if you are a seller it is a great environment,” she said.
While there are fewer opportunities in relative terms, those quality companies that do come onto the market tend to garner the most attention from buyers, making it a seller’s market, Sage’s Vidergauz said.
His firm also has been fielding calls from hedge funds looking to learn more about the fashion business as they evaluate possible investment opportunities.
While the liquidity characteristics of many stocks in the fashion and apparel sector may limit the ability of hedge funds to play an active role, Comisar noted “there is a greater recognition and understanding by sophisticated investors of inherent values such as brand IP, royalty revenues and real estate assets.”
One recent example — although still a relatively rare one among hedge funds — is the acquisition by Esopus Creek Values Series Fund LP in January of the intellectual property assets of bankrupt Loehmanns. Esopus has nearly a 5.3 percent stake in Trinity Place Holdings, the renamed firm of the restructured Syms-Filene’s Basement upon its exit from bankruptcy court. Trinity, primarily a commercial real estate holding company, also holds the IP assets owned by the former Filene’s Basement operation.
Andrew L. Sole, managing member of Esopus Creek Advisors LLC, the investment adviser to the Esopus fund, said, “We learned a lot from the Filene’s bankruptcy.”
He said that knowledge was important in understanding some of the issues that are keeping away potential investors of bankrupt assets, adding that eventually the number of interested buyers could increase as they become more familiar with the auction process.
Sole explained that timing and certain inherent risks are often issues for novice investors in what is already a complicated bankruptcy process.
“People who don’t understand bankruptcy proceedings tend to stay away. They often don’t have the ability to quickly submit bid packages that are due in short order, usually because buyers in a non-bankruptcy sale process typically have to vet the idea through multiple layers of management before a final decision can be made.
“There are many unknowns in bankruptcy. Even if the parties come to an agreement on the purchase of an asset, or you win at auction, there can be objections from third parties such as stockholders and creditors, or even from the judge who is overseeing the proceeding, that can prevent you from completing the sale,” he said.
Another factor fueling M&A activity has been shareholder activism becoming more mainstream in the retail and apparel sector.
“In any coming flat to down stock market, successful activist investors shall be those who are transactional in focus,” said Robert L. Chapman, Jr., managing member of Chapman Capital LLC.
He cautioned that operational activism with retailers can be a nightmare because activist investors have a propensity for underestimating the difficulty in a turnaround situation involving merchandising and fickle customers.
On the side of transactional activism, Barington Capital Group has needled Jones Group to sell itself to boost results, with private equity firm Sycamore Partners set to buy the apparel giant for $2.2 million, including debt. The Clinton Group is exploring financing alternatives to taking The Wet Seal Inc. private, while Eminence Capital has been pushing for a combination of The Men’s Wearhouse Inc. and Jos. A. Bank Clothiers Inc., of which it holds a stake in both firms. Legendary activist Carl Icahn is pushing eBay Inc. to spin off its PayPal unit.
Regardless of who is looking to buy or sell, one trend seems clear: Negotiations are getting tougher, in part because parties also are getting more creative in how they structure deals.
Guggenheim’s Comisar noted that transactions over the past six months foreshadow what he believes will be a continued trend toward more complicated deal structures to bridge valuation gaps and achieve required objectives between buyers and sellers. “Recent deal executions have hinged on seller financing, earn-outs and coincident third-party equity investments. Complex deal structure will be a theme for 2014 to optimize value.”
Ohana said he’s noticed that while the use of earn-outs isn’t new — private equity deals have been using them for some time — they are becoming more in vogue in deals struck by strategic buyers.
In addition, key personnel, such as a creative director, while not an owner or a founder, are now receiving a small stake in the business when it is sold. Even if it’s just 1 percent, it provides a “sense of ownership to these individuals. Just as important, due to the intense competition for talent, a stake in the company also secures that the talent stays with the company even after ownership changes,” Ohana said.
Harrison said people also are looking at partnerships and joint-venture transactions, instead of straight recapitalizations or pure acquisitions.
“Many firms are realizing that if a company has value and you can’t buy the whole thing, it makes sense to buy a part of the business and continue to work with the buyer to see it grow to the next stage. We’ve seen large private equity firms wanting to invest and taking a minority position, something that we haven’t seen done before. It’s an easy way for people to lower their risk and catch some gain on the upside,” Harrison said.
Blackstone Group did just that last month when it acquired a 20 percent stake in Italian fashion firm Versace for about $205 million to help finance the brand’s growth.