By and  on October 29, 2007

LOS ANGELES — Pacific Sunwear of California Inc.’s move last week to explore strategic alternatives for the troubled streetwear chain demo elicited praise from analysts, many of whom have long criticized the company’s unsuccessful foray into the volatile urban market. 

The announcement will likely result in the sale or shuttering of the 154-unit demo, allowing the retailer to focus on reviving its core brand, PacSun, analysts said. The Anaheim, Calif.–based company plans to hire a yet-unnamed investment banker to assist in the strategic review for demo. 

“It’s one of the most significant positive announcements that the company could make in terms of near-term profitability,” said Jeff Van Sinderen, a senior analyst at B. Riley & Co. “It was a good business for some time, and they’ve explored all the possibilities for keeping the business. I think they had decided to give demo until the end of the fiscal year, but saw they were not going to improve in the holiday season.”

Pacific Sunwear also said last week that it would phase out its footwear and accessories boutique concept, One Thousand Steps. With nine doors in five states, the chain will begin to close in January, a company spokesman said. 

Van Sinderen and other analysts blamed much of demo’s problems on an unpredictable urban market. Launched in 1998 at the height of the hip-hop apparel frenzy, the multibrand, mall-based streetwear retailer has been plagued by the flagging popularity of once-robust urban labels. 

“You haven’t seen the hip-hop icons on the guys’ side do a good job of nurturing their brands,” explained Elizabeth Pierce, a senior research analyst in the consumer practice at Roth Capital Partners. “Once [Sean John founder] Diddy and [Rocawear cofounder] Jay-Z started dressing up, they walked away from what they were trying to sell.” 

With an average store size of 2,500 square feet, demo has limited space to explore new brands and a management team seemingly reluctant to toss older labels. 

Still, improvements were under way. In February, Pacific Sunwear CEO Sally Frame Kasaks axed 74 underperforming doors while investing in high-quality audiovisual systems and a premium merchandising mix, including Ed Hardy and Antik, in several of demo’s remaining locations. “From a comp perspective, those doors did well, but the overall profitability just wasn’t there,” said Gar Jackson, Pacific Sunwear’s director of investor relations. “The urban streetwear customer has been elusive for our peer group.” 

Meanwhile, department stores may stand to attract more urban business, as streetwear fans who once shopped demo look elsewhere in the mall. Although demo’s largest labels, including Ecko Unltd. and Rocawear, already sell at Macy’s, some of demo’s smaller brands may also consider department store partnerships, sources said. 

Still, Pierce pointed out that demo isn’t disappearing just yet. A buyer could pick up demo’s real-estate holdings or the chain itself within months. But if demo simply shutters its doors, lease negotiations will take time. And, she continued, the chain has booked merchandise until March. “But there’s an end in sight. This is something that the Street has been waiting for.” 
For good reason. During the first three fiscal quarters of 2007, the demo and One Thousand Steps chains suffered a combined pretax operating loss of $21 million, excluding previously announced expenditures. The demo chain has suffered negative comps throughout the fiscal year, with double-digit decreases in the last three months. 

By comparison, PacSun has rebounded from lackluster numbers earlier this year. Despite continued pressure from surf/skate competitors like Zumiez and surf-inspired specialty chains like Hollister, the retailer saw double-digit gains in August comps and a 5.4 percent increase in same-store sales for September, a difficult month for most apparel retailers. 

Analysts have attributed PacSun’s improved sales to Kasaks’ attempt to attract a larger female customer base and to improve product presentation. 

Kasaks became interim CEO of the $1.45 billion company last year when Seth Johnson left the position after only 18 months amid a slide in company-wide comps. Kasaks became permanent CEO in May.

“We have seen firsthand the dramatic improvement in both merchandising and in-store presentation this past year at PacSun and believe there is more to come,” Jennifer Black of Jennifer Black & Associates wrote in a report last week. “We believe [Kasaks] and her team can turn this company around.” 

As the only national chain specializing in streetwear, demo’s demise seems to symbolize the death of the hip-hop apparel chain. However, similar retailers continue to tack on storefronts, implying that demo’s failure could be a demo problem, not an urban problem. Case in point: Up Against The Wall has 25 locations nationwide, Man Alive has 95 stores and Downtown Locker Room has 70 locations. <

DTLR’s CEO, Glenn Gaynor, told DNR that the chain’s ultimate goal is to open 250 to 300 stores around the U.S.—some potentially in markets that demo could soon depart. “But you can’t run the business from some central office somewhere. You have to give each store the autonomy to be the local retailer in each market you are in,” he explained. 

That regional attitude, said Pierce, as well as agility in attracting premium labels and streetwear up-and-comers, has engendered success in the urban specialty market. “You can’t just speak one language,” she said. “This customer is more sophisticated than he gets credit for.”

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