PRIVATE PLACEMENT A VIABLE OPTION FOR SA

Byline: VALERIE SECKLER

NEW YORK--Despite their high-risk reputation, women's apparel companies generating annual sales of $50 million or less can woo and win capital in the private placement market--a market that is heating up.
"I think the private placement market is better than it's been the last three to four years, because the institutions have a lot of capital and are more anxious to make investments" due to an improved economy, said Anders Maxwell, a partner in Benedetto, Gartland & Greene, a New York investment bank.
"Three or four years ago, most of these investors were involved with cleaning up bad loans," he added.
Presently, Benedetto is The Donna Karan Co.'s financial adviser in the SA firm's search for funding in the private placement market or elsewhere. As reported, last November Donna Karan called off a much-anticipated $150 million initial public stock offering, saying the timing wasn't right, and in May set its sights on the private market.
The privately held firm notched earnings before interest, depreciation, taxes and amortization (EBITDA) of $33.1 million on sales of $364.7 million in fiscal 1993. A spokeswoman for Donna Karan said the company is projecting gains for 1994, but she declined to furnish figures.
"As a practical matter, I believe [Donna Karan] is in better shape than it was a year ago," Maxwell noted.
Addressing the risks of the fashion business, Maxwell asserted, "There's not much difference between Seventh Avenue and Silicon Valley. Some institutions would rather take a fashion risk than a technology risk. I can't think of an industry that changes more quickly (than semiconductors). I'd rather take my chances with five seasons."
Douglas Burke, a vice president in Sutro & Co.'s Los Angeles-based investment banking division, agreed with Maxwell about the greater availability of private funds.
"If anything, the private placement market is picking up," he said. "Usually, when the public equity market slows down, the private market picks up. Some [analysts] are saying the IPO boom has ended."
Most often, private funds flowing to apparel vendors and retailers land at middle-market firms, those with annual sales upwards of $100 million, noted David Goddard, a managing director at Chase Securities Inc., here.
Barneys Inc.--whose sales in the year ended July 1993 hit $174 million and have been rising sharply since then--firmed up its cash position in April with a $40 million private placement arranged by Chemical Securities Inc., the investment banking arm of Chemical Bank. Funds were raised through the sale to a group of insurance companies of Barneys unsecured senior notes paying annual interest of 8.32 percent and maturing June 15, 2000.
When it comes to small apparel firms, private placements are tough to engineer, but they still amount to the readiest source of growth capital available to such companies, Burke said.
A smaller apparel vendor typically wouldn't be able to raise funds in a public placement of debt, and although a number of smaller apparel companies have gone public and continue to file for IPOs--most recently, two California swimwear companies, Beach Patrol and Sirena Apparel Group--others could have problems doing so, advised Burke.
As the private placement market has heated up, larger-sized apparel vendors like Vernon, Calif.-based Chorus Line, which makes women's dresses and junior sportswear, have successfully obtained private funds. In February, Sutro helped the company, which markets apparel under the All That Jazz brand as well as others, to obtain $26.5 million in private capital (see related story on this page).
The fundamental challenge for smaller apparel resources seeking to raise private capital, say investment bankers, is to offset the perceived risk with various virtues. Key among them:
l A deep management team with experienced players who have weathered fashion cycles in apparel.
l A consistent operating performance, with emphasis on operating income and cash flow.
l A diversified product mix, customer profile and distribution network.
In addition to the uncertainties of the fashion business generally, small apparel vendors face another inherent handicap in that they are seeking a relatively small amount of money, and the lower that figure sinks, the less attractive a loan prospect the firm becomes.
Roughly, a $20-million loan is where a $50-million apparel vendor can expect to top out in the private debt market, estimated Benedetto's Maxwell and others. Maxwell's projection is based on the assumption of a 10 percent pretax profit margin at a firm seeking the debt capital, as well as the presence of a revolving credit line.
Typically, such a company would seek private capital once it has its secured financing in place with a factor and is ready to grow.
"The structure of private placement packages is all over the place--debt, equity and combinations--but most of those done by smallish apparel companies would be a blend of equity and unsecured debt," offered Sutro's Burke.
"It isn't very often you'll see a senior debt placement on a $50-million-or-smaller apparel company," agreed Don Gibson, another managing director at Chase Securities. "That requires proven growth at a larger company, with annual sales of at least $100 million."
When a $50-million apparel company seeks to raise equity funds or obtain long-term loans, usually in the form of notes, in the private market, it needs to take several steps prior to contacting an investment bank to help it get that capital, Burke noted.
These steps, he said, include shoring up its management information systems, having a Big Six accounting firm or a top-tier regional audit its financial statements and, most importantly, developing a clear plan for the use of the proceeds--usually growing the company to the next level.
"I think the biggest single issue with small private placements is having a well-thought-through and communicated business plan," said Benedetto's Maxwell. "That's the one thing we see over and over as the key ingredient."
After the groundwork has been laid, the apparel vendor needs to find an investment banker who will assemble a private placement memo describing the company and the securities being offered. Then the bank searches out bidders for the securities and auctions a description of a note, which contains a summary of terms and conditions.
As the women's fashion business is not perceived as a sector with long-term stability, investment bankers advise that an equity component is vital in private deals done by small resources. With the prospect of high downside risk and a low interest rate on a private loan to a small apparel company, the offer of an equity stake in the vendor would considerably sweeten the package.
Goddard at Chase served up the scenario of a women's apparel firm with annual sales of $50 million dollars, a $20 million senior loan facility and about $10 million in mezzanine financing, another form of private debt that can provide growth capital. "That would imply a probable need of another $10 million in [common] equity," he suggested.
"For smallish companies to raise equity, they usually need to give up a sizable amount of equity in the company--they could have to give up directors' seats and/or a sizable stake in the company," said Sutro's Burke, adding, "An entrepreneurial company that grew to $30 million to $50 million may need aggressive management, an active investor in a private equity placement."
Investors privately placing equity funds in a firm do so hoping to generate a particular return, whether it's to eventually sell the shares at a higher price or to register shares in the company, should it eventually go public. In the latter case, deals could be structured for investors to sell their shares in the initial public stock offering or in the aftermarket. "Most [private investors] dream there are going to be IPOs when they invest the equity funds," said Burke.
Privately held common stock is not registered with the Securities and Exchange Commission, like its private-debt counterpart, and does not trade.
The valuation of a private equity placement is "completely in the eye of the beholder," said Burke. Typically, management presents financial projections to potential investors to for their evaluation.
Equity-placement evaluations are based, in part, on the performance of comparable, publicly owned apparel companies, with a particular eye to cash flows and per-share earnings multiples, noted Fred Taylor, a vice president at Salomon Brothers Inc., New York. Added Burke, "Outside equity investors like to see an exit event like an IPO or sale of the company."
On the debt side, private placements are rated by the National Association of Insurance Commissioners/Securities Valuation Office (NAIC), Standard & Poor's, Moody's and others. But since the vast majority of private debt funds come from insurance companies, the NAIC rating tends to pack the biggest punch. The NAIC only rates insurance-funded private issues; S&P and the rest rate those as well as loans funded by pension funds and others.
The rating of a private debt issue essentially indicates the likelihood of the borrower to default on the loan. It is derived from an analysis of an investment's features, including its cash flow.
The NAIC's rating scale ranges from one to six, with one the top ranking, three indicating an issue below investment grade and six given to a bond that's at or near default. A two from the NAIC is similar to a BBB rating from S&P; a three, to a BB.
While a three from the NAIC usually means a deal doesn't get done, a few loans bearing that rating still can be transacted at higher interest rates, said Roy Hansel, assistant executive director at the New York-based NAIC. A deal rated three that's consummated requires the insurance company to hold more money in reserve to cover its loan.
"We get involved when an insurance company wants to invest privately and they're concerned about the grade or size of the transaction," explained Hansel. "Apparel companies with sales of $50 million are looking at deals under $100 million, but a deal under $40 million gets tougher to do."
"Insurance companies have tons of money to invest, so they'd have to find a lot of $20-million 'homes' in a lot of deals," he said, which is one reason that small firms are facing difficulty getting private loans. "We're slightly different than S&P's and Moody's with size concerns. We place importance on size, but if there are mitigating factors--the company is the only big player or the dominant player in its niche--we would give them an investment-grade rating."
As insurance companies lend the majority of private debt funds, they seek to balance the long-term liabilities they assume in their businesses against long-term assets such as interest earned on their loans.
"Since insurance companies are lending long-term capital, they rely heavily on [a borrower's] historical performance to be a guide," he added. "The higher the volatility of the earnings, the less willing lenders will be to invest long-term in those companies."
Taking the long view of the private placement landscape, Goddard concluded, "The private placement market today is more than senior long-term debt; it can provide growth capital as well. A lot of these smaller fashion companies are looking to grow and expand. They can tap the private placement market."
--Fairchild News Service

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