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Building New Titans: More Mergers Seen

With the Federated-May and Sears-Kmart mergers in the works, the vendor community might feel the need to consolidate its power base in reaction.

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NEW YORK — As the industry digested the news of the Federated-May combo, one question whirled through offices on Tuesday: Who’s next?

The industry has been rife with speculation in the last few months over who’s buying or merging with whom. Observers said that, whatever the eventual size, shape and makeup of the new Federated Department Stores group, one thing is certain: The deal is likely to accelerate the takeover tango.

It will involve vendors as much as retailers. Already there has been speculation that Liz Claiborne Inc. was in talks to buy Ann Taylor Stores, and that the likes of Jones Apparel Group, Kellwood and VF Corp. remain on the prowl for smaller brands to gobble up and develop into megalabels.

And with the American consumer only lukewarm on apparel and Wall Street’s insistence on growth, it’s not that farfetched that two major vendors could join forces in as dramatic a move as Federated’s $17 billion acquisition of May Co. to create a $30 billion giant, executives said.

As Kellwood Co.’s chairman and chief executive officer, Hal Upbin, noted of the Federated-May fallout: “At the end of the day, we certainly don’t become any stronger.”

Though not speaking of Kellwood specifically, Upbin agreed that more vendor consolidation is a possibility.

“There’s always an opportunity there,” he said. “What troubles me a little bit is, even if one were to put a couple of fairly large-sized companies together, I wonder does it really put [them] in a different place vis-à-vis their relationships with Federated and May?”

Rather, there are other reasons to combine. A merger between vendors would take cost out of the supply chain and give the manufacturers more leverage over their own suppliers, he said.

That could set off a seemingly endless scenario of bigger fish-swallows-littler fish until there are only a handful of large retailers and vendors left in the U.S. It already was a joke making the rounds in the industry on Tuesday, with some executives claiming that, in the end, there would be only four retailers and four vendors left to serve them. The coming year has repeatedly been described as “interesting times” by industry executives, who clearly are nervous about the whirlwind of consolidation hitting retailers and manufacturers.

“The industry consolidation is definitely going to continue,” said investment banker Peter Solomon of Peter J. Solomon Co., referring to both the retail and the vendor sides of the fashion world.

Large vendors don’t need to merge to stand up to the combined forces of May and Federated, said Solomon, noting that vendors just need to be big enough to create need for their brands.

However, major vendors are going to have to start making bigger acquisitions to continue on their growth tracks with larger bases, he said.

By way of example, a firm with $5 billion in sales that buys a brand with $100 million in sales sees only a 2 percent bump to its top line, or not quite enough to illicit more than a yawn from an investor. That $100 million brand, even with strong organic growth and the rapid expansion into other categories such as handbags and other accessories, still isn’t by itself going to offer enough growth to keep Wall Street happy.

“All the suppliers to chains, they’re going to continue to consolidate and continue to buy other people, they need it for growth, to sustain their price-earnings ratio,” said Solomon.

“If you sell at 20-times earnings, you can’t grow at 6 to 8 percent [and meet investor demands],” he added.

Others, however, see the Federated-May merger as more of a spark for vendors to consolidate to counterbalance the department store group’s greater clout. “The balance of power is shifting as the retailers consolidate and the apparel guys, without a doubt, feel enormous pressure to consolidate or to change their strategy,” said William Smith, a partner with venture capitalist Christopher Burch.

The dealings that companies such as Liz Claiborne or Jones have with the retailers would be aided by additional bulk, he said.

“Jones and Liz today, as the biggest vendors, without a doubt have more leverage than a $100 million apparel company does,” said Smith. “If they are twice the size, it’s only going to help them with the process. Size is very, very powerful, and so I do think this is going to continue.”

Over the past few years, Jones has expanded its portfolio through such acquisitions as Barneys New York, Nine West and Kasper A.S.L., while Claiborne has beefed up its holdings by purchasing Ellen Tracy, Mexx, Juicy Couture and C&C California. (For more on the industry’s top vendors and their various holdings, see chart, opposite page.)

At the very least, the May-Federated deal, which will create a retailer with 950 department stores, will pressure the manufacturers in terms of markdown money and promotional funding. As investors digested the news on Tuesday, Federated’s shares shot up $4.53, or 8 percent, to $60.98, while May’s advanced $1.64, or 4.8 percent, to $36.15 on the New York Stock Exchange.

“We see the merger of Federated and May as a significantly negative development for many apparel manufacturers,” said Prudential analyst Lizabeth Dunn in a research note.

Not only would the combined retailer have more leverage over the vendors, store closures would also mean fewer doors to sell to, she said.

As far as exposure to the new megaretailer goes, Dunn noted that Jones derives 26 percent from May and Federated, more than Liz Claiborne Inc. (20 percent), Tommy Hilfiger Corp. (17 percent) and Polo Ralph Lauren Corp. (15 percent). She estimated that about 10 percent of Kellwood’s sales are to the two retailers.

“Claiborne and Polo will fare better than other high-concentration companies under the combined Federated-May scenario because of the relatively stronger partnerships those two companies have built with Federated on things like technology and in-store environment,” said Dunn.

In a sense, the combination of May and Federated doesn’t change the dynamic between the department stores and vendors. It just tilts the balance of power even more toward the retailers.

“Retailers have to merge more than manufacturers have to merge because they will gain a competitive advantage,” said consultant Emanuel Weintraub. “The fact that two manufacturers merge doesn’t mean they will gain a competitive advantage. They’ll be able to buy more economically, but it doesn’t mean that they will be able to penetrate a marketplace that is giving diminished recognition to the vendor base.”

Vendors will use their money to extend into retailing further and “control their own destiny,” said Weintraub

That “if you can’t beat ’em, join ’em” approach is part of the strategy employed by Jones Apparel Group and Liz Claiborne Inc. In December, Jones bolstered its retail operations with the surprise acquisition of Barneys New York, while Liz Claiborne has strengthened its U.S. retail presence with Mexx, Ellen Tracy and Juicy Couture stores.

At Kellwood, Upbin said the door has been opened for the acquisition of a retailer or a catalogue, given the opportunity there to increase profits and diversify.

Even so, he said, “I don’t think that’s the answer to dealing with the department stores. We’re still going to depend on our retailer partners for a lot of what we do.”

Life probably won’t get any easier for vendors as those partners are increasingly pressuring branded manufacturers with self-sourced store brands, such as INC and Charter Club in Federated’s case. The development of May’s private label offerings was one area of growth highlighted Monday by Federated’s chairman, president and ceo Terry Lundgren, in announcing the acquisition of the St. Louis-based department store chain.

With the combination of the two retailers, these established private brands will be expanded and likely will continue to get prime real estate over outside branded collections.

The revenues massive retailers offer vendors act as the carrot, while private label programs that can fill space that would otherwise go to outside brands are the stick that together allows retailers to demand markdown money when a line doesn’t sell as well as expected.

As retailers grow, they have to deal with companies that can handle the volume they need, but that doesn’t mean that the multibillion-dollar firms will be the only ones that stay in business.

“Big companies like to deal with big companies,” said Ken Sitomer, a principal at Apparel Holdings Group, which markets the Caribbean Joe brand and has annual sales of a little less than $300 million.

Sitomer estimated that a vendor with $100 million in sales has enough girth that it can supply very large retailers. Under that sales level, though, suppliers face a squeeze.

“It’s the $20 million manufacturers that will probably have more issues,” he said.

Sportswear’s Biggest Players

CompanyAnnual Sales* Brands/Holdings**
VF Corp.$5.88 billion Lee, Wrangler, Vanity Fair, Nautica, Earl Jean, John Varvatos, JanSport, Eastpak, The North Face, Vans.
Jones Apparel Group$4.65 billion Jones New York, Bandolino, Gloria Vanderbilt, Norton McNaughton, Nine West, Easy Spirit, Kasper, Anne Klein, Barneys New York
Liz Claiborne Inc.$4.47 billionLiz Claiborne, Axcess, Juicy Couture, C&C, Dana Buchman, Ellen Tracy, Enyce, Laundry by Shelli Segal, Lucky Brand, Mexx.
Levi Strauss & Co. $4.07 billionLevi’s, Dockers.
Polo Ralph Lauren Corp. $3.18 billion Polo, Ralph Lauren, Lauren by Ralph Lauren, Club Monaco.
Kellwood Co.$2.48 billion Sag Harbor, Koret, Briggs New York, David Meister, Bill Burns, Phat Farm, Baby Phat.
Tommy Hilfiger Corp.$1.84 billionTommy Hilfiger, Karl Lagerfeld.
Phillips-Van Heusen Corp.$1.6 billion Van Heusen, Bass, Izod, Calvin Klein.

*Sales for the last four quarters.

**This represents a sampling of their brands.

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