Smart vendors realize they’re either buyers, sellers or likely to be left behind.
This story first appeared in the May 19, 2003 issue of WWD. Subscribe Today.
No one has ever doubted that the fashion industry is risky. Now, with the economics of fashion superceding the vagaries of fashion, the rules of engagement between manufacturers and retailers have changed forever. All vendors need to understand that if they fail to initiate change within their companies, they will fall victim to this irreversible revolution.
The problem is that too many operators don’t understand the extent to which the changes are required, the speed in which they must be implemented and the options available to them.
As retail consolidation continues and fewer retailers dominate the market, the survivors will look to consolidate relationships with vendors that:
are big, and have significant financial resources;
bring value added in the form of brand equity and design expertise;
are technologically advanced;
have compressed production cycles and mastered speed to market;
are able to manage product cycles for retailers by using retail data links;
are willing to supply merchandise on an as-needed basis, and
are willing to subsidize retail operating margins.
The real survivors of this revolution will be large, well-capitalized companies that are multichannel distributors who:
are product diversified;
are market-driven, not production-driven;
source globally rather than manufacture;
understand that profits will be made on the “buy” side, not just the “sell” side;
are technologically advanced and possess systems that are state-of-the-art, not state-of-the-Eighties, and
have permanently driven down their operating costs to ensure profitability over the long term.
These companies will be professionally managed against a carefully conceived annual financial plan. They will be innovative, nimble, quick to react and bottom line-, not top line-driven.
This means that smart vendors realize they must diversify their businesses. They also realize that with a limited number of available retailers to sell in a given channel of distribution, they can’t increase their businesses organically. The only way to grow or, in some cases, stabilize volume is to sell new products into the channel or open other channels of distribution.
Smart operators realize that it is often less expensive and more productive to acquire a company than to start a new division. Conversely, other operators have concluded they are much better off being part of a larger organization that can propel their business into new channels of distribution, source venues and tap into new state-of-the-art technology.
It also means that virtually every vendor in our industry falls into one of three categories. They are either seeking to buy a company or companies, seeking to sell their business or are temporarily undecided as to which way to proceed.
If you are undecided, start by taking the pulse of your business and asking yourself and your objective, independent advisors the following questions:
Do my operating economics make sense given my current business structure?
Can my existing capital base sustain my business?
Is my management team strong enough to adapt to the dramatic changes affecting this industry?
Does my business have a reason to exist and am I a value-added vendor?
Is my distribution sufficiently diversified to protect my margins?
How effective is my sourcing structure given the quota changes expected to occur in 2005?
Are my systems state-of-the-art?
Can I permanently reduce my expense base?
Am I risking my capital and can I get an adequate return on my capital given the current complexities of the industry?
How do I protect the company’s net worth?
Does the company have an adequate succession plan in place?
What is in the best interest of my shareholders?
Once you’ve concluded this exercise you should have a fairly good sense as to which course of action to take.
If you decide to sell your business there are two types of buyers that may be available to you: financial and strategic. Financial buyers, such as venture capital firms, generally buy companies with two things in mind: the rate of return they can get on the capital deployed to buy the business, and the windfall they can expect when they exit the investment. While financial buyers may provide an eventual exit for the principals and hopefully adequate capital to manage the business, it is unlikely that they can have much operating impact, as they rarely have specific industry expertise or bring economies of scale. Financial transactions are generally based on the projections compiled by the seller, resulting in a stand-alone company left to its own devices to repay the purchaser and show a bankable cash flow and pretax operating profit.
While financial buyers will do their due diligence, it is generally limited to an understanding and optimistic validation of the financial projections prepared with assumptions provided by the seller. With few exceptions they generally do not have the wherewithal to drill down and fully understand the dynamics driving the company. This often leads to disappointing results and post-closing disagreements.
Most transactions in our industry are strategic. That is, one apparel or fashion company buys another. Why? From the seller’s perspective, strategic buyers bring more to the table than just money. In addition to hopefully providing a strong capital base, strategic acquirers can provide market clout, sourcing advantages, access to more sophisticated technology, warehousing, distribution and other corporate services that provide economies of scale. As importantly, strategic buyers also can bring management expertise and a more sophisticated business structure. Strategic buyers can better appreciate the values inherent in the business they are looking at.
The risk to the seller, however, is that very often the best strategic buyers are competitors. Managing confidential information, such as distribution, sourcing and costing, and avoiding “tire kickers” is paramount. On the other hand, strategic buyers often offer a better purchase price since they can reduce their payback period more quickly by leveraging the acquired company’s back-end operations on their own organization.
A carefully conceived strategic purchase can solve many of the acquirer’s needs, but it’s critical to carefully identify those needs and not rationalize one’s way into the deal. Some of the best deals are the ones you don’t do. Once you or your professionals have identified a candidate company and there appears to be interest from the “target,” the company’s principals should have an initial meeting to determine the compatibility of the parties, the strategic advantages of combining, the effect on the two entities’ customers, the ability of a former principal to work for someone else and whether there’ll be synergy or cannibalization in the fusion.
If the chemistry works and the parties conclude that there is a reason to continue the conversations, both parties’ advisors should have a preliminary discussion on the proposed deal structure and how the purchase price would be calculated. If it appears that both parties’ needs can be met, the process should continue, but then it’s time to do the homework and not skimp on due diligence. If you are going to spend your money to buy a business, you should know the business you’re buying, as well as the seller, by the time the deal closes. Have your chief financial officer prepare a realistic, projected cash flow and present it to your lender or financing sources. Be sure you have their support and keep your lender informed about the deal’s progress. Since the lender will inevitably finance a portion of the purchase, it will want to review and approve the deal.
Since the owner-operator is generally the “spirit” of the business and often controls the company’s major customer and sourcing relationships, it is to everyone’s advantage to ensure the principal’s continuity in the business for a reasonable period of time once the sale is concluded. It’s important to be sensitive to the emotional trauma of the seller, who may not only be selling his creation, or that of his family, but coping with a major life change as well.
The key to any successful strategic transaction lies in integrating the newly purchased company into the buyer’s business. More transactions fail because of poor integration than for any other reason.
Successfully executing and implementing such a transaction requires a top-notch advisory team — including your outside accountant, attorney and investment banker. In addition, you should consult a tax accountant so that the transaction can be designed to be as tax efficient as possible, a key to maximizing the seller’s proceeds. As a buyer, you want to be able to expense as much of the purchase price as possible. Ultimately, a compromise will be needed to satisfy both parties’ requirements.
If you are still undecided as to whether you are a buyer or seller, don’t be schizophrenic and try to go down both roads simultaneously. It won’t work. Rather, evaluate your company, carefully consider your options and make a decision.
Allan Ellinger is the senior managing partner and co-founder of MMG, a New York-based investment banking, restructuring and consulting practice focused exclusively on the apparel and fashion industry.