NEW YORK — VF Corp. is the latest multibillion-dollar apparel firm to land a major sportswear brand, scooping up Nautica Enterprises for $585.6 million in cash.
The deal confirms a report that first appeared in a front-page story in WWD on June 24.
This story first appeared in the July 8, 2003 issue of WWD. Subscribe Today.
For VF, a $5.7 billion company that lost out in its attempt to buy Calvin Klein Inc. in December, a Nautica acquisition enhances its portfolio by adding two upscale denim brands, Nautica Jeans and Earl Jean, boosting its presence in department and specialty stores and providing it with a leading brand in the men’s sportswear category. In addition to leveraging VF’s jeanswear expertise, Nautica is expected to benefit from VF’s supply chain capabilities, sourcing, and inventory and brand management.
The deal is the most recent in a string of acquisitions of high profile apparel brands in the last seven months, including Phillips -Van Heusen’s acquisition of Calvin Klein Inc.; Lawrence Stroll and Silas Chou’s purchase of Michael Kors LLC; Oxford Industries’ purchase of Tommy Bahama; Liz Claiborne’s acquisition of Juicy Couture, and Kellwood’s bid last month for Kasper ASL, which is still pending and has subsequent competition from firms such as Jones and Claiborne.
It also raises the question of what’s left to buy, given that everyone from Tommy Hilfiger to Jones has admitted they remain on the prowl for acquisitions to deliver topline growth.
VF is expected to pay Nautica shareholders $17 per share in cash. The company will also pay approximately $14.6 million, net of tax, to cash out employee stock options for a total consideration of approximately $585.6 million. The transaction, expected to close at the start of the fourth quarter of 2003, could add 10 cents to VF’s earnings per share in 2004. The acquisition of Nautica can be terminated by either company if not completed by Feb. 7, 2004, with VF in line to receive an $18 million breakup fee, according to filings with the Securities and Exchange Commission.
News of the sale drove shares of Nautica up a hefty $3.59, or 27.2 percent, to close at $16.78 in Nasdaq trading Monday. VF’s stock also rose, picking up $1.55, or 4.6 percent, to end the day at $35.59 on the New York Stock Exchange. The proposed combination was instrumental in driving share prices up throughout the apparel and retail sectors. [See related story page 2.]
Harvey Sanders, chairman and chief executive officer of Nautica, does not have a contract with VF, but will remain to help with the transition period. Following the merger, David Chu, vice chairman of Nautica Enterprises, will assume responsibility for the Nautica brand, overseeing global design, product development and marketing.
Sanders owns 4.7 million shares of Nautica, both indirectly and directly, making his 13.5 percent stake worth $79.9 million. That includes 1.3 million share options that are exercisable on or before July 22.
VF has entered into a separate deal with Chu to acquire from him his rights to receive 50 percent of the net royalty income from licensing the Nautica trademark for $104 million over the course of four years. Under the agreement, VF will pay Chu $38 million upon the closing of the transaction and $33 million on each of the third and fourth anniversaries of the closing. Chu will also have the right to receive payments in each of the next five years in the event an annual gross royalty revenues threshold is exceeded.
Robert Shearer, chief financial officer of VF, told WWD it is yet to be determined what designer John Varvatos’s role will be in the new company. He doesn’t have a contract with VF either. Nautica has financed Varvatos’s men’s wear business since fall 2000. As reported, Varvatos plans to launch a women’s wear collection for fall 2004.
“He’s a real talented guy,” said Shearer, noting they will work will him over the next few months to determine what his role, if any, will be at the company and how his business fits within the portfolio.
As reported, Virginia Genereux, a research analyst at Merrill Lynch, said in a research note last month that in the event of a change of control and if Nautica’s Sanders is no longer employed by the company, the Varvatos brand must be spun off or sold; or John Varvatos may elect to either be paid 10 percent of the brand’s net income as long as he is ceo, or to receive a lump sum payment of two times the brand’s net income for three years (not to exceed $50 million.) Varvatos’s wholesale business, while still in its infancy, hasn’t been a real money-maker for Nautica.
When reached for comment, Varvatos said, “I’m working on next fall. I can’t say [if I’m going to VF] at this point in time. I’m a Nautica board member. I think it’s a great deal for the Nautica stockholders. I’m exploring my options with VF and in general,” he said.
Varvatos said he’s headed to Europe to put some initial things into the works for the launch of his women’s collection.
Sources said Sanders could possibly finance Varvatos in a new venture, since neither one has a contract with VF, but Varvatos declined comment.
“I’m not worried about it. I’m not worried about the continuation of the business. The business is strong in our own retail stores which are making money. Spring business was very strong at retail, and pre-fall business is very good, and our accounts are very enthusiastic. We just have to figure out the structure. We’ve established a fairly significant business for the designer world,” said Varvatos.
In a conference call to Wall Street on Monday, Mackey McDonald, VF’s chairman, president and chief executive officer, said, “This is a great day for the shareholders of both VF Corp. and Nautica. I know that those of you who have been following VF for some time know that we’ve been actively seeking acquisitions. Our company is in terrific shape: strong brands, a great balance sheet, cash flow and healthy margins.
“We’ve been looking for an opportunity to really leverage this powerful base with the infusion of new brands [and] new growth opportunities. We believe that we’ve been extremely disciplined and patient in our search for acquisitions and that approach has certainly paid off. I’m pleased to say that Nautica fits perfectly within our key strategic and financial parameters.”
McDonald noted that one of the reasons why Nautica was an attractive acquisition was because of the brand’s presence in the sportswear market. “Nautica provides VF with a sportswear platform we can use as a springboard for new growth opportunities. As you know we’re the strongest global player in categories such as jeanswear, intimate apparel, daypacks and outdoor apparel. But sportswear is the largest segment of the apparel industry and we intend to participate more fully in this category,” said McDonald.
McDonald also reminded Wall Street of the company’s criteria for acquisitions: “From a financial perspective, we said that any acquisition we make must be accretive to earnings within a very short period of time and be able to meet our operating margin and a return on capital hurdles. Nautica meets all of these criteria.”
McDonald said that the Nautica brand provides “terrific opportunity longer term in women’s sportswear,” but that the first priority will be a focus on reinvigorating the men’s sportswear business. Chu will focus on that.
McDonald stated emphatically during the call, “We’re not planning to take it down in distribution….[t]he primary reason for the acquisition is so we can better penetrate the department store channel of distribution. We think there’s still plenty of opportunity in that channel of distribution, particularly for good strong product at good value. That’s where we felt the growth will come. We feel we can stabilize the sportswear business with that combination. It’s what we do with all our brands at VF.”
VF’s Shearer told Wall Street that the company also sees growth opportunities in the Nautica men’s and women’s jeans businesses, “particularly the women’s side, which [is] unevolved.” The cfo noted that Earl jeans has additional growth opportunities through the expansion of new product lines and categories.
Sanders said during the conference call, “The Nautica brand generates approximately $2 billion in sales at retail worldwide, including all Nautica branded products licensed by the company. This transaction today also validates the commitment of both management and our board to maximize value for our shareholders.
Nautica had income of $20.7 million on sales of $693.7 million in fiscal 2003. Net royalty income came to $9.3 million, up 18.7 percent from the prior year.
Sanders pointed out that Nautica will benefit from VF’s strong supply chain and infrastructure support, as well as its international presence.
Barington Group said Monday it has discontinued and withdrawn its proxy solicitation in light of Nautica’s announcement Monday that it has signed a definitive merger agreement to be acquired by VF Corp. As reported, Barington, which holds 3.1 percent of Nautica’s stock, had asked shareholders to replace directors John Varvatos and Charles Scherer (managing partner at Hughes, Hubbard & Reed, Nautica’s law firm) with former Revlon executive William Fox and Barington chairman James Mitarotonda. Barington previously said Nautica “has shown poor operating performance” and its board “lacks representation from a sufficient number of independent and experienced directors.” Nautica was expected to hold its annual shareholder’s meeting today, but that will be delayed due to the VF deal.
VF executives said that Nautica has the potential over the next three to four years to meet VF’s long-term operating margins and return on capital targets of 14 percent and 17 percent, respectively.
VF’s Shearer said, “Our balance sheet will continue to remain very strong. In terms of the impact of the transaction on our balance sheet, our debt-to-total capital ratio will remain below our long-term target of 40 percent. With the strong cash flow of our combined companies, we would expect to be in the 30-to-35 percent range by year end, with further improvement expected in 2004.”
Robert Drbul, analyst at Lehman Brothers, wrote in a research note, “”We believe that 10 cents of accretion in the first year is achievable as it is predicated on flat revenue and royalty income.”
McDonald was en route Monday to the Pacific Rim for a previously planned trip and was unavailable for further comment. However, Shearer told WWD that VF’s priority is to get the Nautica men’s sportswear line _ which has suffered at departments stores _ back on track.
“It’s about making sure the product and brand stay true to its heritage. Nautica has been a classic brand for 20 years. They’ve strayed from it. One of David’s challenges is to make sure the brand positioning is very clear and the product supports it,” said Shearer.
Shearer said that even before they consider launching a women’s Nautica sportswear business or adding new licensees, they need to clarify and strengthen the men’s sportswear brand. “We need to clean it up and get back to the roots and heritage of the brand, and then start thinking about women’s,” he said. He said Nautica swimwear, sleepwear and jeans are all growing businesses.
In April, Nautica announced it planned to discontinue its wholesale ventures in Europe, close its remaining European offices and transition its business there to licensing or other arrangements. Europe currently accounts for about 2 percent of Nautica’s sales.
Asked about the fate of Nautica’s money-draining 12,000-square-foot store at 50 Rockefeller Center here, VF’s Shearer said, “We’ll keep that store. We recognize it’s one of those areas where we have to address the costs. We’ve got to improve the profitability.”
Nautica has had particular difficulties in its core men’s sportswear division in department stores in the last few years, while its women’s jeanswear and Earl Jeans operations also were hit hard in fiscal year 2003. Nautica’s men’s jeans, sleepwear and children’s wear performed well last year, however.
VF’s denim lineup includes Wrangler, Chic, Brittania and Gitano in the mass market and the Lee and Riders labels at national chains and department stores. VF’s other, nondenim brands include Vassarette, Jansport, The North Face and HealthTex.
VF’s Shearer said the Nautica deal came together “relatively quickly,” and the company has been looking for a brand for quite some time. He said they began their initial discussions over two years ago.
“I think it’s a tremendous deal for VF Corp. It brings them an upstairs brand that’s very compatible with the rest of the company and the timing was very appropriate,” added Gilbert Harrison, chairman of Financo, the investment banking firm, which rendered certain services to VF in connection with the transaction.
Robin Lewis, president of Robin Lewis Inc., a consulting firm and publisher of Robin Reports, observed, “I think this is an acquisition that fills a weak hole in VF’s portfolio. It plays into their denim strength and the synergies there.
“Also, there is nobody better than VF in the back end of marketing. They will do a superb job of clearly positioning the brand. They’ll profile that customer and they’ll do all the research. VF’s biggest challenge will be at the front end of marketing, the creation and design of product, the marketing, the advertising, the sizzle and the p.r. All the stuff that creates excitement. That’s not to say they haven’t had good success in that area, particularly with Lee Jeans.
“As long as they have David Chu, it will give them some strength in the front end of marketing. After Chu leaves, it’ll be a major issue as to who they’ll put in to run that business,” said Lewis.
Furthermore, he said VF should take advantage of Nautica’s retail stores. “VF should view Nautica’s retail stores “long term as another channel of distribution, not just as a testing store and showplace. They should figure out how to grow the retail business and Earl business. It’s a great opportunity to pursue owning their own distribution,” said Lewis, recalling how VF has consistently said that it wasn’t a retailer.
According to Lehman’s Drbul, “We believe the acquisition is complementary, as it would allow VF to leverage its existing expertise in the denim category. Furthermore, we believe Nautica fulfills VF’s previously stated acquisition priorities to round out its presence in the upper-tier and specialty jeanswear and sportswear.”
Paul Altman, vice president of The Sage Group, a Los Angeles-based investment banking firm, thought VF made a smart move to acquire Chu’s 50 percent share of the royalty fees. “This has significant implications for VF; Nautica has overwhelmingly demonstrated the appeal of the Nautica brand across multiple products, and VF will now benefit free and clear from any current and future licensing endeavors.
“VF gets a large amount of top-line business, but hopes to improve the profitability of Nautica in the next few years which will boost its own bottom line, and hopefully the returns of its stockholders,” said Altman.
As for whether VF paid a fair price, Altman noted, that even though some stockholders may have been frustrated with Nautica’s recent performance, Nautica’s shareholders should be happy with this outcome. “If you compare the price offered to Nautica’s price at Thursday’s close, VF paid a market-level premium of 29 percent. But the shareholders have benefited more than this. If you look further back in time, to June 10, when an investor group began urging Nautica to explore a sale, the premium is very significant. On that date, Nautica traded at $10.77, implying a near 60 percent premium for this transaction over the last month.This is a dramatic and meaningful result of shareholder activism at work.”
He said to calculate the total purchase price for valuation purposes one should adjust the $586 million in equity value by the $70 million in net cash Nautica has on its books, so that the net financial cost to VF is approximately $518 million.
With a total enterprise value, VF is paying 6.6 times Nautica’s EBITDA (earnings before interest taxes, depreciation and amortization) for the last 12 months to March 31, 2003, adjusting for cash on hand.
“This is a reasonable and fair multiple, albeit slightly below the average of recent transactions. While a significantly higher EBITDA multiple was recently paid in the Phillips Van Heusen-Calvin Klein deal, most recent transactions have been completed at similar or lower EBITDA multiples to this transaction,” said Altman. In addition, he noted, “An all-cash deal such as this is generally preferred in this market environment, providing Nautica’s shareholders with ultimate flexibility despite certain tax consequences.”
According to Jeffrey Edelman, analyst at UBS, the $586.6 million deal is about 0.8 times Nautica’s trailing 12-month sales and about 7.5 times fiscal year 2003 earnings before interest, taxes, depreciation and amortization.
Allan Ellinger, senior managing director of Marketing Management Group, a consulting firm said, “It sounds like a great deal for everybody. VF is certainly the most logical buyer at the moment. They have the most to gain without cannibalizing any existing businesses, and it gives shareholders of Nautica a graceful exit.”
Manny Weintraub, head of the consulting firm that bears his name, observed, “As a strategic move, I think it sends a signal to Wall Street. VF is buying a designer company without a designer name. I wouldn’t say David Chu is the darling of the fashion press, but they know who he is. Who in VF is its key designer? VF is a superior company doing everything well, but without anyone stepping out as the head designer. The acquisition is a signal by VF that it is not a sleeping giant, as well as a message to Wall Street to keep an eye on its stock because it will be doing things. The addition of David Chu is a signal that it is becoming more edgy, but not too edgy.”
VF said it will finance the acquisition initially through available cash and short-term borrowings. The company anticipates that with any required borrowings the resulting ratio of debt to total capital would remain below VF’s long-term target of 40 percent. The financial adviser to VF was Citigroup Global Markets Inc.
The boards of directors of both firms have approved the merger. The merger is subject to Nautica shareholder approval, receipt of customary government approvals and other customary conditions. In connection with the deal, VF has obtained commitments from Sanders and Chu to vote all Nautica shares owned by them in favor of the merger, representing a total of approximately 10 percent of the current shares outstanding.
The Navigation of Nautica
1983 David Chu launches Nautica.
1984 State-O-Maine Inc., a public company, acquires Nautica.
1993 State-O-Maine changes its name to Nautica Enterprises.
1998 John Varvatos joins Nautica from Polo Ralph Lauren.
1999 Nautica Jeans Co. launched in the fall.
2001 Nautica opens 12,000-square-foot New York flagship at 50 Rockefeller Plaza in April.
2003 In June, Barington Group begins proxy battle to replace in cumbent directors and explore ways to enhance shareholder value, including through a sale of the firm.