M&A Musings

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Who’s Next on the Block?

\"RRBy Judith Russell

Why speculate on M&A candidates? Other than the fact that it’s fun, and human nature – like guessing who’ll toss his or her hat into the presidential race, or which celebrities will enter rehab next or become A-Rod’s next romantic interest – it illustrates, in bold fashion, just how much air is still in the retail market system, needing to be let out.

What makes a company a target? Depressed valuations, healthy balance sheets, good cash flow, and low debt are the most talked-about attributes. Being small – anything under $5 billion in market cap – also helps with the digestion and financing process. Underperforming brand equity, the ability to connect with the consumer, and global growth potential are all additional intangible traits that should not be ignored.

A corollary to the old “too big to fail” is the concept of “too small to succeed.” Many of the small companies in the retail industry won’t remain stand-alone businesses because it will be increasingly inefficient to do so. Operational excellence increasingly requires critical mass and low overhead. There are roaming packs of wild financial watchdogs – in the form of bigger companies, activist investors and other private equity folks – who are standing by, ready to pounce, to wring the inefficiency out of the things, all in the name of “maximizing shareholder value through a value optimizing business combination” – in other words, to make a big, fast buck. As the old adage goes, nature abhors a vacuum.

\"\"Let’s take a look at some of the key retail and consumer companies that might be in play, and why.

Home Stores – Bed, Bath & Beyond (BBBY) is reportedly on the prowl, looking to expand beyond the beyond. It experimented with gourmet foods last year, so might look to acquire its food supplier, specialty foods company Cost Plus, though we wouldn’t rule anyone out. Also in this space is Williams-Sonoma which, if you ask me, hasn’t even begun to realize its potential, and has been mentioned as a possible acquisition candidate.

Children’s Apparel – Tongues are wagging about Carter’s (CRI), Children’s Place (PLCE), and recently-taken-private Gymboree. Should all three merge, according to one investment bank, they would save tens of millions in overhead and add a mid-double-digit premium
to average share value.

Bookstores – Unless you’re like the cynics who believe that bookstores will go the way of record stores, and there are lots of us, scuttlebutt has it that Borders (BGPIQ) and Barnes & Noble (BKS) might still tie the knot. As if anyone cares. Might Amazon (AMZN) just buy the two of them, own the college, airport, and pop-up bookstore space, and use some of the bricks-and-mortar to open localized distribution centers? Perhaps.

Teen Apparel – We know that the 4 or 5 players in this sector, which includes Abercrombie (ANF), American Eagle (AEO), Aeropostale (ARO), Buckle (BKE), and others, are locked in a day-in, day-out share war, so wouldn’t it make sense for them to join forces and find their natural equilibrium? It depends on the cost, of course. American Eagle is apparently a prime target of private equity, and particularly vulnerable because of weak sales. Most consumers can’t tell these retailers apart anyway, so maybe there’s an AeroEagle & Fitch in our future after all.

Another possible candidate here is American Apparel. The company has already breached its loan covenants, and founder Dov Charney just got slapped with another harassment lawsuit by a former employee. Yet it’s one of the hottest brands around, and not just in NY and LA. I just returned from Europe, where it seemed every other teen I saw walking on the major shopping avenues was carrying an American Apparel shopping bag.

Footwear – Deckers Outdoor (DECK), maker of UGG and Teva, is a publicly-traded company with a $3 Billion market cap. 96% of its revenue comes from one product line – that of the ubiquitous sheepskin UGG boots. What happens if the brand’s star starts to tarnish? You guessed it. The stock will plunge faster than you can say “baaaa.”

Apparel – Columbia Sportswear (COLM) has lost some of its shine since founder and product development genius Mother Gertrude Boyle stepped aside to let Tim run the show. This is a very tough competitive environment now, and The North Face seems to be winning the innovation war. UnderArmour (UA), despite its meteoric success with stretchy, breathable activewear, has stumbled in its attempt to build an athletic footwear business, so may end up acquiring a sneaker company with an existing brand and product expertise. And let us not fail to mention Jones and Liz.

Beauty – Avon (AVP) is calling, and it’s an SOS call! Possible suitors include L’Oreal (OR), P&G (PG), and Unilever (UN), all of whom would no doubt love to get their hands on Avon’s direct-to-consumer expertise, particularly the international part.

Electronics – Best Buy (BBY) is in a perpetual game of Whack A Mole, it seems…just when it cuts a competitor down to size, another pops up somewhere close by. We might see some activity in trying to acquire some niche businesses, like Game Stop, which just changed its agreement with some of its top leaders, paving the way for it to be taken over.

Other – The cat’s finally out of the bag. The toy business is seasonal. Toys R Us (TYJPF) has basically shined a neon sign on that revelation with its big pop-up store success. What’s next? Will it do another IPO? Will it be acquired by another big retailer, like Target or Walmart, or be snapped up by a foreign company? Will it acquire some new businesses, like perhaps, Build-A-Bear Workshop? And finally, there are just too many bricks-and-clicks office supply companies out there. Will the big 3 become 2? Who among the Staples, Office Depot and Office Max world will be left after this game of Musical Ergonomic Chairs?



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