Last updated: Cover Story

Bidding wars are leading to retail companies grabbing very high multiples

Sector Snapshot

While the retail industry experienced an M&A slowdown for the first six months of 2013, "the second half of the year saw a significant pickup," says John Berg, CEO of retail-focused investment bank Financo. A low supply of high-quality assets, coupled with the large amounts of cash the strategic buyers and private equity groups have on hand, is leading to bidding wars for desirable retailers. In turn, the bidding wars are leading to companies grabbing very high multiples.

"Word got out that there was a dearth of good product in the market," Berg says. "It's not unusual to see the ultimate purchase price go up two or more multiples during a process."

"When we see companies that have a strong track record, we are encouraging them to really think about going as quickly as they can. The conditions really are extremely strong for selling a business," Berg says.

It's not just corporations that are paying high prices. "We're seeing private equity firms stepping up to multiples that much more resemble those that a strategic buyer may pay," says Hadley Mullin (pictured), managing director of private equity firm TSG Consumer Partners.

The sector is continuing to attract a lot of private equity interest, says PricewaterhouseCooper's Leanne Sardiga, a partner and head of the firm's U.S. retail and consumer deals practice.

"When it comes to retail, there are two themes to the deals that are getting done. One is kind of an owner-designer that has brought the business to a certain level, but needs perhaps additional expertise to expand the business internationally or in the U.S.," says Sardiga. The second category is underperforming retailers: "PE can come in and buy that business for a lower valuation and make changes for the company to get back on a growth path."

Notable Deals

Office Depot Inc.'s (NYSE: ODP) $1.2 billion acquisition of OfficeMax Inc., which closed in November, brought the two office supply retail chains together in a move to cut costs and improve financial strength. The company's increased size after the combination of the second and third largest office-supply chains should help it compete with market leader Staples Inc.

TowerBrook Capital Partners LP's July purchase of True Religion Apparel Inc. for $835 million brought the apparel brand, known for expensive jeans, under private equity ownership. Nearly a year earlier, True Religion's stock price had fallen sharply because of increased competition and economic conditions, and the company had announced it was pursuing strategic alternatives. Based in New York and London, TowerBrook boasts retail knowledge. For example, the firm previously invested in Jimmy Choo Ltd. With TowerBrook at the helm, True Religion could gain valuable brand-building and international expansion.

Lowe's Companies Inc.'s (NYSE: LOW) deal for 72 Orchard Supply Hardware stores in August for $205 million gave the hardware giant an increased presence in California. The transaction, which had to be approved by the U.S. Bankruptcy Court for the District of Delaware after Orchard sought bankruptcy protection in June, gives Lowe's an expanded presence in California, where the company was underpenetrated. The move will allow Lowe's to compete with the Home Depot Inc. (NYSE: HD), which has more than 150 stores in California.

Coming Up

"Activity is very strong right now, and I expect it to get stronger over the next six months," says Berg. Because the average age of companies in private equity portfolios is around six years, "and that's old on average," according to Berg, PE firms should be exiting some retail businesses soon.

Areas that may see further M&A activity include grocery and e-commerce companies, according to Sardiga. "In the realm of e-commerce and M&A, some retailers have found that building that capability in-house is more difficult than acquiring it," says Sardiga.

But because of the low supply of quality assets, dealmakers need to take more creative approaches, including splitting up and selling parts of businesses. "It's going to be a continuing challenge on the supply side," Sardiga says.