Industry Watch – Like Hemlines, Assets Are Shifting In the Apparel-Making Industry: As clothing manufacturers face flat sales, they are embracing m&a to help improve their bottom-line results

U.S. apparel manufacturers are embracing consolidation and restructurings in an attempt to make their bottom lines as attractive as the beguiling garments the industry sends down its runways to entice consumers. But flat sales, disappointing results, and shareholder pressure to improve returns are challenges that the U.S. apparel manufacturing industry must face as it evolves. “Wall Street and shareholders are saying to the public apparel companies that they want to see 10% earnings growth per year. Since these companies are only generating 3% to 4% internal growth, they have to look outside of themselves for opportunities to grow,” said Emmanuel Weintraub, president of Emmanuel Weintraub Associates, a Fort Lee, N.J.-based apparel industry consulting firm. The U.S. apparel manufacturing industry racks up sales of about $180 billion per year. In light of that mandate, Mitchell Kummetz, an apparel analyst at A.G. Edwards Inc. in St. Louis, noted that companies have only two options to grow their business: increase their sales through existing distribution channels or increase their sales through new distribution channels. Cross-licensing deals and pushing brands into new types of outlets are two options for manufacturers to expand existing channels, but they aren’t foolproof, Kummetz said. Investing in new distribution channels can also be treacherous for apparel manufacturers. Witness the demise in late May of the high-end fashion retailer Boo.com. It spent $135 million on marketing and advertising in an effort to establish the site as the leading Internet merchant of brands such as Donna Karan and Liz Claiborne. Despite the backing of fashion industry heavyweights like French entrepreneur Bernard Arnault and Italy’s Benetton family, Boo.com didn’t survive. Majors are bulking up, independents are at risk A spokesman for the American Apparel Manufacturers Association characterized the industry as a mature, highly competitive business in which consolidation has been an ongoing strategy. He said that of the top 20 companies in apparel manufacturing, nearly all have done an acquisition of one sort or another in the last five years. But despite this record, he said there is still plenty of room in the business for more consolidation. One investment banker who specializes in the apparel industry, Alan Ellinger, president of Ellinger & Associates in New York, said, “This has been a woefully undercapitalized industry and while some of the larger public companies are completely up to date, there are a lot of family-owned operations out there that aren’t’ going to make it as independents.” Ellinger also said that consolidation among retailers is driving consolidation among manufacturers. The absorption of Macy’s Inc. about six years ago by Federated Industries Inc. set the stage for much of the consolidation going on today among manufacturers. This doesn’t mean there is a shortage of opportunities in the industry now. In fact, some observers say that the process is still in an early stage. “I believe we are only in the third inning of the consolidation game, and we are seeing the pace pick up. The need for greater mass, profitability challenges, and technology requirements are contributing to the increased pace of consolidation,” said Brad Paine, a director at Kurt Salomon Associates, an Atlanta-based consulting firm. He noted that the vast majority of deals done in the sector are strategic rather than financial. “Financial buyers are typically reluctant to get too close to anything that has a strong fashion element.” Kummetz said the $1.4 billion acquisition of Nine West Group Inc. by Jones Apparel Group Inc. announced in March 1999 was an interesting deal because it linked a maker of clothing with a shoe company. In doing so, it opened up new distribution channels for both brands. Jones has pursued a multi-brand strategy by marketing its products under several nationally known brands, including Jones New York, Evan-Picone, and Rena Rowan. It also sells the licensed brands Lauren by Ralph Lauren, Ralph by Ralph Lauren, and Polo Jeans Co. By hooking up with Nine West, Kummetz said that Jones showed its willingness to go outside of its core competency and target a different consumer group. “At the time of the merger, we identified the potential to create complete lifestyle brands, expand our distribution channels, and improve our operating performance,” said Sidney Kimmel, Jones’ CEO. Liz Claiborne Inc. has also pursued a strategy of acquiring brands that are more diverse than its core focus, and that are designed to expand the demographic reach of the company. In the last year, the New York-based manufacturer has acquired Segrets Inc., Podell Industries Inc.’s Laundry sportswear line, and Lucky Brand Dungarees Inc. “Liz Claiborne is following a strategy of acquiring a portfolio of brands in the hope that the acquisitions will provide growth opportunities that aren’t there for the company’s mature core brands,” Kummetz said. He pointed to Lucky as a strong specialty store brand that will allow the company to reach a younger audience for its products. Lucky designs and markets a range of men’s, women’s and children’s jeans. It also operates a chain of retail stores. Licensing pacts: a two-edged sword Confronted by pressure to increase the flow of goods through existing and new distribution channels, licensing pacts have become an increasingly large part of some apparel manufacturers’ business plans. But they can be a mixed blessing because in exchange for what is often a big jump in sales numbers, there is an accompanying loss of control over the brand by the licenser. The downside of this trade-off is being played out in the high-profile lawsuit filed in late May by Calvin Klein Inc. against its jeanswear licensee. Calvin Klein sued the licensee, Warnaco Group Inc., in the U.S. District Court in New York in an effort to end its licensing agreement, due to expire in 2034, for jeans manufacturing. The suit alleges that Warnaco weakened the Calvin Klein trademark by selling its merchandise to discount outlets. Klein decided to let the lawyers loose after Warnaco announced a deal to sell jeans through J.C. Penny’s stores. This was thought to be a fatal blow to Klein’s efforts to position his company as a purveyor of luxury brands so that he could sell it. The legal action follows months of unsuccessful efforts to find a buyer for Calvin Klein. In October, the company hired Lazard Freres & Co. to review strategic options. One industry source said that Tommy Hilfiger expressed some interest but thought that the $1 billion price tag on the property was too high. According to The Wall Street Journal, Warnaco made a $900 million bid for Calvin Klein, but it was not accepted. In 1994, Warnaco bought the Calvin Klein underwear business for $64 million. Should Klein prevail in court and recoup its brand for jeans, it would presumably make the company more attractive to a potential buyer and might up the price over the $1 billion mark. Hilfiger itself has seen its stock drop after an announcement that its operating earnings will drop by 30% to 40% for the next financial year. This weakness has led to speculation that it won’t be a player in any near-term m&a action. The 1999 pact between Liz Claiborne and Kenneth Cole Productions Inc. is another example of a multi-brand licensing strategy between two industry heavyweights. Under the agreement, Liz Claiborne agreed to produce the Kenneth Cole New York collection of women’s contemporary sportswear starting this year. The adult line’s debut will be followed by the launch of a junior line under the Unlisted.com brand in Spring 2001, and the launch of a women’s status denim and sportswear line under the Reaction Kenneth Cole brand for the Fall 2001 season. Making things even cozier for the new partners in licensing was the consummation of Claiborne’s purchase of one million shares of Kenneth Cole Productions Class A stock. A recent deal by another apparel manufacturer, the $53 million acquisition of Club Monaco by Polo Ralph Lauren, announced in March 1999, took people by surprise, according to Kummetz. He said that the acquisition of Club Monaco, which is a vertical retailer like Abercrombie & Fitch or Gap Inc., was a strong strategic move: It offers the advantage of giving Polo Ralph Lauren the ability to control the brand’s destiny. While Polo Ralph Lauren, like many designers, licenses out its brand to apparel manufacturers, the opportunity to control all aspects of a brand’s operation is attractive. “More and more you’re seeing older vendors such as Polo Ralph Lauren emphasizing their own retail business because the thinking is that they can better develop those markets. Certainly, the ability to determine all aspects of the products from manufacturing to retail display is a plus for these companies,” Kummetz said. As apparel manufacturers continue to seek opportunities to improve returns, they are embracing spin-offs and restructurings as well as straightforward m&a deals to achieve their desired mix of products. In the case of Sara Lee Corp., the company announced in May that it will restructure its operations. This will create opportunities for new combinations in the apparel industry. The conglomerate said it plans to sell its Champion athletic apparel business, but it will retain a number of apparel businesses that operate under the brand names Playtex, Hanes, and Wonderbra. At the same time it is divesting some operations, Sara Lee will be adding some underwear, hosiery, and activewear businesses to its portfolio as a result of its $239 million acquisition of U.K. apparel maker Courtaulds Textiles PLC, announced in March. Another player in the reshuffling of brands and divisions, although it is starting from a smaller base, is Stephen L. Ruzow’s Pegasus Apparel Group. Backed by about $100 million from Pegasus Capital Advisors, a private equity fund in Greenwich, Conn., Pegasus Apparel plans to assemble newer, American fashion brands and combine them along the lines of the European fashion houses such as Gucci Group NV, LVMH Moet Hennessy Louis Vuitton, and other luxury empires. So far Ruzow has assembled controlling interests in Pamela Dennis eveningwear, Daryl K, and Miguel Adrover. Whether he will succeed in creating an American equivalent of LVMH or Gucci remains to be seen, but Ruzow does have his supporters. “Steve is a veteran of this business and I expect he’ll put together a powerhouse,” Weintraub said. Taking a broader view, Weintraub reiterated a consensus view held by many participants in the U.S. apparel industry: “The trend toward increasing consolidation is fully in place and it will accelerate as companies seek to grow and dominate their sectors of the market.”