Retail M&A Should Bypass Specialty Chains: Smaller specialists might attract private equity firms willing to finance build-outs

While consolidation is forecast to continue among general merchandise giants in the wake of the K Mart Corp.-Sears, Roebuck & Co. merger, the m&a wave probably will bypass the enormous number of small and mid-sized specialty chains on the U.S. retailing scene. The split-screen outlook mirrors the divergent macro forces governing the two broad segments. Department stores and mass discounters are fighting the battle on basic economics – requiring scale and purchasing clout to reorganize, relocate, cut costs, and meet the cut-rate prices at volume leaders Wal-Mart and Target. Solidifying a place in the right niche By contrast, the smaller chains compete by offering quality, convenience, or cache; targeting specific segments, such as teenagers or high-income families; or locating in geographic niches – such as rural areas – that they can lock up. The challenge for this diverse segment – which embraces deep-discount “dollar” stores; premium and low-price food chains, specialty apparel; costume jewelry; consumer electronics; and many others – is to hit the core strategy hard, keep atop evolving trends, and quickly reposition, if and when the market signals change. Deals by strategic buyers, retailing experts say, is not going to be a major part of future trends. But they see very good opportunities for private equity firms using their deep pockets and credit lines to execute roll-up or build-out plays. Not that it’s going to be a walk in the park for the specialists. Their survival, says Ana Dutra, a retailing expert at Mercer Management Consulting, depends on their becoming “even more focused and specialized in their niche segments than they were before But in doing that, they can be big winners in the future because all the larger chains are playing with at this point are size and volume.” In addition to focusing on their strong points, the specialty chains also must be prepared to “reinvent” themselves when their base markets erode, notes Andrew Rees of LEK Consulting, who says the pressure to be a quick-change artist is especially acute in apparel. “Their issue is how to maintain differentiation and how to maintain the interest of the core customer base,” he says. “It’s fickle and is looking for newness over a period of time.” Dutra says that acquisitions don’t fit for many specialists because they may lose flexibility if they get too large. Rees says the reasons that companies often acquire don’t apply much to the specialty retailer. He notes, for example, that it’s often easier to grow organically than to buy another chain for its locations and he doesn’t see much payoff in diversifying by putting a number of different types of chains under the same corporate roof. Retail conglomerates housing vastly different types of chains were tried in the 1980s but came up short because they lacked much commonality in such areas as purchasing and marketing costs. Prospects for financial buyers However, Rees, adding that a retail build-out needs “a lot of capital,” says there is a good shot for the private equity player that buys a small chain and puts up the money to grow it. Once it gets to a good size, the chain can be taken public. “The stock market likes specialty chains,” Rees says. Richard Kabobjian, a Managing Partner in Deloitte & Touche’s Northeast Consumer Business practice, says that strategic acquisitions might not be all that remote if larger scale can help the stores generate back-office, purchasing, sales and general administration, and other synergies. “It’s a scale issue in trying to compete and become more cost-efficient,” he says. “You can get synergies from larger size.” Richard Spears, a Partner in Merger and Acquisition Services at Deloitte Tax, says these cost-side factors could be very important in PE-financed build-outs. “I think there will be a lot of roll-ups on the PE side,” he says. Copyright 2005 Thomson Media Inc. All Rights Reserved. http://www.thomsonmedia.com http://www.majournal.com