M&A volume remains low, but deals across the retail sector continue to crop up as acquirers search for winning brand names that resonate with consumers, says Antony Karabus, president of SD Retail Consulting, an advisory unit of Hilco Trading LLC.
Target Corp.'s (NYSE: TGT) recent purchase of Chefs Catalog and Cooking.com comes to mind, as well as the acquisition of eyewear retail chain Óticas Carol by a group led by 3i Group plc (LON: III). Then there was Sycamore Partners' $600 million takeover of pop-culture themed Hot Topic Inc.,
Meanwhile, famous names like J.C. Penney Co. Inc. may not attract customers they used to, Karabus adds. The clothing retailer is currently revamping its business strategy following the recent departure of chief executive Ron Johnson and engaging investment firms known for financing troubled franchises, including Wells Fargo & Co., TPG Capital and Gordon Brothers Group. As of late April, investor George Soros bought a 7.9 percent stake in J.C. Penney valued at $265 million.
Meanwhile, beachwear retailer Billabong International Ltd. (ASE: BBG), finds itself mulling over a $300 million bid from Sycamore Partners - far less than the $824 million offer it rejected last year from TPG.
Mergers & Acquisitions sat down with Karabus, whose expertise has helped many leading retailers including Victoria's Secret, Neiman Marcus, Bloomingdale's, Aldo Shoes and A&P. Buyers will pay more, he explains, if the target brand will aid in setting them apart from rivals and keep customers coming to stores instead of opting to buy goods online.
What should a buyer consider while looking for brand-name targets?
It's a combination of product and shopper experience. Does the target have a very clear niche? Does it have intellectual property? Are the barriers to entry high? Extraordinary companies - Nordstrom Inc. (NYSE: JWN), Victoria's Secret Stores LLC, Cabelas Inc. (NYSE:CAB) and Starbucks Corp. (Nasdaq: SBUX) - have such tremendous strengths in their values and mission. They are streaks ahead of everyone else who does what it is they do. Everything they do is wrapped around that core reason for being. Look at Whole Foods, for example. Their reason for being is so evident that when you walk into the store, it's clear they're so far above anyone else in that industry. To catch up would be very difficult. If you have a well-defined position in the market, it's very hard to be copied or emulated. Some of my clients look for the Amazon effect and whether it's likely to be minimal. One retailer, Sur La Table, sells very high-end kitchen gadgets. Why is their position defensible? They have cooking classes in all of their stores. Well, you can't have cooking classes on Amazon. So, part of that experience is, if you cook something great, you're going to want to buy the materials to cook that meal and the Sur La Table experience can't be replicated by Amazon. [Sur La Table is backed by Bahrain-based Investcorp, owner of SourceMedia, Mergers & Acquisitions' publisher.]
Where did Billabong go wrong?
When they bought extreme-sports retailer West 49 Inc. for $83 million in 2010, I didn't understand what they were doing. It was supposed to be similar to sporting goods retailer Zumiez Inc. (Nasdaq: ZUMZ) but it didn't quite turn out that way. Billabong had a wonderful brand but they lost that image. It was a great niche. Now, you walk into Billabong stores, they're not that exciting. It has a hell of a lot of product and a ton of clothing, but it's not differentiated.
What can Sycamore Partners do for Billabong?
The acquisition was a complete steal. The value has plummeted, but I think a private equity buyer with a laser focus can turn it around. Billabong, at its heart, has a nice brand image for surfers, beachwear and broad shorts, so I don't think it's a lost cause. It has to differentiate its position.
How is the consumer retail space challenged?
The biggest challenge is finding compelling companies that have the potential to create shareholder value. You only create it through significant earnings or sales growth. Finding those companies that have significant and untapped sales growth is not a trivial task. A number of PE firms are sitting on companies that they couldn't sell during the recession. Now, a lot of those companies have to monetize. There has been a lot of speculation on a Toys R Us Inc. exit, but they postponed it. [It was acquired by Bain Capital, KKR & Co. LP (NYSE:KKR) and Vornado Realty Trust for $6.6 billion in 2005.] That would have been a perfect example of a major retail exit. There's only two other options: sell it or just keep it in the portfolio. A strategic acquirer could synergize it to complement what it already has. Is there still a growth trajectory? That doesn't necessarily mean opening up new stores. A PE buyer would have to do something materially different than the other PE firm did over the previous years.
Are strategic buyers worried about the debt of PE-backed retailers coming to market?
Absolutely. You never go out of business for having too much cash, but you do go out of business for having too much debt. If a company has extremely strong growth or earnings potential, you're not going to worry about the debt. Take, for example, Barneys New York Inc. The retailer restructured the debt in March 2012, handing ownership to creditors Perry Capital and Ronald Burkle's Yucaipa Cos. They had to. Some great companies have had to pay down significant amounts of debt. With J.C. Penney, I don't know if they'll declare bankruptcy.
What can modern-day dealmakers learn from past transactions, such as A&P's $679 million acquisition of Pathmark Stores in 2007?
One of the issues with many acquisitions is you get two companies that are underperforming in a similar sector. One of them acquires the other to buy runway. Rather, they buy time by putting two companies together to eliminate a back office and basically save a lot of cost. Two IT systems, two CFOs, two CEOs, and two head offices all go to one. If you justify a price based on cost synergies, I think you have a much higher risk of failure. For me that is the crux of the issue. If you look at A&P today, many say they overpaid for Pathmark, which was not doing that great at the time. They saved a ton of overhead, and you saw that in the annual reports, but the most critical thing about a transaction is not that you save money. You should do a transaction based on a strategic value. Ask yourself what is the strategic reason for doing a transaction? How are we going to serve customers better, sell more at the same price or create better margins? How do we create a better set of capabilities?