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M&A: Is Private Equity Losing Its Steam?

Private equity's domination of the retail mergers and acquisitions market may have an expiration date.

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Peter Boneparth

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William Susman

Photo By WWD Staff

NEW YORK — Private equity's domination of the retail mergers and acquisitions market may have an expiration date.

Heads of investment banks, private equity funds and strategic apparel giants agreed during a seminar last month at the Princeton Club here that private equity's ability to outbid strategic buyers for apparel acquisitions was an historic anomaly, and that the Liz Claibornes and Jones Apparel Groups of the world will win back the competitive advantage.

"Conceptually, if everything were equal, strategics should pay more because we have synergies," Peter Boneparth, president and chief executive officer of Jones Apparel Group, said during the seminar, "M&A: Finding the Strategic Fit.''

But Jones has not made a deal since it bought Barneys New York in 2004 for $397.3 million. Boneparth explained that public apparel companies like his trade around six or seven times earnings before interest, taxes, depreciation and amortization, "so it's hard to rationalize buying at nine or 10 times EBITDA," which is what private equity firms have been paying. However, he predicted that a few bad deals will put an end to that practice in time.

"We used to say we would only do deals over $100 million or $200 million, but it's become a challenge in the last 24 months," Boneparth said. "In a perfect world, we would have contemporaries to round out our portfolio. There have been cases where we have loved the brand, loved the management, but we couldn't come close on the price."

Previously, corporations like Jones were able to spend more because of the cost savings associated with economies of scale, said Adam Rifkin, senior vice president of the retail apparel group at Lehman Brothers. But now, private equity firms can leverage more capital, and the risk associated with fashion has decreased as the market in general thrives with upward shopping and purchasing trends, he said.

"Private equity funds are willing to supply not only the equity but also the debt — they are one-stop shops and management welcomes private equity," said William Susman, president and chief operating officer at investment banking firm Financo Inc.

David Landau, a partner at LNK Partners LLC, a $400 million private equity fund that focuses on the retail sector, said although private equity firms often pay more than strategic buyers, he predicted that trend will reverse itself. "Are private equity firms seeing something the strategic buyer does not, or are they being stupid?" Landau asked. "Time will tell."

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Landau emphasized that private equity firms seek an exit strategy. "We are looking for how we leave before we ever walk through the door," Landau said.

In addition to an "attractive exit opportunity," Landau said private equity firms look for strong management, profitable businesses with growth prospects and business that is "not volatile or dependent on fashion or economic cycles."

Rifkin said that last year, M&A activity in the sector was $134 billion, up 12 percent over the record 2005 total of $119.4 billion, and he expects this year will again break volume records. Rifkin pointed to an upward trend in hostile activity, successful instances of apparel companies creating an initial public offering and public companies' evaluation of all business segments — not just weak areas, as in the past — as they focus on enhancing shareholder value.

Acquirers look for strong brands, multiple formats, consistent cash flow, real estate, international sourcing potential, relative immunity from Wal-Mart, information systems and international growth opportunity, Rifkin said. He added a list of transaction-related considerations: valuations, capital structure and financial flexibility, impact on base business, culture and market reaction.

The average size of deals has dropped, according to CIT, an independent financing company focused on middle-market businesses that cosponsored the seminar. "Smaller branded apparel companies of less than $100 million will be attractive targets for midsize firms," said Christopher Westfall, managing director of the M&A division of CIT, who identified Li & Fung, Iconix, NexCen Brands and G-III Apparel Group as leading middle-market companies.

Midsize vendors who attended the seminar drilled the panelists on how smaller companies without branded products could survive, but the panelists had neither a good prognosis nor an easy answer.

Consultant Emanuel Weintraub, whose firm hosted the talk, estimated market share breakdown at 30 percent private brand, 40 percent national brands and 30 percent unbranded. But he thinks that will shift to 45-40-15, with national brands spending increasing amounts on marketing to hold onto their market share in the face of stronger private labels and unbranded goods vanishing.

What with the emergence of private label, retail consolidation, limited growth in the marketplace and Wall Street's demand of 10 percent growth, companies have no choice but to merge and acquire, Weintraub said. "In an industry with limited growth and redistribution of market share, plus Wall Street's demands of growth — guess what: The big fish need to eat the little fish," he said.

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