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forecasts-analysis

IPO Climate Warming for Some Retailers

Value retailers seen best candidates in revival of public markets.

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Could the retail IPO be ready for a comeback?

With the S&P Retail Index around 388, more than a 70 percent gain since March, some firms eyeing the capital markets believe “green shoots” may begin sprouting in the recently dormant market for initial public offerings. That’s especially true for value-oriented retailers that have weathered the recession better than their upscale counterparts.

“What’s key is that the market is actually open,” observed Thomas Del Zoppo, head of cash equities for the Americas at HSBC Securities. “Now there’s a bit of fresh air coming through, compared with the depths of a year ago when we saw the number of deals pulled or shelved reaching historic levels.”

After a slowdown that began in the fourth quarter of 2008, positive trends have started to emerge in specialty retail mergers and acquisitions activity, with strategic buyers taking the lead. In the second quarter, Syms Inc. bought Filene’s Basement and The Dress Barn Inc. agreed to acquire Tween Brands Inc. Third-quarter activity includes Amazon.com purchasing Zappos.com for $979 million. In addition, in August online apparel retailer MyShape received $11 million in private placement funding.

Now it looks like the dormant IPO market is about to see some action.

In the last 10 weeks, three retailers in North America have filed statements regarding their intent to go public — two in the U.S. and one in Canada. The two Form S-1 filings with the Securities and Exchange Commission in the U.S. were Dollar General Corp. on Aug. 10 and Rue21 on Sept. 18. Dollarama is the Canadian firm that filed Sept. 10.

A fourth retailer, VS Holdings, which operates The Vitamin Shoppe stores, filed its Form S-1 on July 23, and is set to price this month. VS Holdings will be the first retail IPO in two years.

And it isn’t only the U.S. IPO market starting to simmer. Last month, two retailers outside North America unveiled plans to go public. Italy’s online discount retailer, Yoox, said it plans to list on the Italian Bourse in the first half of next year. Australia’s largest department store group, Myer, said it will return to the Australian stock market before Christmas.

On Monday, published reports said that, in another illustration of private equity turning to the public markets for an exit strategy, Blackstone Group, a major private equity player, would sell five companies in its portfolio and float up to eight more as conditions in the M&A and IPO markets improve.

Why now? First, private equity players who snapped up specialty retailers with debt might view this as a good time to exit their investments, now that the market is showing signs of life again. In addition, according to HSBC’s Del Zoppo, firms need to raise operating capital to grow their businesses, and right now the “view from the back-view mirror is looking better. They’re starting to [evaluate] what is the risk appetite of, and risk tolerance of, the marketplace.”

Still, many firms are likely shut out from the IPO market. “Luxury retailers won’t have a good story,” said Christopher Kampe, managing director at investment banking firm Tully & Holland.

So companies such as Neiman Marcus Inc. likely will have to wait before they can test the public waters. The luxury chain was acquired by private equity firms TPG, formerly Texas Pacific Group, and Warburg Pincus in May 2005 for $5.1 billion. In April 2007, word surfaced from Wall Street sources the equity firms were gauging investment interest for a possible Neiman’s IPO in late summer 2007 or by early 2008. An IPO never materialized.

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Prada SpA also has shelved plans for an IPO for now after flirting with one in 2008. It called off any IPO last fall once the financial markets fell. There had been speculation the luxury house might instead sell a minority stake — rumors that resurfaced Wednesday and which Prada firmly denied. “There are no meetings or negotiations under way,” a company spokesman said Wednesday. As reported in June, private equity firms including Carlyle, TPG, Investindustrial and Clessidra have been circling, but after Prada’s lenders agreed in August to postpone until 2012 the term payment of around 450 million euros, or $663.7 million, of the group’s debts at a holding company level, any pressure to seek additional funds was understood to have eased.

Plus Prada would have the luxury market’s doldrums to contend with. That’s why, these days, few investment bankers are surprised the initial forays into the IPO market are coming mostly from value-oriented retailers.

David A. Galper, head of the healthy and active lifestyles group in the consumer and retail investment banking division of KeyBanc Capital Markets Inc., observed, “The value-oriented retailers are well positioned, considering the consumer mind-set due to the recession.”

While Rue21 isn’t a discounter or dollar store, the banker said its combination of fashion and value provides the retail concept with a compelling growth story for potential investors.

“Unlike some of the other teen or youth retailers, it’s got a unique offering [and] fashion-forward trends at inexpensive prices, with a high accessory component,” Galper said. He noted Rue21’s “attractive real estate model, focused on strip centers, regional malls and outlet centers in small and midsized communities, should lead to a significant expansion opportunity.”

Michael J. Hoffman, managing director in the retail and apparel group at Piper Jaffray Co.’s investment banking division, expects spring and fall 2010 to be periods of improved activity on the IPO front.

“Several companies are performing well in the downturn, while others may need their sales trends to improve. Generally, there appears to be more visibility on how the consumer is behaving at the same time that we are coming up against easier same-store sales comparisons industrywide,” he said.

Piper Jaffray believes increasing interest from the investment community in new companies with strong growth prospects bodes well for retail and apparel companies interested in pursuing IPOs.

“There is interest from the buy side. We couldn’t show investors a deal six months ago. Now they are proactively reaching out to us and asking for a call on any new deals,” Hoffman observed.

He said the companies that float first will be rewarded for performing well through what has been a challenging period in the retail sector.

According to Steven J. Tricarico, managing director for retail and apparel in the consumer investment banking division at Jefferies & Co. Inc., “The equity markets historically need a good growth story, such as unit rollouts, to entice people to buy the stock. The winners are the concepts that have continued to do well despite the economy,” Tricarico said.

In his opinion, retailers have a better shot at successful IPOs than apparel vendors, given the life cycle of most brands. “Apparel brands are the most pressured of any group, and it is harder for them to survive if they don’t have [sufficient] scale.”

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Tricarico explained that investors are also willing to give credit for forward earnings, meaning companies looking at a spring IPO can rely on using projected 2011 earnings as a basis for valuations.

In addition, many retail IPOs have done well subsequent to going public.

According to data from ICR, a Westport, Conn.-based financial communications firm, the stock appreciation average was 190 percent for 10 IPOs in softgoods retail, apparel and footwear over the past five years from their IPO prices within the first two years of going public. Those 10 IPOs were: Under Armour Inc.; Zumiez Inc.; Citi Trends Inc.; J. Crew Group Inc.; Crocs Inc.; Lululemon Athletica Inc.; Ulta Salon, Cosmetics & Fragrance Inc.; New York & Company Inc.; DSW Inc., and Hanesbrands Inc.

The last successful one was Ulta, in October 2007. Before Ulta, the last two successful specialty-apparel retail IPOs were Lululemon in July 2007 and J. Crew in June 2006, with the latter one of the most successful flotations in history. Mall-based specialty retailer Metropark USA Inc. filed for an IPO in June 2008, but that was then pulled.

Tully & Holland’s Kampe said, “If these [upcoming] IPOs are successful, I would expect others will follow suit.”

Kampe noted the number of deals funded in the last few years by private equity firms, many with a high level of debt that needs to be paid down. “Many of those financial sponsors might want to exit their investments, and this new IPO market can appear exciting and very interesting. Ultimately, this could be the exit avenue for these private equity firms if the market proves to be vibrant,” he concluded.

On Monday, stocks gave back most of the morning’s gains and the S&P Retail Index finished up less than 0.1 percent at 387.83. After briefly topping 9,900, the Dow Jones Industrial Average finished the day at 9,885.80, up 0.2 percent while the S&P 500 closed at 1,076.18, up 0.4 percent.

Lest anyone get too positive, Piper Jaffray’s Hoffman cautioned the economy will have to show continued improvement for the IPO trend to continue. “If we lose momentum on the economic recovery, there’s the potential for the market to shut down again,” he stressed.

 

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