Not Quite a Fever, But Industry's LBO Tempo Could Pick Up

Fashion stocks could be back in fashion, as several private equity investment firms specializing in LBOs are taking a closer look at this sector.

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In a classic LBO, such as the 1999 transaction involving St. John Knits International, capital is borrowed to take the firm private. Buyers, because they use debt to fund their purchases, expect the company’s operating cash flow to service that debt. Typically, the debt consists of the assets of the targeted firm, which generally is pledged as collateral for the borrowed funds.

Private companies can also enter similarly structured deals. Whether the targeted firm is private or public, the exit strategy of the buyer, after fine-tuning the target’s operations, is to cash out either by selling the company or by taking it public through an initial public offering.

Howard Bader, an attorney at Ballon Stoll Bader & Nadler, observed, "There is so much pent-up money out there ready to do deals, and many companies out there treading water. We see both apparel firms looking for investors and boutique investment firms looking to do deals."

Most of the queries don’t pan out, Bader said. Smaller boutique investment firms face competition from the larger, better-known players. In addition, many of the firms seeking sources of new capital may not provide the "pop" in the investment that typically attracts buyout firms.

"One of the problems is that you have to be really careful about where the money is invested. There are mature businesses out there looking for financing, but then there’s really no or little possibility for expansion. The deals that get done tend to have an upside to the story," Bader said.

Just how many retail and apparel firms will eventually cuddle up with an investment partner before the year is over is still unclear. One roadblock to the completion of an LBO these days involves the financing component of the deal. Banks are getting stingier about how much they’re willing to provide in loans. That means that buyout firms have to put in more equity, as much as 50 percent in some cases, compared with the mid-to-late Eighties, the Golden Age of the LBO, when as little as 10 percent could get a deal done.

Another change is that buyout firms are more cautious now, a remnant of the days not too long ago when many got burnt. Investments soured either because the targeted firms failed or the weak market conditions meant that a hoped-for IPO or sale suddenly became impossible to do.
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