NEW YORK — Think the past 18 months have been busy with mergers and acquisitions deals? You ain’t seen nothing yet.
Bankers and analysts expect the flurry of interest in retail to continue over the next six months, driven by many of the same strategic and financial players that have led the current wave — everyone from Jones Apparel Group and Liz Claiborne Inc. to Texas Pacific and Cerberus.
But the times they are a changin’. While retail remains a focus, especially for private equity players, bankers and analysts predict the nature of the deals will shift — they expect fewer deals in the department store sector and a ramp-up in the home goods arena. Also, due to rifts in the economy, such as the impact of rising energy costs on consumers and businesses, M&A activity could be transformed from a seller’s market into a buyer’s one.
As a result, the 20 to 40 percent premiums seen in recent deals, such as the $17 billion acquisition of May Department Stores by Federated Department Stores and the $5 billion purchase of Neiman Marcus Group by Texas Pacific Group/Warburg Pincus, are expected to fade.
Instead, the market will see transactions that have less lofty price tags. Meanwhile, any weakening of stock prices or retail bankruptcies due to softer consumer spending will set into action the private equity investors that specialize in snatching up distressed companies.
For the fourth quarter, though, the short-term outlook remains super bright for M&A activity in the retail and apparel sectors.
“You should expect an increase in mergers because the markets are so good right now for M&A activity,” said Ken Wasik, director of the consumer products group at Houlihan Lokey Howard & Zukin, an investment banking services firm. “The interest rate environment is ideal, the stock market is strong, the amount of capital seeking acquisitions is large, so absolutely we’ll expect it.”
Banking sources estimate there is currently about $100 billion in the private equity market ready to be invested. In the public markets, stock valuations have seen tempered growth, which may be the right environment for launching an initial public offering or for at least tendering shares. An IPO to watch is the $200 million one of J. Crew, which is getting ready for a road show. Another is the upcoming $100 million IPO of hot activewear brand Under Armour.
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Current market conditions may explain why several recent IPOs — such as Zumiez Inc., Citi Trends Inc. and Volcom Inc. — have been successfully priced in the market since launching earlier this year. Shares of specialty retailer Citi Trends, for example, are up about 63 percent since its initial offering in June, far outpacing the S&P 500. The overall stock index is up about 1.6 percent since the beginning of the year.
But given the wave of consolidation that already has taken place in the department and specialty store sectors, these are less likely to be the focus going forward. After all, how many chains are left to buy? The main question at the moment remains the in-flux situation at Saks Inc., but otherwise most major department store players appear immune to any takeover activity.
As a result, bankers and analysts say that, over the next three quarters, the home furnishings segment could be where the action is.
Wasik said the M&A environment for the home goods sector is already in full swing — though he said it’s not as strong as the M&A market for premium apparel retailers. The reason is that the financial strength of home goods companies has plateaued in recent years, he said.
“There are some things in the pipeline right now. We should be seeing things happening in the fourth quarter. Some [home goods] retailers will change hands,” Wasik predicted.
Specifically, he expects to see the bigger home goods companies consolidate. “There’s a couple big players out there that could make sense in getting together, mainly because the trading multiples have come down,” Wasik said.
According to one analyst who spoke on the condition of anonymity, there have been rumblings in the home furnishings market for the past six to 12 months that some type of consolidation would take place. This would be driven by the extreme growth in the mid- to late Nineties of stores such as Pottery Barn, Pier 1 Imports, Restoration Hardware, Bed Bath & Beyond and Linens-N-Things. These retailers have seen sales surge as the housing market has boomed.
Following the growth of those stores, however, the mass merchants also started beefing up their home furnishings offerings. “You had companies crop up like Cost Plus, which is trying to infiltrate the East Coast — it’s typically in the West Coast states. If you layer on top of that the fact that you can go to Target and get really decent towels, there’s been a lot of change in this zone, so I think that’s been driving the speculation of the consolidation,” the analyst said.
One speculative take-out candidate in the home goods market is Pier 1 Imports, analysts said. Trading at around $12, its stock is cheap. For that reason, the company could be willing to be scooped up by the right buyer, especially since it’s been struggling for a while now. Sales in the company’s last fiscal year were up just 1.6 percent at $1.9 billion, and the company recently lowered its second-quarter earnings guidance, saying comp-store sales could drop as much as 9 percent due to weak traffic and subsequently heavy promotions.
In the broader retail segment, the market will continue to keep an eye on Saks Inc. as it readies to sell its northern department store business. But, as previously reported, strategic and financial players were looking at Saks Inc., its department store group and its Saks Fifth Avenue business. At least one of the lead bidders, Cerberus Capital Management, backed off because the assets were too pricy. Several bankers said this signals a change in the M&A market toward a seller’s one.
However, Howard Tubin, senior analyst at Cathay Financial, who follows mainly specialty retailers, doesn’t necessarily agree the M&A market could turn to a buyer’s market in the second half of the year from the seller’s one seen in the prior year. But he did concede that certain retailers already on the block should not expect to get the same premiums seen in deals done earlier this year.
“I do still think there’s a lot of private equity money out there,” said Tubin. “I still think it’s going to be depending on who is putting themselves up for sale, and it’s going to depend more on the business, the [financial] performance of the business. So [the Neiman Marcus Group] got sold at a nice multiple because its business was very strong, and it was firing on all cylinders and it was the premier name in luxury retail. And now Saks [Inc.] is looking to sell their department store group, but I wouldn’t expect the Saks department store group to get the same multiple Neiman’s got.”
As for which company could be ripe as a takeout candidate, Tubin thinks it depends on the type of retailer. “I think the guys who have momentum [going into] the spring [2006] season will probably continue to perform well. In terms of just a fundamental perspective, the guys who don’t have any momentum for the spring, it will be difficult for them…in the second half of the year.”