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Struggling mall retailers are looking like buyout bait

Michael Santoli
Michael Santoli
Retailer Chico's jumped over 14% in early trading on a report that the company could be considering going private. The mature women's clothing chain has struggled along with its competitors in this crowded field. However, its earnings seemed to be better than the industry average in its group. The lack of mall traffic has hurt Chico's and the long, harsh winter didn't help. Competitors haven't had it any easier. Coldwater Creek went bankrupt and only just recently found a buyer, while J. Jill has changed ownership many times. Francesca's has never done as well as the day it went public.

Wall Street’s vultures are starting to walk the mall browsing for fresh prey.

Within a laggard retail sector, a crowded collection of long-established specialty chain stores selling clothes, shoes and accessories have struggled acutely.

This subset of retail, populated by tired “concepts” now on the wrong side of consumer preferences, has been so spurned by investors that they are stuffed with idle cash and appear cheap enough for some opportunistic and risk-embracing buyout firms to begin taking a look.

Late Thursday, consumer-focused investment firm Sycamore Partners reported a 9.9% stake in clothing retailer Express Inc. (EXPR) and said it wishes to discuss acquiring the clothing retailer, driving the shares up more than 20% in late trading.

Earlier this week, reports held that Chico’s FAS Inc. (CHS), the once-hot chain of nearly 1,500 women’s-wear shops, had discussed selling to private-equity firms for as much as $3.2 billion.

The stock jumped by nearly 9% on the news to $16.73, though it remains 15% below its 52-week high and a yawning 64% lower than its all-time peak in early 2006, when it was riding rapid store growth and a flush, credit-floated consumer in its core Sunbelt region.

Chico’s has plenty of company among retailers with depressed share prices and scarce growth given weak mall traffic, bargain-hungry shoppers.

Bernstein Research periodically scans the universe of public stocks to compile a list of LBO candidates based on several quantitative factors that a buyout shop would consider in determining if a company could be profitably acquired using a mix of cash and debt. On its latest screen, 25 of the 88 stocks that surfaced were in the consumer cyclical sector, and most of those were chain retailers.

Aside from Chico’s, the list includes Petsmart Inc. (PETM), Urban Outfitters Inc. (URBN), UGG boot maker Deckers Outdoor Corp. (DECK), Guess Inc. (GES), Buckle Inc. (BKE), Steven Madden Ltd. (SHOO), American Eagle Outfitters Inc. (AEO) and Fossil Group Inc. (FOSL).

Shares of these companies are down an average of 33% from their all-time highs, with the median stock off 24% from its peak.

The Bernstein screen is not meant as an outright predictor of likely buyout targets, but rather highlights companies that look cheap relative to cash flow, with lots of cash on the books and little debt, among other technical characteristics. They represent beaten-up value sectors of the market where buyout firms might hunt.

There are some retailers on the list that would appear rather too big for private equity to plausibly swallow, such as Bed Bath & Beyond Inc. (BBBY) and Kohl’s Corp. (KSS). For an investor, this is a mark of once-beloved consumer-growth companies that the market is no longer valuing as if they can reliably grow any more.

Specialty retailers tend to trace a beguiling and then humbling lifecycle, with the best of them hitting on a mix of brand appeal and merchandising smarts that underwrites rapid expansion. Sales often stay buoyant for years before either over-expansion or fading fashion value slows them down.

Managers who know mostly aggressive growth often have a hard time husbanding capital and delivering decent returns when the top line decelerates. And that’s when analysts and growth portfolio managers turn away.

This sector was an under-appreciated beneficiary of the loose credit, housing and consumer boom of a decade ago, following customers into fresh suburbs and exurbs where home-equity credit lines supported spending on clothing and gadgets. From 1995 to 2009, shopping center square footage in the U.S. expanded by 30%, more than twice the 14% growth in the population, according to Deutsche Bank’s RREEF Research. And not much has been eliminated since then.

The standard pitch for why private buyouts can make sense is that it allows once-public companies to operate free of the glare and short-term pressures of Wall Street. This is often a euphemistic way of saying that when private, a company that needs to shrink toward viable profitability is able to do so. It’s quite hard to be a public company without promising investors growth -- especially a consumer company.

The trouble for private-equity operators in soaking up some of the excess retail competitors is that it’s tough to gauge what a “normalized” level of mall traffic or in-store soft-goods sales might be. Online retailers have accelerated their market-share gains and consumer behavior is showing few signs of reverting back to a mall-centric consumption habit.

This leaves wide open the risk that struggling specialty retailers are “cheap for a reason,” and perhaps explains why there hasn’t been much deal activity here despite buyout shops rolling in cash and promiscuous debt markets happy to enable their next conquest.

Leonard Green Partners, which owns a small stake in Chico’s, is a longtime opportunistic buyer of bedraggled retail operators, as well as stronger ones. It is now an owner of J. Crew and Sports Authority.