Will a frenzy of retailer M&A finally commence...
by Shopping Centers Today
Retailers and private equity firms alike are hungry to boost their portfolios through mergers and acquisitions, experts say. But like finicky eaters who cannot seem to make up their minds, some have been staring at the menu of possible acquisition targets for years now. Will a feast of retail M&A finally commence in 2012 and 2013? A spate of buyouts is likely, thanks to low interest rates, surging stocks, pent-up demand and other factors, observers say.
“Retail M&A is going to happen,” said attorney Francis J. Aquila, whose practice at Sullivan & Cromwell focuses on corporate governance and M&A. “It will happen at two ends of the spectrum: Those companies that are the winners will seek to consolidate their sectors and will be acquisitive; those that are not doing as well will seek to shed assets, and some will put themselves up for sale.”
In the wake of the financial crisis, smart retailers did everything they could to slash costs and shore up balance sheets. They now must find some other way to boost profits, which makes M&A more likely, says Robert J. Coble, who specializes in consumer markets as KPMG’s national leader of corporate transaction services. “To become profitable now, retailers will have to find a larger customer base through geographic or product spread,” Coble said. “You can do that organically by opening new stores. But the fastest way is to acquire a known customer base through acquisitions, which is why this is going to be the trend for 2012.”
The pace of retail M&A is already on the upswing, according to research firm Dealogic. During the recessionary nadir of 2009, Dealogic recorded 173 U.S. retail M&A transactions, at a total value of about $7.8 billion. Last year the firm recorded 271 deals, valued at about $15 billion all told. That was a substantial improvement over 2009, to be sure, but still a long way from the $48.3 billion deal volume reached in 2005.
So far this year, some of the widely discussed M&A transactions in retail include the possible sale of Collective Brands, which owns the 4,160-store Payless ShoeSource chain, and the ongoing bidding process for women’s apparel chain Talbots, which has 517 stores. Private equity firms, in particular, are keen on both Talbots and Collective Brands, says a source close to the deals and who requested anonymity. (Potential buyers for Collective Brands include Brown Shoe Co. and South Korea’s E-Land Group, according to Bloomberg Businessweek.) Meanwhile, the better-performing retail chains are bound to start gobbling up their weaker competitors, Coble predicts. “There are a lot of [weakened retailers] out there,” he said. “It runs the gamut from small bookstores and boutique apparel companies to large grocery chains and mass merchandisers.”
Ascena Retail Group, owner of Maurices, Justice and Dress Barn, is among those stronger operators considered likely to make an acquisition or two in the near term. Ascena declined to discuss specifics, but the company is reportedly exploring the possibility of targeting the likes of Lane Bryant, Talbots and others.
After a 2011 holiday season that beat expectations, Ascena posted record sales and earnings for its fiscal second quarter (ended January 28). Meanwhile, David Jaffe, Ascena’s president and CEO, is spending a bit more time contemplating strategic moves — including M&A — now that some executive-level personnel changes are in place at the company. “We now have strong executive teams in place at all three brands,” he said. “Acquisitions, if we are fortunate enough to find one, are always hard, but we are in a pretty good place in terms of our ability to focus on this, and we have the right players to make it happen.”
Ascena has made such deals happen before. Founded as Dress Barn in 1962, the Suffern, N.Y.–based company acquired Maurices (now about 800 stores) in 2005. Much to Wall Street’s surprise, the company spent $412.7 million in November 2009 to acquire the then-troubled Tween Brands and its 905 Justice stores. In the weeks before the Wall Street collapse, Tween Brands had started the process of cutting its overhead in half and converting its premium-price Limited Too stores to the lower-price Justice banner, Jaffe says. And yet analysts failed to appreciate the wisdom of Tween Brands’ shift to this leaner, value-focused approach, he says, and they took a dim view of the company’s debt load and dismal holiday-season performance. “That is why [Tween Brands’] stock got hit, and that is why we were able to come in and merge with them,” Jaffe said. “We had a very strong balance sheet, and that is what they needed. So it worked out great for both of us.”
As a holding company, Ascena is now focusing hard on back-end efficiencies that will make its brands more competitive. “What we are doing now is developing more and more of what we call shared services,” said Jaffe. “Think about all of the stuff that is not customer-facing. Why have those things distracting the brands, so to speak, when we can do them faster, better and smarter internally?”
But if Ascena’s story illustrates the potential benefits of M&A for retail chains, it is nonetheless a relatively rare phenomenon of late, says Marc S. Cooper, head of the retail and apparel practice at Peter J. Solomon Co. “There have been very few retailers who have gone out and bought other, lower-growth retailers with the idea that [the acquirer] would be better operators and enjoy savings and synergies,” he said. “There aren’t that many Ascenas out there.”
The debt markets were tough from July 2011 until the end of last year, says Cooper, but this alone does not explain why M&A activity has not been more robust. After all, successful retailers and private equity firms alike have been sitting on lots of cash, and both have had strong incentives to grow. One possible explanation for the conservatism is unease about the economic future. Indeed, this is clearly part of the reason M&A activity has been sluggish in Europe, according to a KPMG report on global M&A trends for 2010 and 2011. “There was a clear dip in activity in the third quarter, as companies and consumers in Europe felt the full impact of financial problems in the euro zone,” the authors noted. “European activity slumped as businesses chose to wait for a resolution to the crisis rather than make plans in the face of uncertainty, while consumers reined in their spending.”
But this was not necessarily true everywhere in the world, says Coble. “If you look at the emerging markets like India, China and Latin America, they have been very stable over the last five or six years with respect to M&A,” he said. “There is a huge customer base there, and deals in those emerging economies are going to be active and growing.”
Two noteworthy international deals from last year include Wal-Mart’s $2.4 billion acquisition of a majority stake in South African retailer Massmart, and Target’s purchase of 189 Zellers leases in Canada. Growth was the goal in both deals, but for U.S. retailers looking to grow domestically, the trick is to figure out which of their competitors have good growth prospects and are worth buying, and which ones could vanish altogether. “There are still a lot of retailers out there that are not cutting it, but they are not necessarily going to be acquisition targets,” Cooper said. “In fact, they are probably going to go out, because there is a fair amount of inherent, excess capacity out there in the malls. Also, many retailers have recognized that traffic at the malls is down. They have to be more discerning as to which of those locations are actually going to work for their concepts.”
Likewise, the strategy for many private equity firms used to be “grow the store count, and get out with a nice return.” But today many chains are trimming underperforming stores, not opening new ones. “The private equity community is being very cautious about what they do in the retail world,” Cooper said. “The big issue is: What is the exit strategy? One thing that the recession reinforced to everyone is that store growth does not go on forever. A lot of the retailers are hitting maturation. It is great to be able to buy a company, but how are you going to get a return on it?”
Throw in wildcards like high gas prices, unemployment and the rise of “show-rooming” — the practice whereby consumers visit a store to physically examine merchandise they then buy online at a lower price — and the prospect of acquiring a retail business of any sort starts to seem more daunting. “Retail more than any other sector is affected by employment and the health of the consumer,” Aquila said. “One retailer CEO said to me recently: ‘To the extent that gasoline hits $5 a gallon, that means that my core customers — basic middle-class and working-class people — are going to have that much less that they can spend in my store.’ ”
In this environment, making growth projections is risky indeed. “As a retailer, I really cannot project out two years,” Coble said. “I do not know what the buying activities are going to be, and I do not know how consumer confidence is going to change.”
Despite these caveats and concerns, however, M&A experts still predict a rise in activity as this year progresses. Rather than blockbuster deals worth billions, some of these transactions will be smaller-scale and cross-channel, as brick-and-mortar chains acquire technology companies, catalog operators and other vendors that can help them serve their customers better. “You’re going to see more of this,” Cooper said. “For example, we helped eBay buy GSI, which is an Internet outsourcing platform for retailers. We helped Zagat’s sell itself to Google. We recently helped The Home Depot buy what was, essentially, a technology company, and we are now engaged by another online business that is actually going to sell itself to a retailer.”
Another example of such cross-channel deals is Williams-Sonoma Co.’s November acquisition of lighting retailer Rejuvenation, which operates four stores but does most of its business by catalog. “It was a great acquisition,” said retail consultant Jeff Green, who heads an eponymous firm in Phoenix. “Who knows catalogs better than Williams-Sonoma Company? They can help Rejuvenation on the catalog side, and Rejuvenation has room to grow, so they can help Williams-Sonoma on the brick-and-mortar store side. Some of these deals are going to be under the radar, in other words, but they may eventually have a big impact.”
By Joel Groover, from the May 2012 issue of Shopping Centers Today.