Spring Is in the Air for Retail M&A

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Retailers are barely finished with the holiday 2010 season, but it might as well be spring, because the merchants' mating season has already begun.

"They're poking their heads out, taking a look around and seeing where they are and what they're capable of doing," says Bruce Cohen, a partner in the private equity practice of consultant Kurt Salmon.

Merchants are getting back to business after the recession and showing stronger earnings again, as seen in the latest quarterly results. After maneuvering through the downturn to operate leaner and more cost-effective companies, retailers have good cash flow, lower debt and rising stock prices as consumers come back, Cohen says. Combine that with cheaper credit available for their suitors, and retailers are becoming attractive targets for private equity investors -- and each other.

Signs of Vigor


"The companies that have done well and have strongest balance sheets and the private equity groups that were holding on to funds and looking for opportunities feel they have reached the bottom of the cycle," said Cohen "As the trend picks up with consumers coming back to stores, they want to redeploy that capital."

In late 2010, retail M&A began showing signs of vigor when J.Crew (JCG) accepted an offer from private equity firms lead by Leonard Green & Partners, and when Bain Capital signed a deal to take Gymboree private for $1.8 billion in cash. Just before Christmas, Leonard Green again made a deal to acquire fabric and crafts retailer Jo-Ann Stores (JAS) for $1.6 billion.

The action has sped up in the new year, with Family Dollar Stores (FDO) announcing in February it had received a buyout offer worth almost $7.6 billion from investor Nelson Peltz's Trian Group, which had picked up a 6.6% stake in the discount chain last fall. During the same month, BJ's Wholesale Club (BJ) announced it had hired Morgan Stanley to explore a possible sale; A.C. Moore Arts & Crafts (ACMR) put up the "for sale" sign and said it had received "expressions of interest"; discounter Big Lots (BIG) hired Goldman Sachs to shop it around; and bankrupt retailer Blockbuster went out looking for a white knight.

The latest retailer to put itself on the block was teen apparel specialist Delia's (DLIA), which is reportedly doing the private-equity rounds, looking for a buyer after losing much of its cachet in recent years.

Conducive Environment for Deals

The deals are not always led by retailers looking to sell and investors looking to cash in. Some retailers are looking to buy for strategic reasons. Nordstrom (JWN) picked up online "flash sale" site HauteLook in February as a way for the department store to dive deeper into online sales, to "learn how to operate better in that world," CFO Mike Koppel told analysts.

Many retailers have abundant cash flow they can use to experiment with new defensive strategies in an environment that is changing dramatically, noted Michael Exstein, retail analyst at Credit Suisse First Boston. In a note to investors, he singled out Walmart's (WMT) acquisition last year of streaming video service Vudu as one example of retailers' experiments.

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"This is really an indicator of greater confidence overall about the industry," says Cohen. "A lot of retailers went through a lot of pain during the recession to rationalize their companies to be able to survive, and not wanting to expand so quickly coming out of the recession, are still good cash generators."

Additionally, today's low interest rates are very conducive to dealmaking, and retail stocks have appreciated significantly as consumer confidence bounces back. That makes stock combinations also attractive, says Cohen. The Nordstrom-Hautelook deal, for example, is a combination of cash and stock worth up to $270 million.

Here are some retailers that haven't yet joined the fray but could become takeover targets:

Williams Sonoma (WSM): Most merchants report that home-related retail categories are still suffering the effects of a poor housing market. But Morningstar analysts singled out the parent of the kitchenwares chain and furniture retailers Pottery Barn and West Elm as an attractive target. Investors have gotten used to seeing nice stock upside from this company, which just approved a new stock repurchase program. And with wealthy consumers back spending in force and more confident than low-income shoppers, a play for an upscale retailer makes more sense than hitting up a discounter.

Barnes & Noble
(BKS): The "for sale" sign has been up on this door since last summer, as the family of founder and chairman Leonard Riggio and activist shareholder Ron Burkle fought for control of the bookstore chain. A merger with Borders Group was floated several times just before the rival bookstore went into bankruptcy. With its main competitor on the ropes, could another takeover try lie ahead?

OfficeMax (OMX): Takeover rumors have popped up occasionally as analysts have noticed the office-supply chain has a plenty of free cash flow, good real estate and an attractively priced stock compared to competitors Staples and Office Depot. OfficeMax took a hit to its stock in February when it warned that the year ahead will be tough (no surprise, when your customers include a large portion of small businesses) even as it announced earnings that beat estimates. Credit Suisse First Boston analyst Gary Balter singled it out as an attractive investment in the office supply market, which he noted isn't getting much love from investors, despite attractive stock valuations and cash flow.

Fred's
(FRED): This chain of discount stores operates mainly across the South. It doesn't generate the kind of free cash flow to attract a private-equity buyer, but could be a target for another retailer, Brian Sozzi, retail analyst at Wall Street Strategies, said in a note to investors. It has its own private-label brand and has been expanding pharmacy operations, which would make it attractive to a drugstore chain such as CVS Caremark (CVS) or Walgreen (WAG), which don't have a large presence in its markets, he said.

Private equity can be a catalyst for a deal in some situations, but all the retail companies are evaluating the opportunities right now, says Cohen.

"The last couple of years they weren't entertaining any of this. So in looking at where they are today, everyone is reemerging," he says. "Two Thousand Eleven is the new spring, where people are coming back out of the winter of recession."

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