Is Regis Corp. Buyout Bait?

Regis Corp. (RGS), which operates hair restoration centers and beauty salons, has hired Peter J. Solomon Company to "explore strategic alternatives." Management, it seems, is thinking of selling out.

In light of Regis's strong financials, a leveraged buyout is a reasonable option. The stock price is up 14% in today's trading on news of the hiring.

While the company, whose brands include Supercuts, Sassoon Salon, Regis Salons, MasterCuts, SmartStyle, Cost Cutters and Cool Cuts 4 Kids, generates nice cash flow, its stock price has suffered during the recession. Since 2008, shares of Regis have dropped from $31 to $18.

Frugal Consumers Put Off Hair Cuts

For the most part, Regis focuses on the value segment of the hair salon business, targeting shopping centers and neighborhoods. In light of the overall rise of consumer frugality, this appears to be a good strategy.

However, the business is somewhat discretionary. For example, consumers aren't making as many visits to Regis locations. The upshot is that the company's business has sputtered. In the most recent quarter, revenues fell by 5.6% to $590 million and same-store sales were off by 2.7%.

To steer through this, Regis has cut costs and rationalized its commission structure (keep in mind that the biggest expense item is labor). The company has also cut its store expansion and even raised prices so as to increase margins.

But such moves have not impressed investors. Instead, they want to see growth return. Unfortunately, this will probably take several years.

Why Go Private?

Even with stagnant growth, Regis has predictable annual cash flows of about $250 million. And because customers mostly pay by cash, the working capital requirements are fairly minimal. All in all, Regis should have no problem financing a going-private transaction.

What's more, private equity sponsors are likely to be attracted to some of the long-term trends. No doubt, the frequency of beauty salon visits is likely to increase as the economy picks up. Furthermore, Regis is going to start realizing returns from its U.K. operations.

The company also has a 55.1% equity stake in Empire Education Group, which is the largest beauty school operator in North America. For 2010, the revenues are forecasted to grow 12% to $170 million, with EBITDA of $20 million to $24 million.

Finally, Regis still has lots of opportunity for growth. Consider that the company has only 4% of the North American market. In other words, Regis can acquire smaller operators to bulk up. And, with the soft economy, valuations should be quite attractive.