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J. Crew Women's Spring 2011 Photo By Kyle Ericksen |
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Millard “Mickey” Drexler Photo By: Courtesy Photo |
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Posted WEDNESDAY NOVEMBER 24, 2010
From WWD ISSUE 11/24/2010
Millard “Mickey” Drexler may have just fired the starting gun for a new and potentially transformative round of industry dealmaking.
By joining with private equity firms TPG Capital and Leonard Green & Partners in a $3 billion buyout of J. Crew Group Inc., Drexler is also readying the company for expansion and giving its new concepts like Madewell and Crewcuts a chance to mature away from Wall Street scrutiny.
Under terms of the deal signed Tuesday, Drexler will remain chairman and chief executive officer and keep his equity stake in the business, which is currently 5.4 percent. Stockholders will be paid $43.50 a share — a 15.5 percent premium over Monday’s closing price but still below the more than $50 the stock sold for in April.
Investors pushed up J. Crew shares 16.8 percent Tuesday to $43.99, as the S&P Retail Index slipped 0.8 percent, or 3.74 points, to 484.47, and the Dow Jones Industrial Average, conscious of European debt concerns and new hostilities on the Korean peninsula, fell 1.3 percent, or 142.21 points, to 11,036.37.
The retailer will consider other offers until Jan. 15. If nothing better materializes and shareholders give the thumbs-up, the deal, which was first reported by The New York Times, is expected to close in the first half.
“We are in this for the long term, and we do what we do day in and day out so we can deliver the best possible products to our customers,” Drexler said Tuesday.
Private equity firms flush with cash have been circling retail properties, which were forced to get leaner because of the recession and are inviting acquisition targets because of relatively low stock prices.
“This is the start of the trend we’ve all been waiting for,” said David Bassuk, managing director at AlixPartners’ retail practice. “The news has always been, the private equity players are swirling around, watching what’s going on. This is the story of them putting their money to work.”
The holiday season could single out the best retail opportunities and lead to a “very active” round of mergers and acquisitions in the first quarter, Bassuk said.
“You will see more retail deals in the $1 billion to $3 billion range,” said David Shiffman, investment banker and managing director at Miller Buckfire & Co. “At that size range, large-cap and midcap [private equity] firms can put significant capital to work. In addition, strategic acquirers are building large cash balances and will use M&A for growth.”
The economic downturn set the stage for deals that are now coming to fruition. In addition to J. Crew’s pending buyout, Bain Capital Partners completed its $1.8 billion acquisition of The Gymboree Corp., which closed Tuesday.
“We’re going into 2011 with some tailwinds,” said Arash Farin, an investment banker at The Sage Group, noting overall holiday sales are expected to rise modestly. “There’s a lot of private equity money that is looking for new deals.”
The M&A machinery virtually shut down for a time during the depths of the recession and money piled up, leaving some private equity firms to choose between spending it or giving it back to their investors. McKinsey & Co. estimated private equity firms have about $100 billion to spend on retail.
Faced with consumer apathy because of the recession, retailers found religion of sorts and cut costs and inventories, becoming the tight operating machines they always claimed to be.
But something more fundamental might also be going on.
Marc Cooper, managing director at Peter J. Solomon Co., said J. Crew is a bit of an outlier in that it is a sizable retailer with “some interesting growth potential.” Other established retailers that could get taken private are becoming “cash generators” with fewer prospects for growth, he said.
It’s the maturing of the retail industry,” Cooper said. “It’s the overstored nature of retail in the U.S. How do you create value for shareholders?”
One option is the leveraged buyout, where an investor uses borrowed money to buy a company at a premium and then takes cash generated by the business to pay down that debt. Cooper said the signs of a maturing sector can also be seen in dividend payouts, share repurchases and the activities of activist investors.
Public companies also tend to chafe under the glare of analysts and quarterly reporting requirements, and Drexler, who was ceo of Gap Inc., knows how complications multiply as companies grow and are pressured to keep on growing.
“What Drexler is capable of is taking [the J. Crew] brand and making it an affordable Ralph Lauren, and I think that’s brilliant,” said Les Berglass, chairman of executive search firm Berglass+Associates.
Drexler will need to add to his management team as the company grows, Berglass said. “He needs both merchandise support to execute his dream and operations support to guarantee his profit,” he said.
“As a private equity business, they can aggressively ramp up smaller concepts without worrying about the drag on earnings,” said Eric Beder, analyst at Brean Murray Carret & Co.
“The Street doesn’t have much patience” for the nurturing of new businesses, Beder said, describing the deal as a “growth LBO.”
“There’s still significant growth opportunity with J. Crew stores, there’s international and there are the new concepts,” he said. “These are the drivers that the Street is ignoring now.”
Although Drexler’s place in the “new Crew” is secure and his reputation sterling, the deal arrives at one of the weaker moments in his seven-year tenure as ceo. On Tuesday, the firm reported that its profits for the third quarter ended Oct. 30 fell 13.8 percent to $37.8 million, or 58 cents a share. Although better than the 54-cent consensus estimate, it was well below the 71 cents that analysts had expected before J. Crew, in August, steered the market to an EPS range of between 55 cents and 60 cents for the three months.
In the third quarter, total revenues were up 3.7 percent to $429.3 million. Gross margin receded to 43.5 percent of sales from 48.4 percent in the third quarter of 2009. Full-year EPS guidance was cut to a range of $2.08 to $2.13, down from the $2.25 to $2.35 earlier projected.
Although Crew shares were already down from their 52-week high of $50.96 — reached on April 26, the same day the S&P Retail Index peaked at just below 500 — the pessimistic view outlined in August limited their recovery. On Monday, before word of the buyout had circulated, they closed at $37.65, up $1.16.
On the conference call, Drexler pointed to pockets of strength in the business, such as men’s, Madewell, Crewcuts, accessories and the factory outlets. “The softness is primarily isolated to our women’s retail and direct business,” he said.
The ceo said J. Crew had “momentum in key businesses that hold large potential for further square footage growth.”
Madewell just opened its 20th store in Washington’s Georgetown section last week, Drexler said, and the company is “actively pursuing new store opportunities in key markets” with the plan to open another 10 to 15 units next year.
In the third quarter, J. Crew posted $1 million in losses associated with this start-up business, versus $3 million in losses last year, according to chief financial officer Jim Scully. For the full year, the division is expected to lose $10 million, less than the company’s earlier projection of a $13 million loss.
Drexler also pointed to the success of the company’s recently opened men’s stores on Madison Avenue in New York and in Copley Place in Boston, as well as the wedding and collections store in Manhattan. He called the wedding store “a long-term roll-out opportunity in key markets.”
Turning to Crewcuts, he said “really healthy growth” in stores and online also warrant the addition of more stand-alone stores.
This would be TPG’s second round as a J. Crew owner. It acquired 88 percent of the company in 1997, sold most of its stake when J. Crew went public in 2006 and only sold off the final pieces of its investment last year.
