Consensus Advisors: Eat Dog Eat
Through a special arrangement, presented here for discussion is a summary of a current article from Consensus Advisors, a boutique investment and advisory firm specializing in the retail industry.
Each Fourth of July, a select group of world class competitors gather at the corner of Surf and Stillwell Avenues on Coney Island for an epic nationally-televised battle: The Nathan’s Famous Fourth of July International Hot Dog Eating Contest. After fasting for a couple of weeks, these “gurgitators” come to the table anxious to devour wieners at a remarkable rate.
In a somewhat similar fashion, after a two-year self-imposed “fast,” investors have aggressively returned to the retail sector. The resurgence of interest has been driven by the return of deal-hungry private equity to the sector. Private equity firms, which had been very deliberate in its pursuit of buyout opportunities in the years following the financial crisis, are beginning to reassert themselves.
Two of the largest private equity players that led the buyout frenzy from 2005 to 2007 are now driving the resurgence. Leonard Green, which devoured, among others, Neiman Marcus, The Container Store, Petco and Sports Authority prior to the financial crisis, have purchased four household names — J. Crew, Jo-Ann Fabrics, 99 Cents Only Stores and BJ’s — in the past 12 months. Bain, which between 2005 and 2007 consumed entities such as Toy “R” Us, Guitar Center and Burlington Coat — and also participated in the buyout of Michaels — stepped up in late 2010 with the purchase of Gymboree.
One of the key investor attractions is that retailers have historically carried relatively low levels of debt. The net debt level in retailers has decreased even more in recent years, as retailers have stockpiled cash in lieu of store openings. The relatively low debt levels and high cash balances allow for the acquiring firm to layer on significant levels of debt to finance the acquisition, as opposed to more expensive and risky equity.
Private equity has patiently waited out the financial crisis but are anxious to aggressively get back in the game.
However, the retailers’ relatively high cash balances are also turning many into investors themselves. With the risk/reward relationship of opening new stores still skewed toward risk, retailers are looking for other ways to put their money to work. By pursuing M&A transactions, retailers are able to achieve cost-savings and synergies only available to strategic investors.
So, as more private equity pursue the next tier of retail deals, it is likely that they will compete against some of the larger retailers in the bidding war. As hot dog eating champion Joey Chestnut has demonstrated, it’s exciting to step up to a full plate with a true hunger and a desire to succeed.
Discussion Questions: What conditions for buyers and sellers make for a successful retail merger? What lessons should retailers have learned from past periods of heightened M&A activity?