Dressing Up the Stock with Brand New Takeover Talk
On 8/25/14, the Board of ANN INC. (NYSE-ANN) received a letter from Engine Capital LP and Red Adler LLC, collectively owning in excess of 1% S/O, urging the exploration of strategic alternatives. Engine and Red Adler believe that ANN is "deeply undervalued" and that shareholder value could be increased "substantially"; they believe ANN could be worth "between $50 and $55 per share to a third-party acquirer." The company responded that it "welcomes open communications with shareholders and values constructive input toward the goal of enhancing shareholder value." The ANN share price closed at $39.94 that day, a 6.4% increase over the prior day close of $37.52 and 8.3% higher than the prior 20 day closing average price of $36.89. Yesterday, it was reported that ANN had hired J.P. Morgan (NYSE-JPM) as investment banker; the stock closed at $41.87 (and traded close to $43/share intraday), up 4.8% from the prior day and ~16% in total over the prior two days. Last, we note that Golden Gate Capital owns 4.375M shares (9.6% S/O) with ~$36/share average price (per a 13D filed on 3/20/14); they purchased the entire position during 1Q14.
ANN has traded up to the $42/share peak reached a number of times in 2014, a price level that has been a ceiling over the last six months. Conversely, the stock has seen price support at a $36/share trough, a level which it strongly bounced off of last week on higher-than-average share volume. Based on a mid-range 30%-35% price premium, the price peak and trough support $54-$57 and $47-$49 per share takeover ranges, respectively. We are in the latter camp given the weakness in discretionary consumer spending, mixed results from established specialty apparel retailers, challenges from the ongoing shift from bricks-and-mortar locations to online purchases and potential limitations from purchasing and overhead savings. An acquisition by a private equity firm is more likely than a strategic buyer. Mergers of similar specialty apparel retailing concepts, such as the recent acquisition of Jos. A. Bank Clothiers, Inc. (JOSB) by The Men’s Wearhouse Inc. (NYSE-MW), are an exception rather than a rule; the large price premium and double-digit EBITDA multiple was driven by savings/synergies (unusual for apparel industry deals). Golden Gate owns the parent company of Eddie Bauer; JOSB signed a DA to acquire the brand but the deal was terminated when the MW acquisition was announced. We view the ANN shareholder activists, with their immaterial equity position, as being a vocal public proxy for the current silence of Golden Gate, the largest ANN holder.
Our current takeover valuation for relatively mature specialty apparel retailers are forward multiples of 7.5x-8.5 EV/EBITDA and 18x-20x P/E. A standardized analysis can be a little tricky given the seasonality of revenues, impacts of unseasonal and/or unusual weather impacts, the specific target audience and the ebb and flow of consumer confidence and spending. The J. Crew Group, Inc. going private transaction (announced late-2010, completed March 2011), had a $2.9B deal value and $2.65B EV (net of cash); the forward multiples were 8.6x EV/EBITDA ($305M, 16.5% margin) and 19.2x P/E ($2.26 EPS). ANN has a gyrating EPS consensus forecast, with fiscal year numbers projected to decline 10% this year but rebound 19% next year (with the truth probably being somewhere in between). Applying the JCG multiples to ANN FY15E $271M EBITDA (10.6% margin, -2.0% YoY) and $1.99 EPS (-9.1% YoY) implies takeover values of $54 and $38 ($46/share mid-point), respectively. The same multiples to CY15E $294M EBITDA (11.1% margin, +18.7% YoY) and $2.35 EPS (+19.3% YoY) implies takeover values of $45 and $58 ($52/share mid-point), respectively. As a leveraged buyout candidate, ANN provides the benefits of no debt (other than future lease obligations) and $150M cash (as of 8/2/14). The company has beaten EPS consensus the last ten quarters, but YoY EPS was down 8% last quarter and 24% the prior one. We believe that on a standalone basis, the uncertain near term growth potential should reflect ANN CY15E valuation multiples of 5x-6x EV/EBITDA ($35-$42/share) and 14x-16x P/E ($33-$38/share).
Over the past three years, the company has been actively managing the retailing operation by limiting the growth of Ann Taylor stores in shopping malls and reducing the retail footprints while more rapidly expanding the number of Loft stores as well as increasing factory and outlet store locations for both concepts. The ~11% EBITDA margins at ANN are roughly inline with Chico’s FAS, Inc. (NYSE-CHS), a specialty woman’s retailer (four store brands) with good merchandising and fairly efficient operations, and there may not be much upside from potential improvements. An alternative suggested by Engine and Red Adler is a leveraged recapitalization ($40/share financed with $600M debt or ~2.0x EBITDA leverage) to buyback one-third of S/O. This conceptually may seem like a good idea but realistically is a non-starter as debt leverage and specialty apparel retailing generally do not mix well. Uninterrupted access to vendor credit is what keeps inventory in the stores and the flexibility to markdown sale prices on a timely basis. Golden Gate would likely not tender shares into any buyback and its ownership position could increase to ~14% S/O; ANN does not currently have a shareholder rights plan. ANN announced a $250M open market share buyback in August 2013; it repurchased $50M of shares in the past quarter. Last, ANN is incorporated in Delaware and has a staggered Board (8 directors, 3 classes); the last annual meeting was held in May 2014 and shareholders do not have the right to call a special meeting.
Unless Golden Gate chooses to get involved in the activist process, Engine and Red Adler will likely continue to be the mice that are roaring; they will probably be viewed as pipsqueaks by the ANN Board unless something more substantive is put on the table (such as a fully finance proposal from a qualified acquirer). Otherwise, the activists have done a fine job near term pointing out that the stock may have become oversold, trading at relatively inexpensive fundamental valuations based on expected financial improvements in the upcoming quarters.