American Eagle Ripe for LBO With Cash Flow Discount: Real M&A

American Eagle Ripe for LBO With Cash Flow Discount
American Eagle trades at 10.2 times its free cash flow, or cash from operations after capital expenses, which is cheaper than all U.S. retailers targeting teens, according to data compiled by Bloomberg. Photographer: Jin Lee/Bloomberg

For the discriminating private-equity shopper, there may be no better bargain in retail than American Eagle Outfitters Inc.

American Eagle, known for jeans and preppy shirts, trades at 10.2 times free cash flow, the cheapest among U.S. retailers that sell clothes to teenagers, and holds the most cash relative to its market value, according to data compiled by Bloomberg. While the Pittsburgh-based company has been reducing its inventory, the company still took longer to sell its merchandise last year than any period since 1995, the data show.

With no debt and Chief Executive Officer Jim O’Donnell departing, the teen retailer is ripe for a leveraged buyout because new owners could avoid fashion missteps and boost sales with international expansion and newer brands, according to Morningstar Inc. After losing ground to Abercrombie & Fitch Co.’s price cuts and discounted clothing at Hennes & Mauritz AB’s H&M brand and Forever 21 Inc., American Eagle has outgained specialty retailers this year as takeover speculation increased.

“Now would be the time to strike on this,” said Brian Sozzi, an analyst with Wall Street Strategies Inc. in New York who recommends buying the shares. American Eagle trades at “a nice discount to other teen apparel retailers for this type of brand that generates this type of cash. With some fresh eyes in there, I think it would make sense,” he said.

Jani Strand, a spokeswoman for American Eagle, declined to comment.

Cheapest Teen Retailer

American Eagle closed yesterday at 10.2 times its free cash flow, or cash from operations after capital expenses, which is cheaper than all U.S. retailers targeting teens, according to data compiled by Bloomberg. New York-based Aeropostale Inc. was valued at 14.7 times, Urban Outfitters Inc. in Philadelphia at

23.6 times and New Albany, Ohio-based Abercrombie at 29.5 times.

American Eagle was also lower than the median of 14.8 times for U.S. apparel retailers with a market value greater than $1 billion, data compiled by Bloomberg show.

The shares gained 32 cents, or 2 percent, to $15.99 on the New York Stock Exchange today.

The company, which has no debt, ended the fourth quarter with $734.7 million in cash and short-term investments after generating $381.2 million from operations last year. American Eagle’s net cash is equal to 24 percent of its $3.1 billion market value, the highest among U.S. retailers, as it spent less on real estate and renovations, said Linda Tsai, a Stamford, Connecticut-based analyst at MKM Partners.

Balance Sheet Fortress

“It’s natural for a company that generates so much cash flow to have speculation around it,” said Ashley Abney, an analyst for Louisville, Kentucky-based River Road Asset Management LLC, which owned about 930,000 shares as of Dec. 31. “Their balance sheet is a fortress.”

American Eagle surged 9.1 percent on Feb. 10 for the largest gain in almost two years on speculation it may be acquired. Citigroup Inc. in New York placed both teen retailers American Eagle and Aeropostale on a list of potential leveraged buyouts two days earlier.

The company had risen 9.3 percent this year through yesterday compared with a 1.9 percent gain for the 66-member Standard and Poor’s Supercomposite Specialty Retail Index.

This week, American Eagle CEO O’Donnell, 70, announced he’s retiring more than eight years after taking the job. Chairman Jay Schottenstein is leading the search, and a date hasn’t been set to hire a replacement.

Private-Equity Leadership

“Without a firm direction from the upper management, it could be a prime candidate for leadership under private equity,” said R.J. Hottovy, director of consumer research at Chicago-based Morningstar.

Any buyer would have to turn around a company that reported an 11 percent drop in same-store sales in December, even as holiday shopping in the U.S. rose the most in six years. Same-store sales surged 15 percent at Abercrombie as it used markdowns to win back shoppers who had shifted to buying cheaper wares at American Eagle and other chains during and after the recession. Increased competition coupled with fashion misses in women’s tops led to a 4.2 percent decline in American Eagle’s sales to $916.1 million in the three months ended Jan. 29.

“They continue to be viewed as the laggard in the industry,” said Wall Street Strategies’ Sozzi. “You can’t drive consistent sales and earnings by just selling pairs of denim.”

Net income has declined for three straight years to $140.7 million in fiscal 2011, about a third of its profit in 2008.

Inventory Turnover

Inventory shrank 7.7 percent last year, the first drop in seven years, as management tried to control merchandise stock to cope with the fickle teen retail market. Still, it took an average of more than 63 days to turn over its inventory last year, the most since it took about 75 days in the year ended January 1995, data compiled by Bloomberg show.

To spur growth, American Eagle is expanding aerie, a women’s lingerie line started in 2006, and 77kids, a children’s store begun in 2008, while reducing its namesake brand locations.

American Eagle may be an attractive takeover target because the shares don’t account for future sales growth from aerie and 77kids, said Jay Kaplan, a New York-based money manager for Royce & Associates LLC, American Eagle’s largest investor with

9.96 million shares, or 5.1 percent of the stock outstanding, at the end of December.

“The market is paying them for the current state of the business and the rest is kind of a free option,” Kaplan said.

Stock Decline

After declining 14 percent in the past year through yesterday, American Eagle was valued at about 5 times last year’s earnings before interest, taxes, depreciation and amortization, according to data compiled by Bloomberg, which includes net debt. The stock drop compared with a 15 percent gain for the S&P Specialty Retail Index.

“If a private-equity firm is going to come in and lever up the firm, you want one that generates a lot of cash to pay down that debt,” Morningstar’s Hottovy said. “At the same time, American Eagle looks fairly cheap on a fundamental basis. So that might attract financial buyers as well.”

Options traders are boosting bullish bets to the highest in almost seven years. The ratio of outstanding calls to buy the stock versus puts to sell has more than tripled since early January to 2.83 on March 8, the highest since April 2004.

American Eagle’s skew, a measure of prices for puts versus calls, tumbled to the lowest level in almost four years last month. Three-month puts 10 percent below the stock price traded

0.5 percent higher than the equivalent calls on Feb. 15, down from a 19 percent premium a year ago, the data show. The premium was 6 percent as of yesterday.

J. Crew Takeover

Interest in specialty retailers has gained steam since J. Crew Group Inc. announced in November that TPG Capital in Fort Worth, Texas, and Los Angeles-based Leonard Green & Partners LP would buy the New York-based chain for $3 billion.

American Eagle may fetch $20 to $24 a share, according to Morningstar’s Hottovy and MKM’s Tsai. That’s as much as 53 percent higher than yesterday’s price of $15.67.

A price tag in that range would be the equivalent of an Ebitda multiple between 6.9 and 8.6 times. Retail deals greater than $1 billion announced in the last 12 months were struck at a median 8.6 times Ebitda, data compiled by Bloomberg show.

An American Eagle buyout may be similar to Boston-based Bain Capital LLC’s takeover of Gymboree Corp. last year at 7.7 times Ebitda, including net debt, or J. Crew’s sale at 8.4 times Ebitda, Tsai said.

American Eagle is becoming more attractive after forecasting sales gains and cutting costs. Selling, general and administrative expenses as a percentage of revenue dropped 2.6 percentage points last quarter. The chain also said same-store sales will grow by a low single-digits percentage this year.

‘Pretty Cheap’

“It’s pretty cheap if you think about where some of these companies have been taken out,” River Road’s Abney said.

Elsewhere in mergers and acquisitions, Atlanta-based Cumulus Media Inc., a U.S. radio-station owner, offered to buy larger rival Citadel Broadcasting Corp. for $2.4 billion, excluding net debt, to expand its coverage and cut costs.

London’s Rio Tinto Group, the world’s second-largest mining company, raised its bid for Sydney-based Riversdale Mining Ltd. by 3 percent to A$3.9 billion ($3.9 billion) as share purchases by steelmakers threaten to scuttle the deal.

There have been 4,437 deals announced globally this year, totaling $430.8 billion, a 12 percent increase from the $386.2 billion in the same period in 2010, according to data compiled by Bloomberg.

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