Payless Shoes Poised for Buyout at 76% Sales Discount: Real M&A

Payless Shoes Poised for Buyout at 76% Sales Discount
Shoes sit on display at a Payless ShoeSource store in New York. Photographer: Daniel Acker/Bloomberg

Collective Brands Inc., owner of the Payless ShoeSource chain, may lure private equity buyers as it trades at a 76 percent discount to its sales.

Collective Brands, which is reviewing “a full range” of plans to bolster shareholder value after falling 36 percent this year, has a price-to-sales multiple that’s cheaper than 96 percent of U.S. apparel and shoe retailers greater than $500 million, according to data compiled by Bloomberg. While the Topeka, Kansas-based company has the most debt relative to earnings in the industry, revenue is projected to climb to a record this year and next.

The company’s same-store sales have dropped for four straight years as Payless customers cut back on spending amid the highest unemployment rate since 1983. While Collective Brands’ debt may deter some buyers, a leveraged buyout firm would get wholesale brands from Saucony to Sperry Top-Sider that Morningstar Inc. estimates are worth $1 billion, more than the $813 million market value of the entire company as of last week.

“It’s definitely a cheap stock right now,” Paul Swinand, an analyst for Morningstar in Chicago, said in a telephone interview. “For somebody to want the core Payless business they would need to have a strong stomach for turnarounds, which is why it makes more sense for a private equity buyer. In order to make money you need to take risk, and to me, the risk-reward here is not bad.”

The board of directors, along with advisers Perella Weinberg Partners LP and Kurt Salmon, will explore strategic and financial alternatives to boost shareholder value, Collective Brands announced Aug. 24.

Stride Rite, Keds

Mardi Larson, a spokeswoman for the company, declined to comment on the review process or the potential for a sale beyond the August statement.

The company operated 4,455 Payless ShoeSource stores as of July 30. The retail outlets in the U.S. brought in about $2.1 billion in sales in the year ended in January, or 61 percent of total revenue. Collective Brands’ wholesale business supplies shoe brands, including Saucony, Sperry Top-Sider, Stride Rite and Keds, to other retail stores and made up 19 percent of sales.

Before interim Chief Executive Officer Michael Massey announced the strategic review, Collective Brands had fallen 51 percent this year before today, compared with a 7.3 percent drop in the 66-company Standard and Poor’s Midcap Consumer Discretionary Index. The shares were down 36 percent for the year through Sept. 16, valuing the company at 0.24 times revenue of $55.77 a share in the last 12 months, data compiled by Bloomberg show. That multiple is the cheapest of any U.S. apparel or footwear retailer with a market value greater than $500 million, the data show.

CEO Resignation

Collective Brands rose 44 cents, or 3.3 percent, to $13.86 today. The stock posted the second-biggest gain in the S&P Midcap 400 Index.

Matthew Rubel resigned as chairman and CEO in June following four straight years of declines at stores open at least a year.

A U.S. unemployment rate averaging 9 percent this year is forcing families to restrain spending with economic growth deteriorating two years after the longest recession since the Great Depression ended. Luring customers in the wake of the downturn has been the biggest challenge for Collective Brands, which targets price-conscious consumers in urban areas, according to Morningstar’s Swinand.

Lower Spending

“The customer that you’re catering to, they’re not buying as much at this time,” Kevin Roche, a fund manager who helps oversee about $6.5 billion for Penn Capital Management Co. in Philadelphia, said in a telephone interview. “People are worrying about what the next week will bring, so they’re going to be spending less. That’s what makes this model difficult.”

Roche’s firm owned about 140,000 shares of Collective Brands as of June 30 and sold the stake after management announced the strategic review.

Collective Brands, facing competition from shoe departments at discount retailers such as Target Corp. and Wal-Mart Stores Inc., is closing 475 underperforming Payless and Stride Rite stores in the next three years, more than 300 of which will be shut by January, the company said last month. That means shuttering about 10 percent of its locations.

The market capitalization of Collective Brands, which changed its name from Payless ShoeSource Inc. in 2007 after acquiring Stride Rite Corp., has declined 71 percent since reaching a peak of $2.8 billion in 1998, data compiled by Bloomberg show. The market value of $813 million as of Sept. 16 is half the $1.6 billion, or as much as $27 a share, that Morningstar’s Swinand estimates the company is worth based on a sum-of-the-parts valuation.

Sum of Parts

The wholesale business alone may be worth about $1 billion, based on a multiple of 12 times estimated earnings before interest and taxes in 2012 for the unit, Swinand said.

Collective Brands’ combined businesses may be worth $18 a share to $25 a share, Dorothy Lakner, an analyst at Caris & Co. in New York, estimated in an Aug. 25 note to clients. That represents an equity value of $1.1 billion to $1.5 billion, she wrote.

While a financial buyer could boost a profit margin of 0.9 percent in the last 12 months that’s worse than 93 percent of retailers in its industry, the company’s $427.3 million in net debt might discourage a bid from a private equity firm that would need to borrow more money to finance an acquisition, according to Susquehanna International Group LLP’s Chris Svezia.

Balance Sheet

Collective Brands already has 3.3 times more debt than earnings before interest, taxes, depreciation and amortization in the last 12 months, the highest ratio among U.S. apparel and shoe retailers greater than $500 million, data compiled by Bloomberg show.

Private equity firms may prefer companies with stronger balance sheets, Svezia, a New York-based analyst for Susquehanna, said in a telephone interview. Teen retailer American Eagle Outfitters Inc. of Pittsburgh, which was listed among Morningstar’s top takeout candidates in a Sept. 14 report, had $514 million in net cash last quarter, the data show. Guess? Inc., a Los Angeles-based clothing chain with $416 million in net cash, also made the Morningstar list.

“You’re buying something with a net debt position, not a net cash position,” Svezia said. “I’d be hard-pressed to imagine that, with all the possible retail companies up for grabs, Collective Brands would float to the top of being most attractive to private equity.”

Private Equity Scenarios

Collective Brands is rated B1 by Moody’s Investors Service, four levels below investment grade, and the equivalent B+ by Standard & Poor’s. Based on Bloomberg’s Company Credit Ratings, which analyze borrowers based on indebtedness, market value, profitability, volatility and other financial ratios, the company has a B2L credit rating, three levels below investment grade.

One option would be for a buyout firm to acquire the entire company and then divest the wholesale business to raise cash and improve the balance sheet, Svezia said. Another scenario may involve the company breaking itself up, then selling its brands off to industry buyers and the Payless retail business to a leveraged buyout firm, Morningstar’s Swinand said.

Private equity buyers may include Leonard Green & Partners LP and Bain Capital LLC because they’ve bought retailers in need of a turnaround in the past, he said. Leonard Green of Los Angeles and Sports Authority Inc.’s management took the company private in 2006, the same year Boston-based Bain Capital bought Burlington Coat Factory Warehouse Corp.

Boat Shoes

Michael Gennaro, chief operating officer at Leonard Green, and Alex Stanton, a spokesman for Bain Capital, didn’t respond to telephone calls and e-mails requesting comment.

Collective Brands’ Sperry Top-Sider boat shoes and Saucony running sneakers are the company’s most attractive and fastest growing brands, according to Susquehanna’s Svezia. The international Payless segment has also been outperforming the U.S. division, Swinand said.

While U.S. sales rose less than 1 percent last year, international revenue -- predominantly from Payless retail stores and franchises in South America, Canada and Central America -- increased 12 percent to about $590 million. That unit made up more than 17 percent of total revenue.

“They have some plum assets,” Svezia said. “There’s still potential for growth.”

Even with its budget-strapped customers struggling amid an uncertain economic recovery, Collective Brands’ total revenue is projected to climb 2.2 percent to a record $3.45 billion this year and $3.51 billion next year, based on analysts’ estimates compiled by Bloomberg.

“A strategic review doesn’t mean you’re going to have a buyer pounding at your door,” said Roche of Penn Capital. Still, “the company is definitely cheap. It would be an attractive investment for someone,” he said.

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