Kenneth Cole Lowballing Kenneth Cole Means 20% Markup: Real M&A

Kenneth Cole Productions Inc. CEO Kenneth Cole
Kenneth Cole Productions Inc. Chief Executive Officer Kenneth Cole. Photographer: Stephen Yang/Bloomberg

Merger arbitragers are convinced Kenneth Cole Productions Inc. isn’t as cheap as its namesake founder contends.

The shoe and clothing retailer has traded above a $15-a-share offer every day since the 57-year-old chairman announced the management-led buyout last week. After the New York-based company lost almost half its market value in the past five years, the proposal valued Kenneth Cole at 3.7 times its estimated earnings before interest, taxes, depreciation and amortization, according to data compiled by Bloomberg.

A deal at that price would be the U.S. apparel industry’s cheapest takeover as analysts project a rebound in profitability from an all-time low. Cole, who owns 47 percent of the company and needs majority approval from its remaining shareholders, will probably raise his bid to win enough votes, WallachBeth Capital LLC said. Kenneth Cole is worth almost 20 percent more using historical premiums, a price that still lets Cole take the retailer private at a discount to the median Ebitda multiple.

“The market is saying, ‘Kenneth, you have to sweeten this deal in order for us to go along,’” Steven Marotta, an analyst at CL King & Associates in Albany, New York, said in a telephone interview. “Based on what their projections are for the back half of this year, is it possible they are getting a crazy, unbelievable valuation for the company at $15? Yes.”

Lisa Hellman, a spokeswoman for Kenneth Cole, said that Cole declined to comment beyond the Feb. 24 statement when asked whether he intends to increase his offer.

40-Foot Trailer

Shares of Kenneth Cole, which today reported fourth-quarter earnings that exceeded analysts’ estimates, advanced 1.3 percent to a 16-month high of $15.90 in New York.

Cole started his business in midtown Manhattan three decades ago, in a 40-foot trailer he had borrowed from a friend, according to the company’s website.

The designer, who couldn’t afford to rent space for a showroom, obtained a parking permit for his mobile shoe store by adding the word “productions” to the company’s name and posing as a film crew shooting a movie called “The Birth of a Shoe Company,” using models as actresses. Today, Kenneth Cole sells everything from men’s cologne, watches and messenger bags to women’s high heels and swimwear in its own outlets and in department stores including Macy’s Inc. and Nordstrom Inc.

Shares of Kenneth Cole, which climbed to a record of almost $50 each in 2000, had sagged 45 percent in the past five years as rising costs and the worst recession since the Great Depression left the retailer mired in its deepest earnings slump since going public almost two decades ago.

Arbitrage Bet

The company earned less than a penny for each dollar of sales in 2010 after generating an operating profit margin of 15 percent at its peak, according to data compiled by Bloomberg.

During the financial crisis, Kenneth Cole incurred losses on every dollar of revenue.

On Feb. 24, Kenneth Cole said that it received a takeover proposal from Cole, who is also the chief creative officer, which valued the entire company at $274 million. The bid was 18 percent higher than Kenneth Cole’s stock price in the 20 days prior to the announcement, the data show.

Shares of the company surged past the deal offer to $15.49 on the day it was announced and ended at $15.69 yesterday, or 4.6 percent above the value of Cole’s proposal. That indicates traders who profit from acquisitions are betting a higher offer will emerge, according to data compiled by Bloomberg.

“To buy it here, you’ve got to believe he’s going to raise it,” said Eric Sacks, a special situations analyst at Oscar Gruss & Son Inc. in New York. “Often the initial bid is not the final bid. There usually is some further negotiation.”

‘Very Powerful’

Cole’s current bid values Kenneth Cole at 3.7 times the $30.6 million in Ebitda that analysts project the company will generate this year, according to data compiled by Bloomberg.

That’s less than half the median multiple of 8 times for U.S. apparel takeovers based on reported earnings.

CL King’s Marotta says the retailer can command a higher price as its operating margin recovers. Analysts estimate the company’s margin increased to 2 percent in 2011 and will double to 4.3 percent this year, data compiled by Bloomberg show. In 2013, it will exceed 5 percent.

“When you look at it from a trailing standpoint, you’re looking at highly depressed earnings,” he said. “As business improves, particularly from low operating margins to moderate operating margins, that’s very powerful on the bottom line.”

Cole’s ownership stake gives him a disproportionate influence on the process, which limits the ability of minority shareholders to seek competing offers, according to Sam Poser, an analyst at Sterne Agee & Leach Inc. in New York.

Controlling Interest

The founder owns Class B stock, which entitles him to 10 votes for every share held, data compiled by Bloomberg show.

That means he controls 89 percent of Kenneth Cole’s votes, according to a Feb. 24 filing with the U.S. Securities and Exchange Commission.

“No other company can step in and make him do anything,” Poser said. “Kenneth has controlling interest, so he’s going to make this deal happen the way he wants to.”

Apparel takeovers in the U.S. have historically been announced at an average premium of about 38 percent, according to data compiled by Bloomberg. That implies an offer price of almost $18 a share for Kenneth Cole and an Ebitda multiple of 4.6 times this year’s estimates, which is still 43 percent less than the industry median, the data show.

“Of course he has room to bump it,” Yemi Oshodi, New York-based managing director of M&A and special situations trading at WallachBeth, said in a telephone interview. “The way most arbs are trading this and looking at it is that he’s probably going to bump it.”

Before it's here, it's on the Bloomberg Terminal. LEARN MORE