Wet Seal Drawing Buyer as Activist Bristles at Value: Real M&A

Wet Seal Inc., the U.S. chain that sells tank tops and denim leggings to teen girls, stands to boost the lowest retail valuation in America by giving in to an activist shareholder’s push for a sale.

The company, which fired Chief Executive Officer Susan McGalla last month after only a year and a half on the job, was valued yesterday at 2.9 times earnings before interest, taxes, depreciation and amortization, according to data compiled by Bloomberg that includes net cash. That’s cheaper than any U.S. specialty-apparel chain with a market capitalization of more than $200 million, the data show.

Clinton Group Inc., which owns a 4.8 percent stake in Wet Seal and may push to remove the board, said the company’s “right next step” should be to seek a buyer that can revive the chain after four quarters of same-store sales declines. With attractive store locations, zero debt, and cash and equivalents equal to 57 percent of its market value, Wet Seal may appeal to private-equity suitors, according to Snow Capital Management LP. The Foothill Ranch, California-based company could fetch at least $5 a share in a takeover, Clinton Group and Roth Capital Partners LLC said, a 75 percent premium.

“This is a turnaround that is taking too much time,” Jessica Bemer, a senior research analyst at Sewickley, Pennsylvania-based Snow Capital, which oversees $2.7 billion including Wet Seal shares, said in a telephone interview. “It is not out of the question that private equity could come in and make something out of it. You have a very nice margin of error with that balance sheet and some of those assets.”

Steven Goldberg, a spokesman for Wet Seal, said the company wouldn’t comment on whether it would consider a sale.

Targeting Teens

Incorporated in 1990, Wet Seal operates 550 women’s clothing stores in the U.S. and Puerto Rico under the Wet Seal and Arden B names, according to its most recent monthly sales statement. Wet Seal outlets target teen girls and young adults, while Arden B is geared toward women aged 25 to 39.

The company, which boosted same-store sales as much as 45 percent in fiscal 2006, posted four consecutive quarters of declines through July as it struggled to lure shoppers amid competition from chains such as Hennes & Mauritz AB’s H&M and Forever 21 Inc. Wet Seal also is on pace to post its first annual loss since 2007, according to analysts’ estimates compiled by Bloomberg.

“There has been a lack of management consistency and a lack of merchandise direction,” Stephanie Wissink, an analyst at Minneapolis-based Piper Jaffray Cos., said in a phone interview.

Share Slump

Shares of Wet Seal, which peaked a decade ago at $25.73, slipped 39 percent in the past year to close at $2.85 yesterday. That compares with a 14 percent gain in the Russell 2000 Consumer Discretionary Index during the same 12-month period.

Today, Wet Seal rose 2.8 percent to $2.93 after earlier gaining as much as 4.7 percent.

Clinton Group began accumulating a position in the company in recent months, building its stake to 4.8 percent, according to Joseph De Perio, a senior portfolio manager at the New York-based firm, which oversees more than $2.7 billion.

In mid-June, De Perio sent a letter to Wet Seal’s board criticizing the company’s slumping shares and underperformance relative to peers.

The board in early July said it was conducting a review of its capital plan, including its use of cash and operating performance. It fired McGalla later in the month.

Then, De Perio said in a July 23 letter to the board that it should hire an investment bank and seek a sale.

“We suspect there are more than a few potential buyers that will be confident of their ability to use Wet Seal’s substantial asset base to create a steady and valuable earnings stream,” he said in the letter.

Strategic Review

Clinton Group estimates Wet Seal could fetch a price of $5 to $8 a share from a buyer.

De Perio said the firm declined to comment beyond its correspondence with the retailer. Wet Seal on July 30 said that it is “considering all options” to enhance shareholder value and is developing a strategic plan to be released on Aug. 21.

Including net cash, Wet Seal was valued yesterday at 2.9 times Ebitda, the lowest among U.S. specialty-apparel retailers with more than $200 million in market capitalization and less than half the industry median of 6.1 times, according to data compiled by Bloomberg. It traded at a 58 percent discount to sales, less expensive than 90 percent of peers, the data show.

New Vision

“You have a relatively cheap valuation,” Eric Beder, a New York-based analyst at Brean Murray, Carret & Co. LLC, said in a phone interview. A financial firm “could buy it, take their vision with the company and run it without having to worry about satisfying a prior CEO. There could be a very exciting private-equity transaction where they could take it public again as a growth story.”

Liz Pierce, a Newport Beach, California-based analyst at Roth Capital, said a buyout firm could be attracted by Wet Seal’s strong balance sheet and room for operating improvement. The company’s niche in the teen market and 468 Wet Seal chain stores could also attract an acquirer willing to turn the company around, Pierce said.

Wet Seal’s $148.11 million in cash and cash equivalents are equal to 57 percent of its market value, the highest among its U.S. peers, according to data compiled by Bloomberg. Its operating margin of 3.12 percent is less than a third of the group’s average, the data show.

Good Opportunity

“You’ve got a great balance sheet,” Pierce said. “It gets back to the picture of the market share, the potential, good real estate, and you have the opportunity to improve margins.”

Wissink at Piper Jaffray said private-equity firms may not have much to build on after prior management struggled to define Wet Seal’s look, and as customers become more cost-sensitive.

“Is there actually brand value?” she said. “A financial buyer would have to have some confidence that there is going to be value. It would have to reemerge into the public market in a different way or the brand would have to have some value in a different category. That is the thing that I am less convinced about.”

Still, with Wet Seal trading at 1.07 times book value, the lowest for a U.S. chain, an acquirer not wanting to run the chain could “just decouple the business and sell the pieces,” Wissink said. “You’ve pretty much covered your investment.”

Snow Capital’s Bemer says the company’s competitive struggles may not be as much of an impediment for a buyer, given the potential for new management to remake the brand.

“The ability for brands to renew themselves over time is unique in the specialty-retail area,” Bemer said. “More so than other parts of the market, a company can come in and change their look overnight, or in a season or two. We’ve seen it before. It’s not easy, but it’s possible.”

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