April 29 (Bloomberg) -- Rue21 Inc., which sells tank tops and graphic tees to teenagers at affordable prices, is shaping up to be the next target after private-equity investments in retail reached the highest amount since before the U.S. recession.
As Rue21 plans to open its 1,000th store by the end of January and ultimately boost its U.S. presence to more than 1,700 locations, the chain is projected to more than triple its free cash flow this year, according to data compiled by Bloomberg. With Rue21’s lack of debt leaving room to finance a leveraged buyout, Piper Jaffray Cos. said private-equity firms could be tempted to offer as much as a 50 percent premium for the retailer.
“For private equity, it’s attractive,” Amy Hu Sunderland, a Hong Kong-based analyst at Grandeur Peak Global Advisors LLC, which owns shares of Rue21, said in a telephone interview. “They have very strong economics when it comes to their business and their financial model. It generates very strong free cash flows, which private equity tend to like.”
Rue21, based in Warrendale, Pennsylvania, would follow 38 private-equity deals last year for apparel and shoe retailers that reached $5.7 billion, the highest volume since the onset of the U.S. recession in December 2007, data compiled by Bloomberg show. The $739 million company, whose stores in regional malls and strip centers compete with low-priced clothing at Wal-Mart Stores Inc. and Target Corp., would be the industry’s latest target after the $600 million buyout of retailer Hot Topic Inc. last month.
Joseph Teklits, a spokesman for Rue21, said the company doesn’t comment on speculation.
Buyout firms’ appetite for retail deals increased in 2012 as the economy expanded 2.2 percent and consumer confidence also improved, said David Fann, chief executive officer of TorreyCove Capital Partners LLC, a San Diego-based firm that advises private-equity managers and investors.
That corresponded with the biggest influx of private-equity retail transactions since at least 2000 and the highest dollar amount of investment since 2007, according to data compiled by Bloomberg. Last year, Leonard Green & Partners LP acquired a 25 percent stake in the Topshop and Topman fashion chains and Clayton Dubilier & Rice LLC bought wedding gown retailer David’s Bridal Inc. for about $1.1 billion.
Buyouts of retailers may accelerate even more in 2013, according to Joshua Schachter, a money manager at Sewickley, Pennsylvania-based Snow Capital Management LP.
“Interest rates are very attractive for borrowing,” Schachter, whose firm oversees about $3 billion, said in a phone interview. “There’s a lot of cash on the sidelines from private equity that needs to be deployed.”
Retailers such as True Religion Apparel Inc., the maker of designer jeans that’s exploring options including a sale, and Rue21 may “ultimately fit the bill for the profile these companies are looking for,” he said.
Rue21’s 912 stores target girls and boys who want “to look and feel 21” with $10 t-shirts and $18 rompers. After emerging from Chapter 11 bankruptcy protection in 2003, the company held an initial public offering six years later. The shares are up 64 percent since that November 2009 IPO.
Apax Partners LLP, a London-based private-equity firm, is Rue21’s biggest shareholder with control of almost 30 percent of the stock. Apax has been invested in Rue21 since 1998, making it the firm’s oldest current investment, according to its website. Todd Fogarty, a spokesman for Apax, declined to comment on Rue21.
Rue21 is one of the three most attractive LBO targets among U.S. specialty retailers, Randal Konik, a New York-based analyst at Jefferies Group LLC, wrote in an April 25 research note, sending the stock up 4.6 percent. Based on assumptions including about a 30 percent premium and a minimum equity contribution of 25 percent, Rue21 would generate an internal rate of return for a private-equity buyer of 29 percent to 31 percent, he wrote. Aeropostale Inc. and Abercrombie & Fitch Co. were also highlighted.
Clothing chains appeal to private-equity suitors because they tend to have very little debt, generate free cash flow and often offer opportunities for margin improvement, said Jaime Katz, a Chicago-based retail analyst at Morningstar Inc.
“The economics of it make sense,” Katz said in a phone interview. “It’s very easy for them to just raise part of the deal in debt and then squeeze the business out and flip it and pay the debt down.”
Rue21 is poised to generate free cash flow of $49 million this year, the highest since its IPO, according to data by Bloomberg. Stephanie Wissink, a Minneapolis-based analyst at Piper Jaffray, said there’s also room for a buyer to improve the retailer’s margins. At 4.9 percent in the last 12 months, Rue21’s profit margin trails the 7.3 percent average among U.S. specialty apparel stores with market values of more than $500 million, the data show.
“I think private equity can take them out,” said Sunderland of Grandeur Peak, which oversees $750 million. “Most important is they have very good free cash flow.”
Bidders may offer $42 to $47 a share for the company, or as much as $1.1 billion, based on the multiples Sycamore Partners paid for Hot Topic, Wissink estimated. That’s as much as 51 percent more than the stock’s closing price of $31.11 last week.
Today, Rue21 gained 0.6 percent to $31.30 after earlier reaching its highest intraday level in more than six months.
One possible deterrent for a buyout firm could be questions about the value of Rue21’s brand, which is less popular than those of American Eagle Outfitters Inc. or Nike Inc., for example, she said.
Still, Rue21 offers expansion opportunities at a time when other retailers, such as Abercrombie, are shutting down locations, according to Wissink. Rue21 -- located in towns such as Moscow, Idaho, and Paris, Texas -- added more than 500 stores in the past five years and plans to open 125 more this year.
In small towns, “people are either shopping for their clothes at Wal-Mart or they’re shopping at Rue21,” she said. “Growth is scarce in the industry and so private-equity firms are looking for growth.”
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