The Next Fashion Victim: Investors?

Recent deals for apparel makers have pushed prices to worrisome levels

Tommy Hilfiger is hot again, and it's not because of his red, white, and blue ensembles for the back-to-school set. No, this time the buzz is that the company itself may soon go on sale. Although no deal has yet hit the market, rumors of an auction soon after Labor Day have helped push the stock up 38% in August.

Hilfiger's no fashion leader, however. When it comes to mergers and acquisitions, clothes companies are all the rage. That has some smart investors worried that prices are getting too high. "It's a buying spree that doesn't seem to have a whole lot of pricing discipline," says Liz Claiborne Inc. (LIZ ) CEO Paul Charron, a longtime acquirer who has done only two deals in the past two years, despite actively looking. "We see many overvalued properties on the market."

And prices just keep getting higher. James P. Fogarty, a managing director at restructuring advisers Alvarez & Marsal Holdings LLC and former CFO of apparel maker Warnaco Group Inc. (WRNC ) and Levi Strauss & Co., says prices on recent deals have come in at a multiple of cash flow that's roughly 20% higher than what companies fetched just a few years ago. Investment bankers say some of the richest deals have closed at values as high as 15 to 16 times earnings before interest, taxes, depreciation, and amortization, or EBITDA, a common proxy for corporate cash flow. That's twice what public apparel makers command.


That might not be so worrisome if the sector itself weren't weakening. Marshal Cohen, chief industry analyst for NPD Group Inc., expects clothing sales to grow 2.9% this year. But he thinks even that modest rate will slow as consumers snap up electronics over fashion and gas prices hit home.

Few apparel companies are as vulnerable as Hilfiger. Revenue from its U.S. wholesale business, most of it with department stores, dropped 29% to $684 million last year and is expected to fall another 30% this year. Hilfiger is further threatened by Federated Department Store Inc.'s (FD ) pending deal to buy May Department Stores Co. (MAY ) and close 68 stores in 2006. Nor will clothing manufacturers be helped by Federated's expected expansion of its successful and high-margin private-label brands, including Inc. and Alfani, onto May's floor space. "I think Tommy's going to be a hard sell," says Maggie Gilliam, a former Wall Street analyst who runs consulting firm Gilliam & Co.

Caution aside, the run on fashion seems likely to continue. For one thing, suppliers hope that by bulking up, they can regain leverage on pricing with their now much bigger retail customers. Another reason: Private equity funds, which are flush, are in need of places to put their cash. In 2004 and the first half of 2005, such funds have raised $88 billion, according to Thomson Venture Economics (TOC ).

These funds are looking to apparel makers because of their low debt levels, modest capital-investment needs, and high margins, says Paul Altman, a vice-president of Sage Group LLC, a Los Angeles investment bank specializing in consumer brands. In one recent deal, Altman says, he had bids from six interested buyers, though only five had even talked to company management.

Such fevered competition worries long- time apparel investors. Bear Stearns Merchant Banking (BSC ) has done quite well on a number of retail investments including Aéropostale Inc. (ARO ), whose stock is up 34% since its 2002 initial public offering. It recently took a stake in 7 for All Mankind, a fashion jeans maker. But partner Bodil Arlander says that the $1.5 billion fund probably won't want to pay the price Hilfiger might fetch.

For Hilfiger, this may be a smart time to sell out. But if investors are tempted, they should be careful. Like that pricey shirt you just can't resist at the store, it may soon seem like it wasn't worth all that money.

By Nanette Byrnes in New York

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