Catalog IPOs: Wait For A Sale

You know Harry and David? Sure you do, especially this time of year when your mailbox fills with catalogs featuring pears, five pounds for a mere $25.95. Not as arresting as a flock of angels from Victoria's Secret. Yet at the holidays, a membership in the Fruit-of-the-Month Club might be a perfect gift for Aunt Ida.

Harry & David Holdings (HND ) has been shipping gift baskets since 1934, when founders Harry and David Rosenberg branched out from their Medford (Ore.) orchards. This holiday season, however, the company isn't only selling fruit. It also is preparing to sell part of itself in an initial public offering. The deal faces competition, as another familiar cataloger, J. Crew Group (JCG ), is coming public, too. Neither offering has reached the point where the sellers estimate how much they hope to fetch for a piece of their action, and executives at both companies are keeping quiet before their IPOs. Just the same, their securities filings are full of details about their financial positions and prospects for their businesses. Here's how I size up each:

Harry & David. In the year since a pair of private-equity funds took over in June, 2004, Harry & David has enjoyed nice jumps in total sales (8.4%) and operating income (95%), the latter driven by trimming the workforce and other costs. The company also operates 135 retail outlets, where comparable-store sales accelerated impressively, 8.7% vs. 1.7% the year before. Sales at its Jackson & Perkins garden gifts unit (13% of total sales) fell 5.5%, however, the unhappy result of a new rose-growing technique that reduced yields.

For prospective investors, Harry & David's allure is a well-established, consistent business. The trouble is its bruised balance sheet. At last report, the company owed more than $226 million in net debt and accrued interest. That was enough to wipe out shareholders' equity, which turned negative after a refinancing this year that allowed Harry & David's private-equity owners to recoup their original equity stake of $83 million. (Throw in the debt, and the total buyout price was $253 million.) Whatever they raise from the public now will be gravy, and you can bet they will aim for a valuation far above their cost. That worked out to be a steal -- six times the coming year's earnings before interest, taxes, depreciation, and amortization. Harry & David's IPO should prove a treat -- for sellers.

J. Crew. From its 1983 origins in catalog sales of preppy apparel, J. Crew has evolved via a strategy of developing multiple retail channels. Its 202 stores today take in 70% of total sales; Web orders are running 75% higher than catalog sales. Led since 2003 by Millard Drexler, Gap's (GPS ) erstwhile impresario, the business is making some nice noises. J. Crew's past five quarters brought higher comparable-store sales and operating income. Sales per square foot, $73 in the first half of 2004, ran $100 in this year's first half. All good.

Yet apparel retailers, always anticipating -- if not creating -- the next fashion, are inherently riskier than a seller of pears and fruitcakes. One worry for investors is that Drexler's contract permits him in January to step down as CEO and then serve only as executive chairman. Bigger worries appear on the balance sheet, which is laden with $667 million in net borrowings and preferred stock. Texas Pacific Group, a private equity firm that in 1997 bought control of J. Crew, plans to swap preferred stock and notes it holds for common stock. Drexler, who also plans to exchange debt for equity, will hold 15% of J. Crew as the company goes public.

Obviously, neither deal has me reaching for my checkbook. What might change my mind? If the American consumer, against all experience, falls into a deep swoon. Then, look for markdowns in the stocks.

By Robert Barker

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