Can Private Equity and Fashion Look Good Together?

"There's a creative and soft aspect...that's not really controllable"

Private equity and fashion are a bad combo, kind of like pairing a Dior dress with Ugg boots. That at least was the established wisdom until March, when Apax Partners sold Tommy Hilfiger for $3 billion, quintupling its investment in the American clothier in just four years. The rich payoff may inspire other investment firms to sharpen their fashion sense.

There's no shortage of potential acquisition targets. A $22.8 billion drop in worldwide luxury spending since 2007 has left players such as fashion house Gianfranco Ferré and suitmaker Brioni Roman Style cash-starved. Buyout firms have more than $500 billion to spend. "There are many companies that have ownership problems, execution problems, family-driven issues, succession issues, all triggers for transactions," says Christian Stahl, a partner at Apax.

Still, it may take more than the Apax deal to erase the memory of some big disappointments. Among the most high-profile stumbles is Permira Advisers' acquisition of the Valentino Fashion Group, which encompasses the haute couture house whose gowns are perennial red-carpet staples as well as German label Hugo Boss. In 2007, at the peak of the buyout boom, London-based Permira paid $7.2 billion for Valentino, money it may have trouble recouping. The departure of founder Valentino Garavani, the recession, and the nearly $3 billion in debt Permira piled on have hurt profitability. The buyout fund's largest backer, SVG Capital, has written down its initial investment by 53%. Valentino's owners have also had to inject an additional $336 million into the company.

Permira's struggles are instructive. Private equity's heavy use of debt to finance deals is especially ill-suited to a business where revenue streams are unpredictable and subject to what's known as fashion risk. Sharp managers can work to improve cash flow, trim production costs, and overhaul distribution, but that may not be enough. "There's a creative and soft aspect to the industry that's not really controllable," says Stahl. "It's not a manufacturing business, and some people have paid a high price for not being mindful of that."

Then there's the time factor. Private equity's preferred three- to five-year investment period usually isn't long enough "to reposition or develop a brand," says Mario Boselli, president of the National Chamber of Italian Fashion. Texas Pacific Group, for instance, spent nine years buffing Swiss shoemaker Bally International before selling it in 2008.

Perhaps the biggest obstacle to successful deals is the fact that many family-run businesses are unwilling to cede control to financial investors. Private equity accounted for less than 20% of all mergers and acquisitions in fashion in 2009, down from 27% in 2007. In Italy, the luxury houses Prada, Giorgio Armani, and Roberto Cavalli have all spurned overtures from buyout firms in recent years. "Apax hit the jackpot," says Alessio Candi of the Milan-based luxury consulting firm Pambianco. "But attractive targets, which would consider opening their capital to fund growth, are hard to find."

The bottom line: Finding the next Hilfiger won't be easy in a business that is subject to consumer trends and not always welcoming to financial buyers.

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