J. Crew Bonds Show IPO Odds Vanishing With Profits

The bonds J. Crew Group Inc. sold last year to finance a dividend for its private-equity owners are indicating diminished odds that the retailer will explore a stock sale anytime soon.

Bondholders had been pricing in the possibility of an initial public offering this year, according to Tom O’Neill, an analyst at Canaccord Genuity Group Inc. The $500 million of notes, which are callable at 102 cents on the dollar in November or upon an IPO, were quoted above that level until the chain owned by TPG Capital and Leonard Green & Partners LP reported a net loss of $30.1 million in the quarter ended May 3. A drop to 101, below the call price, suggests a receding chance of an IPO.

J. Crew may be required to reduce the book value of its assets if a decline in operating results persists, it said in a June 4 statement, and an IPO or sale may be delayed because of the latest deficit, according to a June 5 report from Barclays Plc. The loss, which followed a 42 percent income drop in the previous period, reflected “a disappointing quarter across all our business,” Chief Financial Officer Stuart Haselden said last week in a teleconference with analysts and investors.

‘Fallen Dramatically’

“It’s unfortunate, but within a year of that dividend they’ve strung together two pretty bad quarters,” said New York-based O’Neill. “The likelihood of an IPO later this year has fallen dramatically.”

Heather McAuliffe, a spokeswoman for J. Crew, declined to comment on the company’s earnings, financing or prospects for an IPO. The retailer has no immediate plans for an IPO or a sale as it navigates the current “challenging period,” Chief Executive Officer Millard “Mickey” Drexler said in an interview last month.

Lisa Baker, a spokeswoman for TPG at Owen Blicksilver Public Relations Inc., declined to comment. Erika Spitzer, a spokeswoman for Leonard Green, didn’t return a phone call seeking comment.

The retailer’s debt, which includes a $1.57 billion term loan, has risen to 6.4 times earnings before interest, taxes, depreciation and amortization, from a leverage ratio of 6 times in the fourth quarter, according to Helena Song, an analyst with Standard & Poor’s. That compares with about 5 times before the dividend, she said.

Cold Weather

J. Crew’s owners and executive management have extracted more than $650 million of dividends from the company, according to a Feb. 21 report by Moody’s Investors Service. “They were mostly funded with debt,” Song said.

The company has a B rating at S&P and B2 at Moody’s, both five levels below investment grade.

J. Crew was among specialty retailers whose sales were hurt by colder weather, Song said. Men’s and women’s apparel sales have declined every month this year, according to SpendTrend research compiled by First Data Corp.

As well, “mall traffic has been on decline for a while,” Song said. “The consumer is getting more used to highly promotional deals.”

J. Crew, whose customers include Michelle Obama, was hampered by a “fashion miss” and elevated inventories at the start of the quarter, according to a June 5 Citigroup Inc. report.

Global Expansion

The company, which has been expanding its brand worldwide, had a 33 percent increase in products available to sell prior to the first quarter, adding to the margin pressure, analysts led by Jenna Giannelli wrote in the report.

J. Crew had a 36 percent drop in adjusted Ebitda in the three months ended May 3, according to a June 4 earnings statement. The company’s net loss in the period was the first since the quarter ended July 2011, according to data compiled by Bloomberg.

“We see the weakness persisting at least through the second quarter,” Hale Holden, a New York-based credit analyst at Barclays, said in a telephone interview. Holden has an “overweight” rating on the bonds, while Citigroup analysts said in a research note today that they changed their recommendation to “sell” from “neutral.”

The $500 million of 7.75 percent senior unsecured notes due May 2019 were issued by the retailer’s holding company and have a pay-in-kind option, which means J. Crew can choose to accrue debt in lieu of making cash interest payments, according to data compiled by Bloomberg.

The retailer expects to continue making cash interest payments, according to Canaccord’s O’Neill. The bonds now yield

7.4 percent, up from 6.89 percent before the earnings report.

Equity Claw

Besides becoming callable later this year, the securities also have a so-called equity claw feature that allows J. Crew to redeem all of the notes at 102 cents, even before November, if there’s a sale of equity, Bloomberg data show.

“If the market had an expectation that an equity claw was going to get exercised soon or they were going to get refinanced, the bonds would trade closer to the call price or even above that,” Holden said.

The term loan, signed in March to refinance debt, has also declined, falling to a record low of 98.875 cents on the dollar on June 6 to yield about 4.4 percent, quotes compiled by Bloomberg show.

‘Macro Headwinds’

J. Crew has also drawn interest this year from Fast Retailing Co., Asia’s biggest clothing retailer and owner of Uniqlo, to purchase the business, two people with knowledge of the matter said.

TPG and Leonard Green bought J. Crew bought in a $3 billion deal in March 2011. According to the June 4 statement, to “the extent that the operating results continue to decline, the company may record a non-cash goodwill or intangible asset impairment charge.” Goodwill, which can be generated when an acquirer pays more than the value of tangible assets in a takeover, is $942 million while the intangible value of the J. Crew brand is $885 million, according to the statement.

Before the earnings report, a person familiar with the situation said J. Crew might command a valuation of as much as $5 billion in a public sale.

The weaker performance “is partly a result of company execution and largely macro headwinds,” Holden said.

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