LBO Rut Still Leaves Room for These Buyout Bets: Real M&ATara Lachapelle
Buyout firms have been reluctant to spend the record $1.18 trillion of dry powder they’ve amassed. That doesn’t mean there aren’t targets worth spending it on.
U.S. stock indexes at all-time highs are keeping private-equity investors at bay this year, driving down the volume of leveraged buyouts to the lowest since 2009, according to data compiled by Bloomberg. The bull market is also stoking competition from public companies, which are becoming dealmakers by financing takeovers with stock.
“Since the public markets have really run up, a lot of public company valuations are too expensive for a private-equity take-private transaction to really work,” said Susan Long McAndrews, a partner at Pantheon, a private-equity investor that manages about $29 billion. That said, “there’s always going to be pockets of opportunity.”
Here are four: Ann Inc., Brink’s Co., Guess? Inc. and Staples Inc. They are among a short list of U.S. companies valued at $1 billion to $10 billion that look cheap relative to the free cash flow they generate and have low enough leverage to pile on debt for a buyout, data compiled by Bloomberg show. Their profitability also trails their peers, signaling there may be an opportunity for financial buyers to cut costs and boost margins.
Representatives for Ann, Brink’s, Guess and Staples didn’t respond to phone calls or e-mails seeking comment.
There have been $31 billion of U.S. buyouts by private-equity firms so far this year, down 59 percent from the same period a year earlier, according to data compiled by Bloomberg.
Instead of purchasing whole companies, financial buyers are increasingly going after bits and pieces of businesses. The three largest agreed-upon buyouts so far in 2014 are for units, including the $2.1 billion deal for Darden Restaurants Inc.’s Red Lobster chain and the sale of Johnson & Johnson’s diagnostics business for $4 billion.
While surging equity prices are one explanation for the dearth in LBOs, another is the disappearance of “club deals,” when firms team up to pursue a big target, said Mel Cherney, a partner at law firm Kaye Scholer LLP in New York who has represented private-equity buyers. The record-setting purchase of TXU Corp. for about $45 billion by a group including Kohlberg Kravis Roberts & Co. and Texas Pacific Group in 2007 is the largest such example. And it filed for bankruptcy this year.
Bloomberg News screened for targets a single buyer could digest, that have the traits private-equity firms find appealing: an undervalued stock, high cash generation, low leverage and a business that could use some sprucing up. They are:
The $1.8 billion owner of Ann Taylor and Loft women’s clothing stores trades for about 9 times free cash flow, or cash from operations after deducting capital expenses. That’s half the median ratio for U.S. retailers of discretionary items, the data show. Ann also has no debt.
“It’s an inexpensive stock relative to the rest of the universe,” yet in a “tough environment where others are struggling, Ann’s business is outperforming,” Liz Dunn, a New York-based analyst at Macquarie Group Ltd., said in a phone interview. “They haven’t been rewarded for some of the improvements in their operations over the last several years.”
There’s room for a private-equity firm to cut costs, such as moving Ann’s headquarters from New York to a less-expensive area, Dunn said.
Golden Gate Capital Corp., a San Francisco-based private-equity firm, reported a 9.5 percent stake in March. It didn’t signal interest in acquiring the entire company. In a letter to Ann, Golden Gate said that its investments are broader than those of a typical private-equity firm and that it intended to work with the company “as a long-term public investor.” A representative for Golden Gate declined to comment further.
Today, Ann shares rose 1.1 percent to $37.94.
The Richmond, Virginia-based maker of surveillance systems and armored trucks earned just 2 cents of operating profit on each dollar of sales in the past 12 months, data compiled by Bloomberg show. That leaves room for improvement at the $1.3 billion company.
A private-equity firm saw a chance to increase profits at Brink’s closest peer. Garda World Security Co. was taken private by Apax Partners LLP in 2012 in a deal that valued the company at 7.2 times earnings before interest, taxes, depreciation and amortization. Even though the Standard & Poor’s 500 Index has surged 46 percent since then, Brink’s was still valued at just 5.5 times Ebitda yesterday.
“Brink’s certainly screens cheap,” said Chris Marangi, a money manager at Gamco Investors Inc., which oversees $47.6 billion and owns Brink’s shares. “It’s a stable business and great brand name, and there are lots of barriers to entry.”
A potential caveat is that it’s “a fairly capital-intensive business, which makes looking at Ebitda multiples a bit misleading,” he said. “But at the end of the day, it would probably ring the right bells for a private-equity player.”
Today, Brink’s fell 0.9 percent to $27.05.
Known for its jeans and handbags, the $2.3 billion clothing chain was picked by Jefferies Group LLC as one of the three best LBO candidates among specialty retailers. Los Angeles-based Guess trades for about 10 times free cash flow and has a negligible amount of debt.
With Guess shares down 14 percent this year, the company has become increasingly attractive for a buyout, Randal Konik, a New York-based analyst at Jefferies, wrote in a report last month. He estimates a private-equity acquirer could earn a 21 percent internal rate of return, assuming it were to pay a 30 percent premium, make a minimum equity contribution of 25 percent and use all of Guess’s free cash flow to pay down debt from the transaction.
A 30 percent premium implies about $35 a share for Guess.
Today, Guess shares climbed 0.4 percent to $26.90.
Ann also made the cut for retailers considered a “strong contender” for an LBO, according to Konik’s report.
The perennial takeover candidate still screens as such. Despite same-store sales declining in 14 of the past 15 quarters as it loses customers to Amazon.com Inc. and businesses use fewer office supplies, the chain threw off $742 million of cash in the 12 months ended May 3.
It’s also a lot smaller now for financial buyers, with a market value yesterday of $7 billion, versus $11 billion less than a year ago. Framingham, Massachusetts-based Staples is shutting more than 200 stores to trim costs as it undergoes a turnaround, moves that would be easier to do as a private company, said Adam Strauss, co-manager of the $311 million Appleseed Fund that owns the stock.
“If I were a private-equity investor, I’d be looking closely at Staples,” Strauss said in a phone interview. “It’s cheap relative to almost any measure we can think of. It’s certainly cheap for a reason in the sense that the business is facing some headwinds in the midst of a business transformation, but you could argue that that’s all the more reason it should be private right now.”
Today, Staples shares rose 0.2 percent to $11.19.
While known for its stores, the “gem” is its contract business, he said. That unit delivers products such as breakroom supplies and furniture to business customers and provides printing and information-technology services.
On the other hand, private-equity suitors probably favor retailers that don’t compete with Amazon because that’s a problem they can’t necessarily solve, said Louis Meyer, a special situations analyst at Oscar Gruss & Son Inc. Apparel stores such as Ann and Guess benefit from shoppers’ preference for trying on items to make sure they fit before making a purchase, he said in a phone interview.
A valuable and well-known brand, growth opportunities for the store base -- either domestically or internationally -- and strong management also help, Meyer said.
While it may take a pullback in stocks to help reignite an LBO feeding frenzy, these may be targets to feast on in the meantime.
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