M&A Deals Slowly Return to the Table

NEW YORK — After several seasons of silence on the mergers-and-acquisitions front, the footwear industry is beginning to see signs that deals might pick up over the next several quarters.

Several companies are flush with cash and have been vocal in their hunt for strategic opportunities in the contracting vendor environment. Still, most analysts believe it is unlikely the market will see any large-scale deals until at least the end of 2010, calling last month’s $979 million marriage between Amazon.com and Zappos.com an anomaly.

“The conversations and dialogue about M&A is picking up,” said Jay Agarwal, managing director of investment banking at Demeter Group, “but we still see a difficult second half of 2009. We don’t think things will get busier until late next year.”

Certainly, there is no shortage of firms hunting for buys.

Acquisitions are a major focus at Iconix Brand Group Inc., which has said it is looking to get a deal done by the end of 2009. “We are seeing many new opportunities for great brands and believe our pipeline consists of actionable opportunities in the near term,” Neil Cole, president and CEO of Iconix, said on the company’s quarterly earnings call this month. He noted that Iconix raised $153 million through a recent equity offering and now has a cash balance of roughly $200 million.

Steven Madden Ltd. also is sitting on a substantial amount of cash — $111.6 million at the end of the second quarter. The company’s management has said there are three acquisition targets on the firm’s radar, and analysts speculate that a men’s or women’s fashion brand with a similar demographic could be synergistic. “Steve Madden is focused on finding another small brand with interesting distribution, something they can fold in easily,” said Scott Krasik, a senior analyst with C.L. King & Associates.

Even Skechers USA Inc., which has completed few buyout deals since its inception, recently said that the abundance of small, niche companies available in the marketplace could be a path for expansion, especially since the company has $257 million in cash to spend. “Skechers has got a lot of cash and needs to drive earnings growth,” said Brian Tascher, VP of the consumer investment banking practice at BB&T Capital Markets. “When they find the right opportunity at the right price, they are absolutely going to pull the trigger.”

But the year so far has been one of the leanest for M&A in recent history. A report by Sage Group released this month, quoting a Thomson Reuters report, noted that the total volume of announced M&A across all industries for the first half of 2009 dropped 40 percent, to $941 billion worldwide.

M&A deals worth less than $1 billion in the U.S. declined 37.7 percent during the first six months of 2009, according to Robert W. Baird & Co.’s investment banking department. The six-month total fell 52.3 percent when including $1 billion-plus deals and those for which terms weren’t disclosed.

“Some of the best-performing businesses in the footwear sector, including Nike, Adidas and Wolverine World Wide, have been cautious because there’s been a lack of visibility into valuation,” said Joseph Pellegrini, Baird & Co.’s managing director. “As an acquirer who is looking at numbers to determine valuation, how do you know you’re not acquiring a falling knife?”

Valuation discrepancies between buyers and sellers have prohibited many deals from getting done in the past year, according to bankers. “It’s a psychological barrier that sellers have to get through,” said Tascher. “Valuations have easily come down 20 percent since the peak in 2007, but a lot of small businesses still have the mentality of ‘my business is better than that valuation.’ That’s being a little short-sighted. Valuations are not going to come back to what they were.”

Skechers’ bid for Heelys Inc. last year is just one precautionary tale. After declining Skechers’ offer of $143 million, or $5.25 a share, Heelys now trades at around $2 a share. “Companies who got greedy on valuation in this difficult environment ended up not getting a sale done, or going into bankruptcy,” said Agarwal. “Many companies deserve higher valuations than what they’re getting today, but the days of double-digit EBITDA multiples are done. Few companies are going to get more than 10 times EBITDA. Most deals are going to hover around 6 to 8 times EBITDA.”

Agarwal believes that some recent M&A successes in the apparel industry, such as last week’s sale of Charlotte Russe Holding Inc. for $380 million to Advent International Corp., could bode well for footwear firms. Advent paid about 7 times Charlotte Russe’s cash flow for the company, which Agarwal said “is a sign that sellers are getting realistic on valuations. This is the first indication that there’s some sanity in the market.”

Retail consultant Emanuel Weintraub pointed to several characteristics of potential sellers in this climate. “If you have a private company and the original owners, or a hedge fund part owner, wants to cash out to increase liquidity, they would be looking to sell,” he said.

Another condition for selling, he continued, could be that a strong brand is hoping for a larger company to lend a hand in financing, sourcing or other operational issues, particularly in this stressful economic environment. “It’s those that have a good business and have been working hard, but who now want someone to help them,” Weintraub said.

Pellegrini believes there is “not a lot of high-quality property available” that hasn’t already been snatched up, but attests that small, niche footwear brands, particularly in the performance and outdoor lifestyle markets, could be ripe for the taking by larger, strategic footwear companies. As examples, he pointed to the outdoor brands Chaco and Ahnu, acquired earlier this year by Wolverine World Wide Inc. and Deckers Outdoors Corp., respectively. “There’s a lot of neat $50 million to $100 million businesses that have above-average growth rates and will eventually become $300 million to $400 million brands,” he said.

Distressed firms, too, make attractive targets. In fact, according to PitchBook Platform, private equity firms have spent more than $3.4 billion in acquiring bankrupt companies in 2009.

“The beauty of bankruptcy is you get to pick and choose the assets you want,” said BB&T’s Tascher. “There are a lot of strategic buyers out there interested in picking up the intellectual property and not the rest of the operations.”

That could be a good thing for recent footwear companies that declared bankruptcy, including Mary Norton and Penny Loves Kenny. But, said Baird & Co.’s Pellegrini, “a fair amount of companies in bankruptcy will disappear. There was an excess of capacity in footwear, particularly on the fashion side.”

Some suggested that firms in danger of bankruptcy will continue to be the only likely sellers on the table for the next few quarters. “Unless you’re really distressed, there’s no reason to sell right now,” said Krasik. “If you’re selling from a position of strength, you might as well wait until the environment gets better.”

And for those sitting on cash, there are other constructive — and less risky — ways to grow, analysts said.

“Investors are about growth, and M&A is an important driver,” said Demeter Group’s Agarwal. “But M&A has to be balanced with other strategies for growth.”

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