M&A Outlook Strong for Year Ahead

Dealmakers, take note: Next year could be a game changer in the M&A arena.

Financial insiders predict that 2014 could mark the return of the mega deal as low interest rates, favorable markets and a boost in private equity pave the way for more activity in the apparel and footwear space.

Joe Pellegrini, a managing director at Robert W. Baird & Co. investment bank, said near-record levels of uninvested funds, or “dry powder,” are likely to drive investments in the new year, with U.S. buyouts on track to book their highest yearly deal value since the onset of the financial crisis in 2008.

“The larger strategic operators — Nike, Adidas, New Balance and Wolverine World Wide — are all generating a ton of cash and paying down a lot of debt,” Pellegrini said.

In turn, he explained, the sweet spot in the recovery cycle, plus the strong capital markets, could lead to an industry-defining acquisition in 2014, akin to Adidas purchasing beleaguered Reebok in 2005.

“These companies would be looking to purchase something impactful enough to move the needle — for example, Nike buying Foot Locker or a distribution company or Patagonia,” Pellegrini said. “The environment couldn’t be better, and private equity firms continue to be very aggressive. Equity capital markets are doing extremely well. New issuance is up more than 50 percent on last year.”

Allan Ellinger, co-founder and senior managing partner of investment banking and strategic advisory firm MMG, also expects a pickup in M&As.

“Activity will continue to be strong in 2014 and it will be highly influenced by private equity going forward. Generally, there are fewer large strategic consolidation options out there, which is why it’s opened the door to private equity,” he said.

Ellinger agreed blockbuster deals could return in 2014, similar to the $3 billion purchase of J. Crew Group Inc. by TPG Capital and Leonard Green & Partners in 2010. And sources said those two companies have been shopping the retailer around again and could offload it next year.

According to data compiled by Thomson Reuters, average U.S. monthly M&A volume increased by 10 percent, to 886 deals per month in July through November, from 808 per month in the first six months of 2013.

Late last week, The Jones Group Inc. inked a deal to be acquired by Sycamore Partners for $15 a share, plus debt. Sycamore is said to be planning to sell the company’s underperforming apparel brands once the purchase is complete. New York-based Jones put itself on the auction block over the summer after activist hedge fund firm Barington Capital Group took a stake in the firm and urged it to focus on footwear.

The Jones deal is lower than the initial speculation in November for between $16 and $17 a share, causing some concern about the outlook for 2014. However, most experts are generally confident that M&A activity will continue to strengthen.

Divestitures should remain robust, according to analysts, as companies slim down to focus on the assets most relevant to their growth strategies. Such was the case at Fifth & Pacific Co., which spent more than a year trimming its brand portfolio to just two: Kate Spade and the Adelington Design Group jewelry line. After Fifth finally managed to sell Lucky Brands and Juicy Couture to private equity players for $225 million and $195 million, respectively, talk has now emerged that buyout firms are circling Kate Spade, which has posted same-store sales increases of more than 20 percent for 12 straight quarters.

Also on the block is Italy-based Vicini SpA, which reportedly has appointed adviser Rothschild to complete a strategic review of the firm’s Giuseppe Zanotti label ahead of a potential sale in 2014. Vicini is estimated to have a price tag of up to 300 million euros, or $412 million at current exchange.

Elsewhere in the sector, investment firm Mill Road Capital Management LLC is expected to make a formal binding offer to acquire R.G. Barry Corp. by the end of 2013 in a deal that could value the company at about $228 million.

The frugality that companies exercised during the recession by building up their balance sheets has created pressure to deploy capital through strategic acquisitions. At the same time, the private equity sector is increasingly busy as firms look to exit investments made in 2008 and 2009.

Market watchers also anticipate a revival in North America’s IPO backlog, which could expand further in the first half of 2014. Robert W. Baird & Co. was a joint bookrunner with Goldman Sachs on the $200 million IPO of Vince Holdings Corp. in November, the first apparel company to go public in the U.S. since Michael Kors Holdings Ltd. in 2011. Shares of luxury apparel firm Moncler closed 47 percent higher on its stock market debut on Dec. 16, stoking predictions of more floats next year.

Although the deal pipeline for the first half of 2014 is looking strong, market watchers cite increased tension in the Middle East, a slower-than-expected recovery in Europe, rising interest rates and a slide in consumer spending in the U.S. as potential risk factors for the landscape next year.

Jeff Edelman, director of retail and consumer products advisory services for RSM McGladrey Inc., said he expects the gradual improvement in spending through the New Year to become more visible in the second quarter to mid-year.

“There has been a bit more movement on the government side, which will remove some of the concerns of corporate management, who are holding back making any commitments adding to the workforce due to regulatory uncertainty,” he said. Improved earnings will support current share price valuations, which in turn generates acquisitions, he said.

Paul Swinand, an analyst at Morningstar, noted that the need for additional distribution channels could result in companies making smaller acquisitions or strategic partnerships to drive growth. “There isn’t a lot of low-hanging fruit in the sector like you saw with the underperforming Reebok. The market has peaked and companies have to put their cash to work and are struggling for growth. It feels like the 11th hour in terms of M&A activity.”

Companies such as VF, Wolverine World Wide, E.Land Group, Kering and LVMH Moët Hennessy Louis Vuitton — which snapped up Nicholas Kirkwood this year — likely will continue to take strategic stakes in high-quality labels as they expand their brand stables, Swinand said. At the other end of the spectrum are the struggling retailers: Kmart, Sears, Gap and JCPenney, all of which are thought to be up for sale but unable to find a buyer.

One sticking point could be valuations, which are hovering around all-time highs. But Ellinger said he expects investors will continue to take a measure of companies in the fashion sector through 2014. “We’re seeing far more private equity firms put their toe in the water and start looking at this industry. Private equity is willing to pay more generous premiums for the appropriate branded companies,” he said.

In addition to the low-interest-rate environment and reduced volatility on a quarterly basis, Pellegrini noted that many footwear stocks are trading close to 52-week and five-year highs as a multiple of earnings, which means potential sellers are being shopped around for top dollar.

“Just like the case of Sun Capital Partners Inc., which acquired Kellwood Co. in 2008 and has since been dismantling that empire, you will see a similar outcome at Jones,” he said. “Strong debt and equity markets mean buyers can fund transactions and sellers can achieve desired sales prices, creating a perfect environment for strong M&A in 2014.”

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