California Apparel News

Factors weigh the effect of recent acquisitions on West Coast companies.

It’s been a busy summer.

The VF Corp. picked up 7 For All Mankind for a cool $775 million—and at the same time picked up clicks-to-bricks retail chain Lucy Activewear in a deal worth $110 million.

The Jones Apparel Group is weighing two offers for upscale retail chain Barneys New York. In July, the New York–based apparel manufacturing giant received an unsolicited bid for Barneys for $900 million in cash from the Japan-based Fast Retailing Co., topping an earlier offer of $825 million from Istithmar, a Dubai-based private-equity and alternative-investment house.

At the same time, manufacturing giant Liz Claiborne Inc. reorganized its 31 megabrands into two divisions, with plans to focus on fashion stars such as Juicy Couture, Lucky Brand and Kate Spade and look into selling off 16 of its other brands, including venerable labels such as Ellen Tracy, Dana Buchman and Sigrid Olsen, as well as more-recent purchases such as C&C California.

Meanwhile, rumors abound that departmentstore giant Macy’smay be acquired by private investment firm Kohlberg Kravis and Roberts.

It remains to be seen what impact these recent deals will have on West Coast apparel manufacturers, although many in the financial community are closely watching the shifting landscape.

California Apparel News Executive Editor Alison A. Nieder recently caught up with several members of the financial community to gauge their reaction to recent news and gather what insight they will be passing along to their clients.

CAN: If KKR does indeed buy Macy’s, what will that mean for West Coast companies? Will the market be more competitive? What action will you advise your clients take?

Hopefully, if KKR buys Macy’s, it will mean more business and more profitable business to West Coast clients. It seems Macy’s has to tweak their business model because their stores are underperforming and some locations are doing poorly. The result is more charge-backs, deductions and less profit for the manufacturer.

Some speculate that KKR would close underperforming stores, thereby increasing the opportunity for manufacturers to maximize their profit in the better-performing stores.—Donald Nunnari, Merchant Factors

I think it will be a very positive effect because Macy’s has to report on a quarterly basis to the public markets, and when you have someone like KKR involved, they have an enormous amount of money and they can start doing strategic planning. I feel that Macy’s has been stagnant as a chain, and I think they need to set new merchandising strategies. So it should have a very positive effect on them. [However] if KKR starts running the company, I think that will have a negative effect. One of the problems today is there are too many people from the corporate side running businesses and not having the merchants like Stanley Marcus [anymore]. I think that’s why corporations are rather stagnant in the department stores today. But if [KKR is] there to provide the money, instead of reacting on a 90-day basis, they’ll be able to set up some corporate planning and strategies to rebuild the corporation from a merchandising perspective. The company has the cash flow and obviously the real estate to back it.

That [brings up] another issue. Will there be spinoff of real estate and bad stores? Because I’m sure they’re looking at the real estate in play. I think KKR is not only looking for the cash flow but also for the real estate reorganization.—Ken Wengrod, FTC Commercial Corp.

This is not necessarily a good thing. Based on past history, this could result in more consolidation, which will squeeze out some smaller non-branded suppliers. Also, if the purchase is financed through a significant amount of debt, the interest burden will move Macy’s to put margin pressure on the suppliers— also not a good thing for our apparel market.—James L. Morrison, First Capital

If KKR in their current state purchases Macy’s, our view is that operations will stay more or less the same. Generally, [a] privateequity company leaves the current management intact and allows them to operate as they always have. Remember, KKR’s potential purchase of Macy’s is predicated on their prior success and their continued projected profitability. We have seen the same scenario in other notable purchases by private-equity firms such as Bain Capital with Burlington Coat Factory and Sun Capital Partners with Mervyns, and that model has held true.

Because of the amount of debt financing involved for purchases of this magnitude, a once-adequate balance sheet becomes less desirable from the perspective of unsecured lenders, such as factors, and, in many cases, credit lines are reduced.

If, however, KKR themselves go public, thus enhancing their access to capital, there is always the possibility that they will purchase other department stores, thereby shrinking the marketplace and making the industry less competitive.—Sunnie S. Kim, Hana Financial

I don’t think it will have a huge impact on vendors, let alone West Coast vendors. Our assumption is that the management team has performed very well there and senior management will be intact and merchandising philosophies will remain the same. Those vendors who are in relationships [with Macy’s] today, I don’t see them getting impacted in the near term.

Of course, once the company has to service the debt, when you get out beyond a year, that’s when you’ll see what’s going on. [If Macy’s is] under pressure to service the debt and provide a return for the acquirer, then there will be pressure on cost containment, pressure on margins, and I think that will translate into suppliers—whether West Coast, East Coast or offshore—having to perform better.

The May Co. acquisition [by Macy’s in 2005] probably had more of an impact on suppliers. [In that acquisition] if you were on the matrix for Macy’s, you were on the winning side, and if you weren’t, you had to prove yourself or you weren’t there.—David M. Reza, Milberg Factors

CAN: What impact do the recent spate of mergers and acquisitions and news of major brands being put on the block (including Barneys and some of the brands in the Liz Claiborne stable) have on California companies?

The impact of the recent M & A rumors on the industry in general, and on California companies specifically, depends upon who isthe buyer. If the buyer is a private-equity firm or other non-industry third party, then little or no change is expected. If the acquisition is made by a competitor, then manufacturers need to prepare for major changes, including a fewer number of stores to sell to, as there are apt to be closures and consolidations. Additionally, the new entity will be larger and have greater leverage over their suppliers and will yield their power in the form of less-favorable pricing and terms for their suppliers.—Sunnie S. Kim, Hana Financial

Near term, we don’t see any issues with Barneys. Obviously the Liz reorganization could produce some pressure on suppliers. They’ve bought some of our West Coast resources with much fanfare. My guess is that looking at their business, they’re saying: “Let’s look at the cost structures. How can we eliminate those?” And that will be good for the company. On the merchandising side, they’re going to continue doing what they’re doing: [looking] for more names [to acquire]. My guess is that they’re going to be more judicious in how they spend their capital.

When companies are looking to be acquired, there might have to be a longer track record or, conversely, the purchase premiums will be lowered to reflect that.—David M. Reza, Milberg Factors

Hopefully, [Istithmar’s] plan will be to expand the Barneys brand globally and increase the business opportunities for the California resources who sell to them. Liz is shedding some underperforming brands like C&C California and focusing on growing Juicy, Lucky Brand and other top performers. I believe C&C is still a good label, and it affords some California manufacturer the opportunity to purchase them.—Donald Nunnari, Merchant Factors

I don’t think Jones had the ability to take [Barneys] to the new level. Istithmar is a very strong, highly regarded operation, and they have invested very heavily in other companies, including Loehmanns. And since they’re more of a passive [investor], if they have good merchants running the company, they can take Barneys more to an international arena, which can help a lot of the labels in California. Companies in the premium market are doing a lot of export through distributors to Europe, as well as Japan and the rest of Asia. I think having a very strong retailer that can enter the international arena can give them an extra edge.

Liz is a totally different [situation]. I think they were looking to expand too rapidly. They didn’t let the power branding of the labels mature to their satisfaction, and it just didn’t pan out.

And [for] those companies they’re [considering] spinning off, they didn’t have the return corporate was looking for. I believe there is [a market for those companies if Liz Claiborne sells them]—but at what price?

There’s an enormous amount of money out there in hedge funds and in the investment community as long as a company shows strong ability to grow—not only in sales but also in gross profit dollars. I think that’s a significant area—to see how the consumer values the company. With that, young companies can raise capital.—Ken Wengrod, FTC Commercial Corp.

CAN: If there is more consolidation within the department-store sector, what measures should California apparel manufacturers take to protect and grow their businesses?

Could there be more consolidation? There could always be more consolidation. Has Macy’s eliminated a lot of competition, or [has] the environment eliminated a lot of competition? Maybe it makes the bet for KKR a lot safer. [Consolidation has] created the uniform national Macy’s brand versus the regional brands [department stores] used to go by.

California manufacturers have to stay true to the flavor of California. We’re known for our sportswear, our premium denim. They have to make sure they don’t ignore export opportunities where the California lifestyle can be translated into their identity when they market themselves abroad. It is a global market.

It’s harder now than ever to run these businesses successfully over the long term. You can be great on cost, great on sourcing, [but] you’ve got to have good merchandising, [and] you have to have good information systems. And even then, a buyout or [leverage buyout] can change your fortunes overnight.

What [the current environment] does is it probably inhibits newer, smaller vendors [from getting] recognized and into the broader distribution that a department store brings. The department stores may be feeling that they can’t take more risk with vendors, so they may be buying from proven vendors because they are under financial pressures to service debt. They may be less likely to solicit new vendors. That’s why you see companies like Liz get broader by offering a top-to-bottom—from a price-point perspective—spectrum of everything from fashion to contemporary to bridge to more-moderate priced products.

You can see some of that [with] some of the smaller companies out here, where an established vendor has the relationship with Macy’s. Maybe it makes sense for an up-and-coming designer resource to [merge] with that company so they can get the benefit of their infrastructure and at the same time get a venue for their fashion.—Dave M. Reza, Milberg Factors

California manufacturers (and all others, as well), will have to find ways to operate more efficiently, discover methods to reduce expenses and eliminate waste in order to protect their margins. The new company formed from the acquisition will be able to negotiate better prices, require more-favorable terms and offer fewer opportunities to sell due to store closures. This will cause some fallout of the weaker players and thus create some opportunities for those manufacturers able to survive.—Sunnie S. Kim, Hana Financial Apparel companies would have to look to diversify into other channels of distribution. There aren’t many department stores left.—Donald Nunnari, Merchant FactorsWe’re seeing a rebirth of new markets other than the department stores. Look at Melrose Place [in Los Angeles]. Melrose Place for years was [the venue for] hair dressers and antique shops. Now you see a lot of apparel companies moving in, and those other shops are moving out. You see it [happening] on Third Street, Beverly [Boulevard] and Abbot Kinney [in Los Angeles]. I see it in New York; the shopping has moved down to the Meatpacking district, to Nolita, to Houston. I think people are looking for different types of product. They don’t want to look like everyone else; they want to differentiate themselves.

If Macy’s is really going to turn things around, they’re going to have to look at how they’re going to recapture that consumer. And then [they will] go back and ask which manufacturers can help them do that. Which brands? Which type of products can take them to a new level to differentiate themselves?

If you look at the numbers, The Buckle has been doing extremely well. They’ve done a great job at [properly identifying their customer], and comp-store [sales] show it. I think there are going to be more [retailers] who will come out of this turmoil with the consolidation that are going to expand. Like The Buckle, they’re giving the customers what the customers want.—Ken Wengrod, FTC Commercial Corp.CAN: What advice do you have for your clients?

Keep up the fashion side of the market. Push as hard as you can to gain some kind of brand recognition. License out accessories for your brand.—James L. Morrison, First CapitalI think [the question is] how can our California clients survive and thrive in today’s competitive, acquisition-filled environment? I would give the following advice to our clients:1) Assume tomorrow will be more competitive than today. It always is.2) Diversify your client base as much as possible. You never know when a customer might not be around six months from now.3) Start and build brands when possible. This will help with growing sales and margins.4) Continually work on reducing costs. Your customer will always want it cheaper tomorrow.5) Create a variable cost structure so that if sales do drop, you can reduce expenses accordingly.6) Don’t give up on the specialty/boutique retailers. They have their issues, but they allow you to diversify your revenue stream.—Ron Vanek, GMAC Commercial Finance

DIRECTORYFirst Capital Western RegionJames L. Morrison President700 S. Flower Street, Suite 2325Los Angeles, CA 90017(213) 996-2610www.firstcapital.comFTC Commercial Corp.Ken Wengrod President1525 S. BroadwayLos Angeles, CA 90015-3030(213) 745-8888www.ftccc.netGMAC Commercial FinanceRon Vanek Executive Vice President West Coast Regional Manager444 S. Flower St., Suite 1300Los Angeles, CA 90071(213) 284-3600www.gmaccf.comHana Financial Inc.Sunnie S. Kim Chief Executive Officer1000 Wilshire Blvd., Suite 2000Los Angeles, CA 90017(213) 240-1234www.hanafinancial.comMerchant FactorsDonald Nunnari Senior Vice President800 South Figueroa St.,Suite 730Los Angeles, CA 90017 (213) 347-0101www.merchantfactors.comMilberg Factors Inc.David M. Reza Senior Vice President655 North Central Ave., 17th floorGlendale, CA 91203(818) 649-8662www.milbergfactors.com