After 2006's boffo year of private equity-led retail buyouts--nearly $60 billion in all--the first half of this year seemed tame by comparison. Private equity firms are still sitting on mountains of capital and have no problems raising debt. But much of the buyout activity has shifted to other sectors or overseas, with the notable exception of Kohlberg Kravis Roberts' $7.3 billion acquisition of discounter Dollar General in March.
But a few announcements in the past seven days signal that the tide may be turning back to retail. Friendly's Ice Cream Corp. announced that it had reached a deal to be acquired by Sun Capital Partners, Inc., and Home Depot agreed to sell one of its supply businesses. Meanwhile, Wendy's International Inc. said that it is now on the market and Jones Apparel Group is rumored to be close to a deal to sell its upscale Barneys New York chain to Istithma, the investment arm of the Dubai government, for a reported $825 million.
“I think retailers still provide great opportunities – they tend to have very stable cash flows and the ownership of real estate in some cases provides opportunities for structured financing that makes buyout transactions more attractive,” says Robert Filek, partner in the transaction services group with PricewaterhouseCoopers. “The lending environment continues to be very favorable, so I would think that as the year progresses we would see more retail buyouts."
So was the previous lull in activity a fluke or a sign that the current LBO era is coming to a close? Industry experts say private equity players are still targeting retailers, but the rising interest rates and doubts regarding consumer resilience are making them negotiate harder on pricing.
On a global scale, retail sector mergers and acquisitions activity had slowed down by about 12 percent in the first quarter of 2007, according to Dealogic, to $24.9 billion in 173 deals from $28.2 billion in 196 deals during the same period in 2006. Of that amount, financial sponsor-backed buyouts in the United States represented only $9.5 billion in eight deals, a 24 percent drop in volume since 2006. And one major transaction – the $7.3 billion Dollar General buyout – accounted for close to 80 percent of that number.
Now, however, the retail sector appears to be picking up steam. On June 17, Friendly’s, which operates more than 500 restaurants nationwide, signed a $337.2 million definitive acquisition agreement with Freeze Operations Holding Corp. and Sun Capital Partners, Inc. On Monday, Wendy’s, which has an international portfolio of 6,658 locations, revealed that it is seeking strategic alternatives, including a possible sale. The company could sell for $39 per share to $40 per share, estimates Citigroup analyst Glen M. Petraglia. And on Tuesday, the New York Times reported that Home Depot was selling its Supply Unit to Bain Capital, the Carlyle Group and Clayton Dubilier & Rice for $10 billion.
Howard Davidowitz, chairman of Davidowitz & Associates, a New York-based national retail consulting and investment banking firm, says private equity execs are still calling him on a daily basis in their search for possible buyout targets. The problem is confronted with rising prime interest rates (8.25 percent, compared to 5.5 percent at the beginning of 2005 and 7.5 percent at the beginning of 2006), a shakier economy and higher asking prices, private equity players want to make sure they will get value for their money.
“One of the things that makes these deals possible is the ability to borrow at favorable rates and the rates have gone up,” Davidowitz notes. “There is only so much good product out there and there is an unlimited amount of money chasing everything, so with interest rates going up, how do you get a return?”
Since private equity players seem to be more careful about debt loads this time around than they were during the LBO era of the 1980s, they wouldn’t want to take on a high level of leverage. In the majority of cases, they want to provide at least 30 percent of equity to the overall transaction value, industry sources say.
The key to getting their attention will continue to be in real estate, says Davidowitz, since sale-leaseback transactions allow the buyers to mitigate their risk. He identifies those companies that own a significant portion of their portfolios, including mid-market department store chain Dillard’s Inc. and warehouse operator BJ’s Wholesale Club, as those most likely to become acquisition targets.
Dillard’s, for example, which posted a 2 percent decrease in same store sales and a 1 percent decrease in total sales this May, owns 241, or 73 percent, of its 328 stores, and would make financing a buyout much easier. BJ’s, which owns 48, or almost 30 percent of its 172 stores, posted a 2.3 percent same store sales increase in May, but has been experiencing slow top line growth. Its operating margin for the first quarter of 2007 was 1.1 percent, down from 1.2 percent during the same period last year.