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Gap: Deal or No Deal?

The ouster of CEO Paul Pressler at Gap Inc. earlier this week, after another lackluster holiday shopping season, has sparked new speculation among industry observers and analysts about whether the company will be the next retailer to fall in the private equity takeover wave.

Most prominently, on his Mad Money program on Wednesday night, James Cramer rated Gap a “triple buy,” proclaiming the company would be acquired for up to $25.00 per share in a private equity takeover. As of noon Thursday, Gap’s stock was trading at $19.17 per share, compared to the historic high of $51.68 per share in February 2000 and to $19.90 per share on the day Pressler’s exit was announced.

By parting ways with Pressler, Gap removed a potential $150 million obstacle to any acquisition: According to the terms of his contract, that's what he would have received as a "change in control bonus" should the company be sold under his watch. Instead, he walks off with a $14 million severance package.

Private equity remains a major X factor in the retail industry. Firms raised a record $215.4 billion in 2006, according to Private Equity Analyst. Of that, $148.8 billion was raised by leveraged buyout funds and retail has been a popular target the past two years.(See Barbarians at the Mall.)

For now, interim CEO Robert J. Fisher, son of Gap founders Donald and Doris Fisher, has been playing down talk that the San Francisco-based retailer is up for sale. According to published reports, Fisher circulated a memo at the company titled, “How We'll Be Great Again” that laid out the retailer’s intent to turn things around and do it without a sale of the company.

Some analysts do think the company can be turned around and say that bringing in new management is a step in the right direction.

“We think it's positive that the search process is being overseen by experienced retailers on the Board,” wrote Banc of America analyst Dana Cohen. Members of Gap’s board include Adrian Bellamy, chairman of The Body Shop, Donald Fisher, Gap's founder and chairman emeritus, Domenico DeSole, former president and CEO of Gucci Group and Bob Martin, former president and CEO of Wal-Mart International.

But not everyone agrees that a buyout is imminent.

“We do not believe this news materially alters the Gap’s chances of being taken private,” wrote Paul Lejuez in his analyst report for Credit Suisse First Boston. “This news seems to us like the Fishers [Gap Inc.’s founders] are leaning toward giving the fundamental turnaround option a try.”

In January, Gap Inc. hired financial services giant Goldman Sachs to help it explore strategic alternatives. Some analysts say Pressler’s departure does not mean the Gap is ready for a deal.

Analysts don’t cite Pressler for Gap Inc.’s lack of must-have apparel that has contributed to its sales decline. Instead, they say, he brought financial discipline to Gap Inc., lowering the firm’s debt to equity ratio from 0.67 in 2002 to 0.09 in 2006. The company posted negative same store growth for 28 of the past 31 months and was recently downgraded by Fitch from a BBB- rating on its senior unsecured notes to a BB+, its highest junk level.

“Pressler’s departure doesn’t change our view of the firm, or our fair value estimate for the stock,” wrote Morningstar analyst Joseph Beaulieu, who puts Gap Inc.’s fair value at $23 per share. “The company still has to fix the ailing Old Navy chain … and find a better positioning for the namesake Gap brand. These are two enormous tasks that aren’t going to be completed overnight.”

Weak customer traffic at its Gap and Old Navy chains resulted in an 8 percent decrease in comparable store sales for the 2006 holiday season, an improvement over the 9 percent decrease in 2005, but no reason for celebration. Old Navy faired the worst of all brands, with a 10 percent decrease for the second year in a row, followed by Gap North America, which posted a 9 percent decrease. Banana Republic, on the other hand, showed improvement, with a 2 percent increase in holiday sales in 2006 compared to a 5 percent decrease last year. In addition, market analysts have been critical of the Gap, whose name was meant as a play on the phrase “generation gap” when it debuted in 1969, for trying to expand its customer base from ages “1 through 100.”

Retail Focus Inc.’s founder and president Bruce F. Katz notes that developers are anxiously awaiting what is going to happen, recalling previous years when the Gap was a destination and integral to a center’s tenant mix.

“Today, it’s no longer a destination, but the leases are still there,” says Katz.

The retailer’s real estate strategy can also be viewed as a strike against the possibility of a buyout.

As of November, Gap Inc. operated 3,157 stores worldwide, totaling more than 39 million square feet of space. However, the majority of the stores are leased, not owned. That prevents potential buyers from selling the real estate, a preferred method of raising cash in private equity buyouts of retailers.

Federal Realty Investment Trust’s senior vice president of leasing Chris Weilminster contends the Gap is still an American icon that will be able to return to its top status. The Rockville, Md.-based firm has three Gap brands at its shopping centers, including several flagship stores.

But, Weilminster cautions, in light of the circumstances surrounding the Gap, it would be foolhardy not to at least evaluate the leases it has.

“I don’t anticipate anything happening with the Gap that will put our real estate in distress, but if there was a situation where they would start a repositioning and [needed to close stores], we have utmost confidence in our ability to re-tenant their space.”

By Elaine Misonzhnik

TAGS: News
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