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National retailers

PLAYERS PREDICT MORE MERGERS

BY DONNA MITCHELL

Drugstore consolidation: In April CVS and the Jean Coutu Group divided the Eckerd drugstore chain between them, having bought it from J.C. Penney for about $4.5 billion.

There’s nothing coincidental about a recent flurry of sales of and bids for retail chains, experts say. On the contrary, they predict that the mergers and acquisitions scene will get busier still.

In April CVS and The Jean Coutu Group bought the Eckerd drugstore chain from J.C. Penney for about $4.5 billion and divided it between them. Downers Grove, Ill.-based Spiegel is selling its women’s apparel catalog business, Newport News, to private equity firm Pangea Holdings for $25 million; it has also put the Eddie Bauer chain up for sale. Federated Department Stores said it would consider buying the 62-store Marshall Field’s chain from Target Corp. And an entire retail holding company is a target too: Hong Kong-based Moulin International Holdings (again, in April) made a $411 million takeover offer to Cole National Corp., owner of Pearle Vision, which operates 850 eyeglass stores in the United States, Canada, Puerto Rico and the Virgin Islands.

With fourth-quarter 2003 financial reporting and first-quarter 2004 shakeouts and bankruptcies played out, April was the perfect time for merger-minded companies to unveil their deals, says Steven Collins, a partner at Advent International Corp., a Boston-based global private equity firm.

This is not just a case of spring fever. Market sources say 2004 will be an aggressive year for mergers and acquisitions in the retail sector, with strong companies showing a pent-up appetite for expansion now that the economy is picking up. During the 2000 recession there were just $16.2 billion in retail mergers and acquisitions, down from $36 billion the previous year, according to Mergerstat, which tracks such deals. In 2001 activity sank even further, to $6 billion.

“You just could not interest banks in lending for new deals,” said Collins. “They had enough portfolio problems on their hands. Everybody was dealing with their [internal] business issues.”

Such thrifty lending chilled the market for financial sponsors, leveraged buyout firms that invest in retailers either in whole or in part. Usually, financial sponsors borrow against the assets of a targeted company to finance the acquisition. But from 1999 through 2002, banks were concerned about bankruptcies and poorly performing loans to retailers; they were offering on average only about two times the cash flow of a company’s EBITDA (earnings before interest, taxes, depreciation and amortization). As a result, financial sponsors made smaller bids to retailers, which more often than not were rejected. Before, the sponsors had been getting loans that were equal to six to eight times a retailer’s EBITDA, says Cheryl H. Carner, director of retail finance at CapitalSource, a Dedham, Mass.-based commercial finance company.

On the block: Marshall Fields’ 62 stores, including its Chicago flagship.

But moods and fortunes have turned. U.S. retailers are better off economically, and the capital markets are more flush with cash and more enthused about putting that money to work. The total market cap of the stocks in the S&P 500 retail index was about $423 billion on April 15, says Joe Bonner, a retail securities analyst at New York City-based Argus Research Co., an independent equity research firm. In May 2003 the sector’s market cap dropped to $316 billion — probably due to anxieties over the impending invasion of Iraq, says Bonner — and has lingered near the $400 billion mark since.

Retailer acquisitions, of which there were $9.6 billion in 2002, climbed sharply last year to $17.5 billion, according to Mergerstat.

Other factors are contributing to all this activity. Intense competition of late in an industry that was already plenty Darwinian has led to a marked divergence of the strong and the weak, making conditions more ideal for amalgamations, say observers.

“Retailers looking to expand their demographic appeal and product lines see acquiring other companies as the fastest way to do that,” said Rob Coble, a partner in the KPMG Atlanta office.

Wal-Mart Stores is also helping to drive acquisitions by forcing retailers to be more efficient. Retailers nowadays have to carve out a specialty niche and dominate it. Home electronics retailer Tweeter Home Entertainment Group is a prime example of one that is trying to do this, says Collins; it is setting itself apart from the competition by improving customer service. Tweeter has gobbled up other chains in recent years — and it is about to acquire NOW! AudioVideo — all of which has gained it negotiating leverage with product suppliers and shopping center landlords, Collins says.

There are still more factors encouraging the acquisition trend. Larger chains with national standing are taken more seriously by lenders. And a consolidated company can attract sufficient executive talent to steer it through a highly competitive marketplace.

Retailers also use acquisitions to enter otherwise hard-to-crack markets, or those that might not support more than one retailer in a particular niche.

“There are a lot of barriers to enter markets, as a competing retailer,” said Alan Clifton, director of leasing and disposition for Passco Real Estate Enterprises, a Santa Ana, Calif.-based real estate investment firm. “It has become [increasingly] expensive and time-consuming to get up and running [in a new market].”

Bon-Ton Stores, for instance, which had confined itself to New England and the mid-Atlantic, expanded its geographic reach into the Midwest through its October purchase of Dayton, Ohio-based Elder-Beerman Stores Corp.

Smaller chains, too, are getting lots of attention from finance firms that see their potential to grow through acquisition and mergers. CapitalSource is one such firm; it makes the bulk of its loans to retailers that reap between $30 million and $50 million in revenues — though it also lends to companies that earn as much as $250 million.

But large or small, retail firms are performing well enough that private equity firms expect a busy 2004. Comparable-store sales for the overall retail sector have been strong so far this year. In March, for instance, comp-store sales grew 7 percent from the same month a year earlier, their best performance since April 2000, according to ICSC’s Chain Store Sales Trends.

“We like retail very much,” said Collins. “Within retail you have a lot of winners and losers, and we think there are plenty of opportunities.”

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