J Crew OKs $2.86 billion buyout, may get other bids

CHICAGO/SAN FRANCISCO Tue Nov 23, 2010 6:11pm EST

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CHICAGO/SAN FRANCISCO (Reuters) - J Crew Group Inc JCG.N agreed to a $2.86 billion buyout as its sales slump, but some on Wall Street expect the U.S. apparel retailer with a devoted following will attract higher bids.

Under the proposed deal, TPG Group and Leonard Green & Partners LP will buy the company for $43.50 a share, a premium of more than 15 percent compared with J Crew's share price before the deal was announced.

Millard Drexler, a highly respected merchant who came to J Crew after years at Gap Inc (GPS.N), will continue as chairman and chief executive officer and maintain a significant equity investment in J Crew.

TPG first bought J Crew in 1997 and hired Drexler six years later. It sold its stake after taking J Crew public in 2006.

"It's still a bargain. You are getting an amazing premium retailer ... You have got Mickey Drexler running the place, and he is gold," said Patty Edwards, chief investment officer of Trutina Financial, which owns J Crew shares.

J Crew shares were up 16.4 percent to $43.84 in early afternoon trade on Tuesday. The retailer is allowed to solicit better offers until January 15 next year. If none materializes, it expects to close the deal in the first half of fiscal 2011.

"They will aggressively shop it," said Eric Beder, an analyst at Brean Murray Carret. "I do think other private equity players will look at it. I think you can easily justify a price of $46-plus."

A higher offer over the holiday season would not be a shock, and shareholders are likely to scrutinize the current deal even more closely as it involves the CEO, according to one retail industry investment banker not involved in the deal.

Fourth-quarter retail deals are unusual because the buyer tends to want to see how the company performs in the key holiday shopping season, while sellers want to make sure they are getting the best price.

J Crew's surprise news may even inspire more private equity interest in the apparel space, including for teen retailer American Eagle Outfitters Inc (AEO.N), which has long struggled to improve sales, and Abercrombie & Fitch Co (ANF.N), a former high-flyer among trendy teens currently in a slump.

"The J Crew deal underscores our belief that the specialty retail sector is an attractive area for private equity," wrote Jefferies analyst Randal Konik, citing the above companies.

Konick noted that "reasonable valuations, strong cash flows, and top notch balance sheets with many companies in a net cash position" were a draw for private equity.

Shares of Abercrombie were up more than 3 percent at $48.97 while American Eagle shares rose 3 percent to $16.94.

FASHION MISS?

J Crew, which had outperformed most retailers earlier this year, may be trying to head off questions over weaker performance during the holidays. The company shocked the market in August when it cut its 2010 outlook, citing "nervous" shoppers and promotions by competitors.

On Tuesday, it cut its 2010 forecast a second time, predicting earnings of $2.08 to $2.13 per share, below its 2009 profit and falling short of a Wall Street forecast for $2.24 per share, according to Thomson Reuters I/B/E/S.

It also forecast sales at stores open at least a year would drop in the mid-single-digit percentages during the holiday quarter, and said discounts hurt third-quarter profit.

The company is clearing through merchandise that did not sell due to a warm weather autumn and uninspiring fashions uncharacteristic of the chain that is usually on target.

"It was not as new and innovative as the customer is used to and the shopper didn't pay up for it," said Beder. He noted that design elements like ruffles had been copied by rivals like AnnTaylor Stores Corp (ANN.N) and Talbots Inc TLB.N.

"It's a fashion miss. They move on from it and you go on. It's nothing structural," Beder said. "These companies always have fashion misses and with good management you aggressively clear it out and you move on."

Analysts see J Crew as still having room to grow, given its limited base of about 220 stores in the United States, its potential for international expansion as well and merchandise that has inspired loyalty from shoppers. The company is also known for first-rate customer service.

Drexler, unlike some CEOs running apparel companies, "has got the eye, he has got the feel. He just gets apparel," said Trutina Financial's Edwards.

A sale to private equity did not appear out of left field, some said, noting J Crew's history with TPG. When TPG bought the company the first time around, it made nearly seven times its original investment after turning the declining brand around, according to a source familiar with the situation.

And Drexler may welcome further distance from Wall Street. While admired by many analysts covering J Crew, Drexler appears more comfortable waxing on about the feel of a cashmere sweater during investor conference calls than he does profit margins.

Company shareholders, however, may still question the surprise deal. At least four different law firms said they were investigating J Crew's board for possible breaches of fiduciary duty over the terms of the deal shortly after it was announced.

The private equity group said it secured financing from Bank of America Merrill Lynch and Goldman Sachs Bank USA.

(Additional reporting by Dhanya Skariachan, Jessica Hall and Megan Davies. Editing by Michele Gershberg, Robert MacMillan, Dave Zimmerman)

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