IPO VIEW-Retailers test IPO market after two-year absence

* Vitamin Shoppe, two other retailers set IPOs

* IPO investors wary of highly leveraged retail chains

By Phil Wahba

NEW YORK, Oct 23 (Reuters) - After two years on the sidelines, a handful of retailers is getting ready to test the initial public markets again, emboldened by the stock market rally and a better consumer spending outlook.

But the companies must prove they can pull in customers despite the lingering economic slowdown, and must show low-debt balance sheets if they want to attract investors, according to bankers and analysts.

Vitamin Shoppe Inc (VSI.N), a North Bergen, New Jersey-based operator of 434 health supplement stores in the United States, is the first of three retail IPOs, all owned by private equity, set to go to market in the coming weeks.

Vitamin Shoppe next week will attempt to become the first brick-and-mortar retailer to go public in two years.

Consumers have sharply pulled back spending amid rising unemployment and the global financial crisis, curbing investors' appetite for IPOs by retailers in particular.

But consumers are beginning to spend again, and the S&P Retail index .RLX, which tracks retail stocks, is up 82 percent from lows hit last November.

"The coast is clear for high-growth, high-square-footage companies that have weathered the recession well," said Gregg Nabhan, a vice chairman at Bank of America Merrill Lynch's equity capital markets practice.

"The U.S. consumer will be looking to stretch his or her spending dollar, and we think that is a secular phenomenon" for the next several years, he said.

The last new stock in the United States by a brick-and-mortar retailer goes back to October 2007, when beauty products chain Ulta Salon, Cosmetics & Fragrance Inc (ULTA.O) went public with a $153.7 million IPO.

Vitamin Shoppe grew at an annual rate of 11.3 percent between 2005 and 2008, when it reached sales of $601.5 million. During that time, it opened 171 new stores, according to its prospectus.

But the company's high debt service costs, a legacy of many companies owned by private equity, may turn off investors. Irving Place Capital Management LP, which bought Vitamin Shoppe in 2002, owns 80 percent of the shares, a stake that will fall to 54.5 percent after the IPO.

"If they are spending too much on interest, they are vulnerable to any swing in revenues," said Francis Gaskins, president of the research firm IPO Desktop.

In the six months ended June 27, Vitamin Shoppe spent $7.7 million on interest. Gaskins said this was high in relation to the chain's $24.8 million in operating income.

The largest retailer in the IPO pipeline is the highly levered but highly profitable discount chain Dollar General Corp, backed by private equity firm Kohlberg Kravis Roberts & Co [KKR.UL]. The 8,577-store chain is expected to go public in a $750 million IPO in the next few weeks.

In the six months ended July 31, Dollar General spent $179.2 million on interest and had an operating profit of $458.1 million, as sales grew 13.3 percent from a year earlier to $5.7 billion.

WATCH THAT DEBT

A number of private equity-backed companies have had disappointing IPOs of late, as investors balked at heavy debt loads and IPO proceeds going to pay buyout firms rather than fund growth.

In a Morningstar research note last week, an analyst called the Vitamin Shoppe IPO "yet another private equity offload" and said the chain faced a "highly fragmented and intensely competitive" industry.

One fast-growing, relatively debt-free retailer expected to go public this year is youth clothing chain rue21 Inc, which operates 500 stores in the United States. In the six months ended Aug. 1, rue21's sales rose 33.3 percent to $233.1 million.

In contrast to the other retailers gearing up for IPOs, rue21's interest expense during that six-month period was just $297,000, on operating income of $14.1 million. The company is owned by funds advised by private equity firm Apax Partners LLP and BNP Paribas North America Inc.

The private equity firms behind any IPOs will need to check their expectations when they price their deals, given the challenges some recent IPOs have faced, Nabhan said.

"The investor is not going to push back on an IPO unless valuation and the structure of the deal are misjudged," he said.

Discount chains and others that offer bargains will likely lead the IPO charge, he added.

"Other IPOs will come from companies that are participating in the unwinding of the consumer bubble," he said. (Reporting by Phil Wahba; editing by John Wallace)