After falling out of fashion with investors in recent months, the apparel sector is preparing for a makeover that may include mergers.
Facing a stagnant market, clothing companies have been expanding during the past several years through a series of small and medium-size acquisitions. But as the retail industry continues a wave of consolidation, apparel makers are poised to accelerate their acquisition activity as a way to increase their negotiating clout with the new retail giants.
Industry heavyweights such as VF Corp., Jones Apparel Group Inc., Liz Claiborne Inc. and Polo Ralph Lauren Corp. are scouting for niche brands and products to add to their already-sizable offerings.
"You should assume that every merger idea, big or small, is on our radar screen," said Paul R. Charron, chairman and chief executive of Liz Claiborne, which had revenue of $4.6 billion last year.
Many believe it is only a matter of time before one or more of the more-than-one-dozen U.S. apparel companies with annual sales in excess of $1 billion try to increase their size significantly with a single move.
"Over the next year, you'll probably see a mega-acquisition. You'll probably see two of the big guys come together," said Marc Cooper, a managing director at Peter J. Solomon Co., a New York investment bank.
Companies are casting about as their share prices show signs of fatigue. The Dow Jones Clothing & Accessories Index has surged 42 percent in the past two years but is up a modest 3 percent in 2005. (That still is better than the broader market, where the Standard & Poor's 500-stock index is down slightly for the year, and the Dow Jones Industrial Average is down 2 percent.)
Investor interest has cooled for a number of reasons. Apparel prices in the U.S. have fallen each of the past six years, according to the Bureau of Labor Statistics. S&P's credit-ratings unit estimates that apparel sales will expand only 2 percent this year in dollar terms, or a little more than half the pace of the broader economy.
Rapid consolidation in the retail sector is putting further pressure on vendors as the new store giants have greater clout to set sales terms. Following Kmart Holding Corp.'s acquisition of Sears, Roebuck & Co., Federated Department Stores Inc. agreed in February to acquire May Department Stores Co., creating a retail giant with nearly 1,000 stores. More retail tie-ups are expected, making pricing negotiations even tougher.
Robert Drbul, an analyst at Lehman Brothers, thinks apparel companies would be wise to think big. "I'm of the opinion overall that they need to do something to better position themselves for growth, but also for survival," he said, adding that the leading players should be thinking in terms of $6 billion mergers instead of $100 million acquisitions.
The need for a shake-up may be most pressing at Kellwood Co., which has about $2.5 billion in annual sales but has watched its share price sink more than 20 percent this year. Kellwood's midmarket brands have lower profit margins than do its larger competitors and are seen as particularly vulnerable to the Federated-May union amid signs that the combined retailer will go more upscale.
Kellwood Chief Executive Robert C. Skinner Jr., who succeeded Hal J. Upbin as Kellwood's chief executive officer earlier this month, said on a conference call this month that the company will broaden its acquisition efforts as it hunts for new brands to reverse a recent slide in revenue. Kellwood, which has a market capitalization of about $700 million, last year acquired Phat Fashions LLC, the hip-hop label created by Russell Simmons, for an estimated $140 million plus a share of future revenue.
Industry trackers, meanwhile, speculate about a potential merger of interests between Warnaco Group Inc., which licenses the Calvin Klein jeans business, and Phillips-Van Heusen Corp., owner of the various Calvin Klein trademarks. Both companies, which each have a market value of about $1 billion, declined to comment on the speculation.
Several vendors are flush with cash and should have more on hand to put to use in the coming months. Virginia Genereux, an analyst at Merrill Lynch, said in a report last month that Jones Apparel "may become more aggressive in pursuing acquisitions than management has recently indicated" after the company expanded a revolving line of credit by $250 million.
A Jones executive said the company took advantage of "optimal" financing conditions and that nothing should be read into the larger credit line. Still, when it comes to acquisitions, "we consistently keep our eyes open," added Anita Britt, executive vice president, finance.
VF, the world's largest apparel company with $6.1 billion in revenue last year, expects to generate around $550 million in cash flow in 2005 and has a $750 million revolving-credit facility. It is "looking very actively" for potential acquisitions, said Cindy Knoebel, a company spokeswoman.
In April, VF completed its acquisition of surf-inspired footwear maker Reef Holdings Corp., which had $75 million in sales last year. This year, VF closed its purchase of Holoubek Inc., apparel licensee of Harley-Davidson Motor Co. with more than $40 million in annual sales. Last year, VF shelled out $396 million to corral Vans Inc., which is popular with young skateboarders and snowboarders.
Industry participants also think that deep-pocketed private-equity funds, attracted by strong cash-flow generation and discounted share prices, could swoop in and acquire a big apparel company before too long. Warburg Pincus and Texas Pacific Group plunked down $5.1 billion this year to buy luxury retailer Neiman Marcus.
By Mike Esterl, The Wall Street Journal
