Bloomberg ran an article April 29 speculating that Rue 21 (NYSE:RUE), Abercrombie & Fitch (NYSE:ANF) and Aeropostale (NYSE:ARO) are all possible private equity targets. Analysts believe that given the high number of deals that took place in 2012--38 valued at $5.7 billion--many more will be forthcoming in 2013. Of the three, I'll weigh in about which company is most likely to walk down the aisle into the arms of private equity firms such as Blackstone (NYSE:BX) and Kohlberg Kravis & Roberts (NYSE:KKR).

Discount Brokers Comparison: Your one-stop shop for finding the perfect broker for your investments.

Rue 21
Apax Partners originally invested in Rue21 in 1998 through Saunders Karp & Megrue (SKM), a middle-market buyout specialist that it merged with in 2005. Rue21 then hit a rough patch in 2001, was forced into bankruptcy in February 2002, and emerged from bankruptcy in May 2003. Investing approximately $52 million since 1998, its November 2009 IPO (SKM didn't sell any shares) and subsequent secondary offering in March 2010, brought the private equity firm $180 million in net proceeds and a realized profit of $128 million. Since then it has maintained and added to its 29.3% ownership interest, which is now worth approximately $222.2 million. That's an annualized return of 14.6%. While it's good, it's not the kind of return most private equity firms are looking for.

Bloomberg's article makes reference to the fact that Rue21's lack of debt combined with significant free cash flow could persuade private equity firms to offer as much as a 50% premium on its current stock price of $31.30. At $47 per share, Apax Partners would be looking at an annualized return of $16.5%. Better, but still less than what most private equity firms expect when doing a buyout. Ultimately, I don't see anything in its current or future performance that will motivate other private equity firms to make a bid.

The odds of a buyout: 25%

SEE:How An IPO Is Valued

Aeropostale
The teen retailer's financial performance over the past couple of years has been anything but stellar. Hitting a high of $32.24 in April 2010, it's been downhill ever since. Back then its operating margin was 38%. Fast-forward two years and they're down below 25%. Like Rue21, it has no debt and almost $3 per share in cash. Its cash return, which is defined as free cash flow plus interest expense divided into enterprise value, is 8.5%.

If a private equity firm offered a 50% premium on Aeropostale's stock it would mean a transaction value of $1.66 billion. With a standard 30% equity downpayment, it would need $1.16 billion in debt in order to complete the acquisition. With interest rates of 7%, its annual interest expense would be $81 million. Its free cash flow in fiscal 2013 was $72.5 million, which means it either needs to pay less for the company, borrow less, or use some of the $232 million in cash on Aeropostale's balance sheet to cover interest expense overages in the short-term until it can improve its margins. This to me seems to be a much better fit for private equity firms.

The odds of a buyout: 50%

SEE: How To Invest In Private Equity

Abercrombie & Fitch
The once-hot specialty retailer has a margin problem much like Aeropostale. As recently as fiscal 2008, its operating margin was almost 20%, more than double the 8.3% margin it achieved in fiscal 2012. Macquarie analyst Liz Dunn believes Abercrombie is ready to start improving its margins and has set a 12-month target price of $63 per share, 28% higher than its current share price of $49.16. Dunn has stated, "The stock is inexpensive relative to its own historic multiple and that of the group … Expectations are low and the company has significant catalysts to drive future sales and earnings."

While doing a deal for Abercrombie would be the most expensive of the three options mentioned in this article, it currently has the highest cash return at 10.7%, meaning any kind of margin improvement over the next couple of years would enable a buyer to pay down the debt relatively quickly. In addition, regardless of Abercrombie's past sexist ways, its brand is clearly the strongest of this particular trio.

The odds of a buyout: 50%-75%

Bottom Line
At least one of these specialty retailers will be taken private in the remaining eight months of the year. My bet is it will be Abercrombie & Fitch. 

At the time of writing, Will Ashworth did not own any shares in any company mentioned in this article.

Related Articles
  1. Investing Basics

    What Is Private Equity?

    This investment vehicle attracts wealthy investors to increase the value of portfolio companies.
  2. Fundamental Analysis

    A Primer On Private Equity

    Private equity investing is becoming more accessible for individual investors; find out how you can get involved.
  3. Mutual Funds & ETFs

    Learn The Lingo Of Private Equity Investing

    Because of the non-public nature of private equity, it can be difficult to the learn the lingo. We break it down here.
  4. Professionals

    Chinese Slowdown Affects Iron Ore Market

    The Chinese economy's ongoing slowdown is having a major impact on iron ore demand.
  5. Investing Basics

    Why do Debt to Equity Ratios Vary From Industry to Industry?

    Obtain a better understanding of the debt/equity ratio, and learn why this fundamental financial metric varies significantly between industries.
  6. Active Trading Fundamentals

    The Biggest Private Equity Firms in San Francisco

    Learn about some of the larger private equity firms with a presence in San Francisco, including KKR, the Blackstone Group and Warburg Pincus.
  7. Active Trading Fundamentals

    The Biggest Private Equity Firms in Los Angeles

    Learn why Los Angeles is a thriving market for private equity, and identify the five largest private equity firms operating in the city.
  8. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  9. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  10. Mutual Funds & ETFs

    ETF Analysis: iShares Morningstar Small-Cap Value

    Find out about the Shares Morningstar Small-Cap Value ETF, and learn detailed information about this exchange-traded fund that focuses on small-cap equities.
RELATED TERMS
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Profit Margin

    A category of ratios measuring profitability calculated as net ...
  3. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis ...
  4. Debt Ratio

    A financial ratio that measures the extent of a company’s or ...
  5. Middle Market

    Definition of middle market
  6. Fast Fashion

    Definition of "fast fashion."
RELATED FAQS
  1. What is the formula for calculating compound annual growth rate (CAGR) in Excel?

    The compound annual growth rate, or CAGR for short, measures the return on an investment over a certain period of time. Below ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. When does the fixed charge coverage ratio suggest that a company should stop borrowing ...

    Since the fixed charge coverage ratio indicates the number of times a company is capable of making its fixed charge payments ... Read Full Answer >>
  4. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  5. What is the difference between the return on total assets and an interest rate?

    Return on total assets (ROTA) represents one of the profitability metrics. It is calculated by taking a company's earnings ... Read Full Answer >>
  6. How can a company execute a tax-free spin-off?

    The two commonly used methods for doing a tax-free spinoff are either to distribute shares of the spinoff company to existing ... Read Full Answer >>

You May Also Like

COMPANIES IN THIS ARTICLE
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!