Uniting CK Should Pay Off For PVH Corp

By Stephen D. Simpson, CFA | November 05, 2012 AAA

The apparel and footwear sectors have been seeing more than their share of acquisition activity over the past year, as companies look to better leverage supply chains and distribution and better compete with overseas competitors. PVH Corp (NYSE:PVH) is paying a lot to bring Warnaco (NYSE:WRC) into the fold (and further consolidate the Calvin Klein brand), but this deal looks like a relative win-win, where both the acquirer and the acquired are making a smart deal.

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The Deal
PVH Corp announced that it had reached an agreement with Warnaco to acquire the latter company for a total consideration of roughly $2.9 billion. PVH is offering a combination of cash and stock ($51.75 per share in cash and about 0.18 shares of PVH) which, at the time of the announcement, valued Warnaco at $68.43, a 34% premium to last close. With the stock component of the deal and the positive reaction to the announcement, the value of the deal has improved since then and could be volatile prior to close.

At the original price, PVH was offering about eight times the average EBITDA estimate for Warnaco in 2013. While that's a premium to recent apparel deals, PVH should achieve above-average synergy potential with this deal and the premium seems reasonable.

SEE: Mergers And Acquisitions: Understanding Takeovers

Why Buy Warnaco?
The most obvious rationale for PVH to buy Warnaco is to recapture more of the value of the CK brand. Warnaco was a very large licensee for CK, accounting for more than 40% of PVH's CK royalty revenue. With that coming in-house, PVH should be able to reap accelerated revenue capture and margin expansion. PVH should also be able to unwind millions of overlapping SG&A expenses and redundant corporate infrastructure.

But that's not the full extent of the potential benefit. Acquiring Warnaco not only gives PVH access to brands such as Speedo and Olga, but also direct operations in countries such as Brazil, China and Korea. Adding in Warnaco should roughly double PVH's exposure in Asia and Latin America. What's more, this deal should accelerate PVH's attempts to expand overseas distribution of the Tommy Hilfiger brand, while the existing European channels for Tommy Hilfiger should also be lucrative for Warnaco's CK business.

Even with this deal, Coty and G-III Apparel (Nasdaq:GIII) will maintain their CK licenses in areas such as fragrances, outerwear, women's suits and so on.

A Shrinking Pool
If you look at the actions of other companies such as VF Corp (NYSE:VFC), Ralph Lauren (NYSE:RL) and Wolverine (NYSE:WWW) lately, there's nothing really unusual about this deal. Scale, particularly global sourcing and distribution, is becoming increasingly critical to apparel and footwear makers, and the cost (and risk) of building new brands really does incentivize ongoing consolidation.

With that in mind, I would think companies such as Oxford Industries (NYSE:OXM) and Perry Ellis (Nasdaq:PERY) will increasingly find themselves facing the choice of getting bigger or bowing out. I'll also be curious to see how, or if, retailers respond to this consolidation; retailers such as Kohl's (NYSE:KSS) don't need or want stronger suppliers to bargain with, and this may prompt more retailers to go the route of J.C. Penney (NYSE:JCP) (which acquired Liz Claiborne) and attempt to make deals of their own to enhance their store brands.

SEE: The Wonderful World Of Mergers

The Bottom Line
As I said before, I believe this is a relatively rare win-win proposition for both PVH and Warnaco. While some Warnaco shareholders may feel that the potential synergies PVH can reap from this deal should argue for a higher bid, the fact is that there isn't another company out there that could reap the same benefits, so there's no reason for PVH to essentially bid against itself and pay more. For PVH Corp shareholders, this deal will increase the risk for the company (as it will no longer enjoy the same low-risk royalty streams), but the long-term growth and margin leverage potential more than outweighs that risk.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

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