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By Jeremy Glaser | 10-12-2010 02:36 PM

Three Retail Takeout Targets

As private equity begins flexing its muscles again, Morningstar's Pete Wahlstrom takes a closer look at three potential takeout candidates.

Jeremy Glaser: I'm Jeremy Glaser with Morningstar.com. There's been a lot of chatter recently about private equity and retail firms, Gymboree was the latest target. I'm here today with Pete Wahlstrom, our Retail Analyst to take a closer look.

Pete, thanks for joining me, today.

Peter Wahlstrom: Thanks for having me, Jeremy.

Glaser: So, do you think that this Gymboree deal was an isolated incident or is private equity really looking at the retail industry closely?

Wahlstrom: Year-to-date, we've seen a lot of activity, both rumor speculative and also some private equity firms coming in and snapping up some retail companies pretty quickly.

Glaser: So, what do you think is causing these big firms to take a look at these companies?

Wahlstrom: It seems as though it's a combination of items including low interest rates, some margin recovery as the U.S. economy recovers, as well as there's a lot of private equity money sitting on the sidelines at this point. The private equity firms need to put that capital to use instead of returning it to their equity stakeholders.

Glaser: What are some of the attributes of retail firms that would make them particularly attractive?

Wahlstrom: We would definitely look for some firms that have either low net debt or stable cash flows, and certainly there is an element of a top line growth story as well that private equity generally is interested in.

Glaser: So, Gymboree seems to have fit those. What are some other companies that you're seeing that seem like they'd also fit the bill?

Wahlstrom: Gymboree is one in the children's apparel space and there's another competing company Carter's, which is also a very large player there that has a retail as well as a wholesale distribution, and the company throws off a lot of cash and we view it as undervalued at this point.

Glaser: So that could be a name that even if it doesn't get bought out, might still be a good addition to the portfolio?

Wahlstrom: That's correct. We do see about 20% to 25% upside in that name as well.

Glaser: And then what about someone maybe outside of the children's apparel industry?

Wahlstrom: Barnes & Noble is an interesting story, in that the Board in August put out a strategic review announcement. So, the company is in the process of looking at private equity suitors. In addition, the Chairman owns roughly 31% of the shares. That's a company that throws off a lot of cash, does have low debt, but it's in an interesting position within a very difficult industry facing the likes of Amazon and Apple, as it continues to do some land grab in the digital space.

Glaser: Are there any other names that you think PE would be interested in?

Wahlstrom: Sure. Williams-Sonoma is another name that screens very well. The company basically has no debt. It's throwing off a lot of free cash. The company is very well positioned within the home improvement and home furnishing space. They have a lot of different brands across Williams-Sonoma, Pottery Barn, West Elm. They also have $1 billion digital online business, that's gaining share pretty dramatically. The company's margins are accelerating again as the top line is growing and the company in the last 24 months has cut out a fair amount of their cost structure.

Glaser: So, it sounds like the Gymboree deal is not an isolated incident and we're going to be hearing a lot about private equity in the coming months.

Wahlstrom: That's our view, and there are some outside market research firms that speculate that there might be upwards of $250 billion sitting on the sideline. And now, we're not looking for a blockbuster deal, but there are some below $10 billion market cap that we think would make very good targets.

Glaser: Pete, thanks so much for talking with me today.

Wahlstrom: Thanks, again. Thanks.

Glaser: For Morningstar.com, I'm Jeremy Glaser.

 

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