Apparel retailers don't make good private equity targets: Analyst

When hedge funds Engine Capital and Red Alder argued that Ann Inc. could be worth $65 a share, the Ann Taylor parent added its name to a growing list of apparel retailers reportedly in the crosshairs of private equity firms.

But Wells Fargo analyst Paul Lejuez issued a counterargument in a note to investors Wednesday, saying he doesn't think Monday's announcement, or similar headlines of potential transactions involving Abercrombie & Fitch, Chico's or Aéropostale, will come to fruition.

Window display of an Ann Taylor store on Fifth Avenue in New York.
Scott Mlyn | CNBC
Window display of an Ann Taylor store on Fifth Avenue in New York.

"Our bottom-line thought is that we do not believe these companies are good candidates for activists/private equity," he said.

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Among his list of reasons, Lejuez pointed to:

  • Sales volatility in the sector, as retailers' performance can "experience wild swings based on hitting and missing fashion trends."
  • Lease obligations, which sometimes get overlooked because many stores in this sector have no debt on their balance sheets.
  • The competitive landscape, including increasingly promotional holidays and pressure from fast-fashion retailers.
  • E-commerce spending, which is only in "the beginning stages" and will not offer a strong return on investment. Instead, it's merely a way to stay relevant, he said.

Changing face of retail
Changing face of retail   

Perhaps most importantly, Lejuez pointed out that these retailers' struggles are not the result of mismanagement—they're pegged to a need for more sales. Ann, for example, was early to trim its store count and size and has managed expenses well, he said.

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"There is often a tendency to assume a management team is doing something wrong when a business is pressured," he said. "These companies are not mismanaging the 'back of the house' type of stuff. …They just need more top line."

In response to Engine Capital and Red Alder's presentation, Ann said its board "continues in a very deliberate manner and on an informed basis to consider and determine the courses of action that are in the best interests of all of its shareholders."