takeover defense: getting bigger and uglier

MW vs. JOSB

Men’s Wearhouse (MW)–yes, W-e-a-r–and Jos. A Bank (JOSB) , two publicly traded men’s clothing companies, are involved in a takeover struggle.

the companies

MW is larger, in terms of yearly profits, number of stores and market capitalization.

JOSB has just over half as many stores.  By most important measures–return on capital, return on equity, earnings growth, cash flow growth–it is the superior company.

action so far

JOSB got the ball rolling by making an unsolicited bid for MW last October.  MW reportedly thought about trying to buy shoe company Allen Edmonds (the stratefy of making itself bigger and less attractive) but opted to go on the offensive and bid for JOSB instead.  MW did so in November, and upped the offer last month.

This maneuver, although not exactly rocket science, apparently caught JOSB by surprise.  Its response…

Last week, JOSB announced that it intends to buy Eddie Bauer from Golden State Capital.  According to the New York TimesGGC purchased EB in a bankruptcy auction for $286 million in 2009 (EB’s second bankruptcy in a decade).

The price?  …$825 million in stock and cash.  In a separate move, JOSB also intends to repurchase in the open market the same number of shares issued to GGC .

When the dust clears,

JOSB will own EB and have the same number of shares outstanding.  But it will also have $340 million less in cash and $589 million in new debt.  If the JOSB presentation materials talk about any borrowings EB may be bringing with it, I can’t find where, so the actual amount of debt on its balance sheet may be higher.  JOSB is projecting interest expense of $40 million for 2014.

what’s going on?

JOSB says the Eddie Bauer purchase will boost the combined company’s earnings by 40% in 2014 and another 50% in 2015.  Wow!

But if that’s true, why did JOSB ever pass over EB and bid for MW first?  According to JOSB’s investment banker, Financo (in a Bloomberg Surveillance interview), it presented Eddie Bauer to JOSB as an acquisition candidate in early 2012!  Moreover, Financo touts EB as a superior acquisition choice to MW.

I have a more cynical view of the situation.  I should be clear, though, that while I’ve studied this industry extensively in other countries, I don’t know much about the ins and outs of either JOSB or MW.  Rightly or wrongly, I’ve regarded men’s clothing as too highly cyclical to be worth the trouble.

Anyway, in this case, I see two sources of added value to the acquirer:

–the positive effect of ending situations where an MW store and a JOSB store compete head-to-head, lowering income for both.  Store openings for all brands under the acquirer’s umbrella can be coordinated to avoid this in the future.

–the merged company doesn’t need two CEOs, or CFOs or virtually any other head office employee.  The same for regional supervisory people.   The budget for advertising and other marketing probably can be a smaller percentage of revenues, as well.  This is the main synergy I see in any acquisition of this type–the management of the acquiree all become redundant and lose their jobs.

The net result–intended or not–of buying Eddie Bauer would be to make JOSB $1.2 billion more expensive for MW.  It’s questionable to me whether “diversification” into the technical or casual apparel EB offers is something MW–or JOSB, for that matter–should want.  I find it hard to believe, despite JOSB’s projections of fabulous earnings gains, that making itself bigger and uglier isn’t the purpose of the Eddie Bauer bid.

Note, also, that there’s nothing in the EB acquisition that requires JOSB to tender for $300 million of its own shares at $65 each.  The only thing the tender does is to erase a huge chunk of cash from JOSB’s balance sheet–making it unavailable for a potential acquirer to use to pay for its bid.

After all, doing so is a standard tactic of takeover defense.

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