M&A Alerts, February 12, 2010

What a Difference a Year Makes

To further illustrate what we have been through, as measured by Standard & Poor's and reported by TMA, distressed debt indicators were down significantly from highs of late 2008. Methodologically, the S&P considers an issue distressed based on a market-determined parameter–if its option-adjusted spread exceeds 1,000 basis points. The number of issuers that meet this threshold according to their findings plunged since December 2008, and the U.S. distressed debt ratio is now in 2010 just below its long-term average of 15%. Nearly, 85% of all U.S. speculative-grade bonds (920 issues) were considered distressed in December 2008– or approximately $400 billion. As of December 2009, one year later that ratio fell to 15%–with only about $64 billion of debt, comprising some 193 issues, considered distressed by S&P.

As measured by select sectors, cumulative changes were recorded as follows:

Retailing: since Jan '07: -22.0%; since Jan '08: -3.7%

Auto: since Jan '07: -28.3%; since Jan '08: -33.4%

Capital Goods (which includes aerospace & defense, building products, construction & engineering, electrical equipment, industrial conglomerates and machinery): since Jan '07: -27.5%; since Jan '08: -31.4%

Hotel and Leisure: since Jan '07: -14.7%; since Jan '08: -6.8%

Technology (which includes communications equipment, computers & peripherals, electronic equipment, instruments & components, office electronics, semiconductors & equipment): since Jan '07: +3.5%; since Jan '08: +3.2%

Industrials Point the Way

As a way to help middle market dealmakers think about the macro economy, an overview of the industrials sector was given. According to TMA's findings, industrials--or companies that manufacture, produce or distribute goods or services--were impacted by the global recession as suppliers filed for bankruptcies; the potential collapse of key industries shook confidence; lean and vulnerable supply chain were exposed; company's encountered the inability to accurately forecast future production needs; the rise of short-term contracts came to fore; and an emphasis on variable cost structures, at expense of cost saving measures took hold.

In Other Broad News

For now, as most readers know, consumer confidence is increasing slightly. Yet, in our current economic state, consumer confidence continues to remain negative. Positively speaking, the job market is anticipated to stabilize this year. Meanwhile, inventories are likely to continue to shrink to adjust to lower sales levels.

Growth

Where's the growth? Well, growth is anticipated for the year in environmental and renewable energy sectors. As such, middle market dealmakers can expect to see an increase in industrials related to emerging sectors. And, according to Bloomberg News, the US GDP is expected to increase 2.7 % in 2010.

All that said, for middle market dealmakers, the credit and investment considerations are numerous. First, the good news, M&A activity is expected to increase. Although, financing will continue to be difficult to obtain. According to the National Association of Credit Management, "credit has started to become available to the manufacturing sector for the first time in over a year."

What this means, of course, is that strategic buyers with access to capital are well positioned to take advantage of opportunities. So, we at the M&A Advisor say: Go for it.

As all middle market dealmakers know, companies will look for synergistic opportunities; and divestitures will be active -- as companies focus on core operations. Meanwhile, distressed opportunities exist; however, opportunities at the very bottom have already been maximized. As many of you probably are aware, while some industrials did a good job of cutting costs to survive through the downturn, these firms are essentially "dead men walking" as they are not likely to be able to take advantage of the uptick in demand.

Finally, expect to see more deal flow from international corporations (which I have covered in previous comments in this column). For more on this topic, join us at our 4th Annual Distressed Investing Conference and Turnaround Awards Gala. Hope to see you there.

Michael J. Kollender is Managing Director and Head of Consumer & New York Investment Banking at Stifel Nicolaus & Company, Inc. Recently, Michael spoke to us about Filene's Basement Chapter 11 filing, and his client Syms Corporation's competition with Men's Wearhouse for the Filene's brand.

On June 18, 2009, Syms Corporation completed the acquisition of Filene's Basement, Inc. in Chapter 11 bankruptcy proceedings. Syms, a wholly-owned subsidiary, acquired the vast majority of the current operating Filene's Basement store leases, store fixtures and inventory. The Company is now focused on maintaining the Filene's Basement name and tradition. The total consideration for Filene's Basement amounted to approximately $65M, plus certain additional costs that were assumed by Syms.

The acquisition, however, was its own unique challenge.

As sales waned earlier in 2009, the 100-year-old chain announced plans to close 11 of its 36 stores, and warned in February of that year that it may need additional funding beyond its then current lending agreements. The fact that the nationally recognized chain was experiencing significant liquidity problems led its corporate parent, Retail Ventures, Inc. to sell the unit for no net proceeds to the Buxbaum Group, a firm specializing in corporate turnarounds and retail liquidations. That sale closed on April 21, 2009.

On May 4, 2009, a few weeks following the Buxbaum acquisition, Filene's Basement filed for Chapter 11 bankruptcy protection with the intent to sell all or part of its assets, as part of the bankruptcy proceeding. On May 15, the U.S. Bankruptcy Court approved a timetable for the auction and sale of Filene's Basement's assets pursuant to Section 363 of the Bankruptcy Code and named Crown Acquisitions, a real estate investment company, the "stalking horse" bidder, after offering to purchase the trade name and leases for 17 stores.

At the conclusion of the auction, held on June 5, Men's Wearhouse was named the winning bidder. On June 10, however, the Court overturned the auction results, and scheduled a new auction to be held on June 12, 2009. After a second auction lasting two days, Kollender and his team at Stifel Nicolaus won the bid for their client Syms, outbidding Men's Wearhouse and Crown Acquisitions, who formed a partnership to submit a joint bid. Syms gained final Court approval at a hearing held on June 17, 2009.

Regarding the competition, Kollender said, "Men's Warehouse was a formidable aggressive competitor. Clearly, if you look at their balance sheet, their market cap is significantly larger and has greater liquidity than Syms. I think, Syms really was able to win the bid because we were creative in the way we structured the transaction.
We were able to appeal to many constituencies. The bank really supported us, and so did the landlords; that ultimately led to a higher value that allowed us to win, and have Men's Warehouse pull out of the bidding. You also have to remember that Men's Warehouse won the first auction. The rarity in this case was that we went to court and had the first auction overturned and had it re-bid. Something you don't typically see in the bankruptcy process. The court had received a 363 sale and Men's Warehouse had not bid through the 363 process."

Yet the deal presented many further challenges for the deal team and required innumerable negotiations with many different parties over a short period of time. Syms and Kollender's deal team worked with numerous landlords to secure leases for targeted retail locations and negotiated a number of licensing agreements for leased departments within Filene's stores. One of the most challenging aspects of the deal was obtaining the necessary financing to not only consummate the acquisition, but also leave Syms with sufficient liquidity to operate its Syms concept while reinvigorating its newly acquired Filene's concept.

At the start of the process, Syms' existing credit agreement did not offer the Company the flexibility to make an acquisition of this nature and therefore, terms needed to be renegotiated. Additionally, Filene's was experiencing liquidity problems and had stopped paying vendors many weeks prior to bankruptcy. Though Filene's was no longer purchasing inventory, the company continued to sell merchandise and after a couple of months most units were operating at historically low inventory levels.

As this was Syms' first acquisition in its fifty year history, the banks needed to be convinced that the Company was capable of undertaking a complex integration in a less than favorable operating environment. Ultimately, after multiple rounds of negotiations, Syms was able to successfully renegotiate the terms of a new credit facility to allow for the acquisition of Filene's and provide capital to support the massive inventory purchases. To meet the terms, Syms was required to restock Filene's stores with fresh merchandise. According to Kollender, "Syms had never drawn on financing before... Which then we had to work with their bank to restructure to an asset based facility in a matter of weeks to allow for sufficient funding of the business."

To assist, Vornado Realty Trust also stepped in and provided $25M of the purchase price to terminate the venture's existing Downtown Crossing lease with Filene's Basement in Boston, as well as amended Vornado's lease, which was assumed by Syms at 4 Union Square South in Manhattan. Kollender reflected on the importance of the key partnership with Vornado, "Early in the process we realized that this transaction was going to be much larger than initially expected. So, we worked with Syms to identify the appropriate partners, and Vornado was at the top of our list because Vornado had certain leases they wanted back. We met with them and within 48 hours had an agreement that we would be a joint bidder in the process. We had and still have a wonderful relationship with Vornado. They were wonderful partners for Syms to work with."

Financing and partnership were not the only hurdles in closing this deal, in addition to obtaining the necessary financing, Syms was forced to spend a considerable amount of time repairing damaged relationships with vendors. The timing of the transaction, the tight lending environment and the retail climate posed significant challenges for the deal team. Syms was only made aware that Filene's was available for sale approximately five weeks before the company filed for bankruptcy and banks, still reeling from the credit crisis, continued to maintain tight lending standards. Additionally, many retailers were experiencing financial stress as consumer spending continued to decline.

In addition to providing Syms with a strong, well-recognized brand, Filene's Basement now offers Syms the opportunity to expand and diversify its national footprint. The addition of Filene's retail locations strengthens Syms' corporate presence in the Northeast and helps the Company penetrate markets, such as Ohio, in which Syms has historically had little presence. "From a strategic perspective the regional factor was very important to Syms. Syms is a regional player and Filenes' footprint laid out very well over Syms region. So, that was a major driver; that you would have a dominant player in the regions by combining Syms and Filene and be able to leverage the distribution center, and route trucks and shipping across the entire business, as well as human capital," says Kollender.

When asked about market share, Kollender had this to say, "You know, it's a massive market. The soft-lines market that Syms and Filene's primarily compete in is a substantial market. It's not that it is a growing market, but a huge market with a shift towards discounts and closeouts. So, there is plenty of room for growth within the market."

The acquisition of Filene's expands Syms reach by more than 70%, significantly increasing the Company's buying power and advertising efficiencies. Filene's also brings more than 2,000 supplier relationships to Syms, which should allow for further buying efficiencies, while presenting the Company with additional merchandising opportunities.

The transaction positioned Syms as a premier player in the off price retail space, but it has also salvaged the Filene's Basement name, tradition and brand integrity while providing for the continuation of the business as a going concern. And the deal team? Well, they were awarded the M&A Advisor's Corporate/Strategic Acquisition of the Year (Below $100mm).