Can Aeropostale (NYSE:ARO) be the next in the list of retail acquisitions following Hot Topic, Teavana Holdings and Nike’s (NYSE:NKE) Cole Haan?  According to Jefferies Group LLC and others, Aeropostale’s lack of debt and solid cash flow generation could be attractive to private equity suitors. 
The retailer has been struggling since the recession due to an imbalance in its product mix and poor response to fashion changes. In the recently concluded quarter, the retailer reported its lowest profit in a decade due to its existing problems and the weak holiday season. By going private, the retailer may have more flexibility and face less scrutiny as it tries to revive growth by revamping its women’s business (which constitutes 66% of overall revenues), reinforce its direct-to-consumer channel and expand its P.S. from Aeropostale brand. It is a matter of execution and potential buyers may see a long term opportunity here.
Valuation & Growth Opportunities Are Appealing
According to Bloomberg, during the period of October 2011-October 2012, Aeropostale’s valuation was 9.6 times its free cash flow. The figure was the lowest among its competitors, thus making it a potentially attractive acquisition target.  While it may appear that Aeropostale has limited room to grow in the U.S., international markets remain unexplored, and Aeropostale’s pricing could resonate well with the value conscious consumers in emerging markets.
In the U.S., the retailer has a lucrative business prospect in the form of P.S. from Aeropostale – its kids’ apparel line that has seen good customer response. Aeropostale currently operates only 100 such stores and there exists an opportunity to expand them throughout the U.S.  Additionally, Aeropostale does not have any debt, which raises the possibility of financing a deal. 
Why Aeropostale’s Stock Price Has Remained Low?
Aeropostale’s performance has remained weak due to the imbalance in its product mix. During the recession, the retailer benefited from its basic product offerings at low prices. Its revenue per square foot increased at an average annual rate of 6% during the period of 2008-2009.  However, as the economic conditions improved, Aeropostale’s pricing advantage was not enough to drive its sales and its customers shifted to other fashionable brands such as American Eagle Outfitters (NYSE:AEO) and Abercrombie & Fitch (NYSE:ANF). 
Aeropostale failed to arrest this shift due to low proportion of fashion-based apparel in its merchandise. The problem still exists, and the retailer’s fashion-based apparel products such as women’s knit tops have received poor customer response.  The revenue per square foot has declined at an average annual rate of 4% during the last three years. Moreover, Aeropostale hasn’t optimally developed its direct-to-consumer channel. As a result, from a high of $30 in late 2009, the company’s stock price plummeted to $14 by the end of 2012. The weak holiday season in the U.S. further disrupted Aeropostale’s efforts to revive its growth.
How Is Aeropostale Addressing Its Core Problem?
Aeropostale’s main problem has been its over dependence on basic apparel and low proportion of fashion-based apparel in its merchandise. As a result, the retailer’s women’s business (which is also its main business) has been the weakest performer since the demand for fashion is comparatively more among women.
In Q4 fiscal 2012, while revenues for the men’s business were down by 4%, women’s business saw a decline of 10%. The retailer is taking a number of steps to address this problem. For starters, it hired new talents as head of design and women’s merchandise, to specifically focus on this issue. Apart from this, the retailer is looking to increase the penetration of fashion-based apparel in its overall merchandise mix and launch new collections.  It is balancing the product mix of tops and bottoms to negate inventory hangover issues. As a valuable initiative on this front, Aeropostale is lowering the space allocated to basic products in its stores and is adding more fashion-focused products.  The retailer believes that the impact of these strategies will be visible in the upcoming summer collection.
Our price estimate for Aeropostale stands at $15, implying a premium of 10% to the market price.Notes:
- Sycamore Partners to Buy Hot Topic for $600 million, Deal Book New York Times, Mar 7 2013 [↩]
- Aeropostale Seen as Next Hot Topic on discount, Bloomberg, Mar 19 2013 [↩] [↩]
- Aeropostale’s SEC filings [↩] [↩]
- Aeropostale Seen as Private Equity Buyout Target, Business Of Fashion, Mar 18 2013 [↩]
- Aeropostale Between a Rock and a Hard Place, Seekingalpha, Jul 10 2011 [↩]
- Aeropostale Q1 fiscal 2011 earnings transcript, May 19 2011 [↩]
- Aeropostale Q4 fiscal 2012 earnings transcript, Mar 14 2013 [↩] [↩]