Still No Potential Suitors For Aeropostale And Here’s Why

Aeropostale‘s (NYSE:ARO) value has diminished by more than 90% over the last four-and-a-half years, due to its consistent poor financial performance. It was among the more popular apparel brands in the U.S. during the economic downturn, as it offered basic products such as logo t-shirts, jeans, sweaters and hoodies at affordable prices. However, once the economy started recovering, U.S. buyers shifted to relatively expensive brands with better fashion content, while Aeropostale remained focused on its logo business. As a result, it lost a number of its customers to retailers such as Abercrombie & Fitch (NYSE:ANF), Gap (NYSE:GPS) and Urban Outfitters (NASDAQ:URBN), and never recovered. The retailer’s comparable sales declined 9% in 2011, 4% in 2012, 15% in 2013, and more than 13% during the first three quarters of 2014.

As Aeropostale’s stock fell below $10 towards the end of last year, speculations of a probable buyout surfaced. Sycamore Partners, who is known to acquire troubled retailers, raised its stake in the company, referring to it as an attractive investment. An active investor began pushing Aeropostale’s management to consider a sale, after which the company adopted a poison pill plan to shield itself from a hostile takeover.

While many expected the retailer would eventually go private, a strategic or a financial buyer never came forth with an offer, suggesting that Aeropostale wasn’t really an attractive acquisition target. Its high operating lease expenses and weak cash flow generation capabilities seem to have discouraged potential suitors.

Our price estimate for Aeroposatle is at $6.38, implying a premium of over 140% to the current market price.

See our complete analysis for Aeropostale

Why a Buyout Appeared Inevitable

Last year, private equity firm Sycamore Partners acquired an 8% stake in Aeropostale, stating it was an attractive investment. Soon after, activist investor Crescendo Partners sent a letter to the company’s board suggesting that the company should consider selling itself. While these events indicated that the retailer might go private, its adoption of the limited term stockholder rights plan suggested otherwise. Later, it was revealed by some sources close to the company that Aeropostale is seeking assistance from investment banks to deal with investor pressure.

Earlier this year, Aeropostale signed an extensive agreement with Sycamore, that provided the retailer with the much needed cash. Under the terms of the agreement, Aeropostale received $150 million from the private equity firm in exchange of 5% of its shares. Aeropostale desperately needed the money as it was burning cash at a rapid pace and was finding it hard to raise capital in the public market. Following the deal, Sycamore’s stake in Aeropostale increased to 14% and its MD Stefan Kaluzny joined the retailer’s board. The private equity firm received the right to appoint another director from Sycamore and an independent member (which was to be mutually agreed upon) to the retailer’s board. At this point, it became evident that Sycamore would pitch a buyout offer at some stage, given its history with troubled retailers.

Why There Have Not Been Any Offers

Aeropostale’s stock hit a record low of $2.24 in December 2014 and is currently trading at $2.64. Its resurrection strategies have failed to prevent customers from shifting to other brands, which has led to significant losses. The company is even closing its under-performing stores to dilute these losses and reduce its operating lease liabilities. Aeropostale reported a total loss of $192 million for the nine month period ending on November 1 2014, but managed to protect its cash reserves as it received a net of $137 million from financing transaction with Sycamore and borrowed $75 million under revolving credit facility.

However, it is evident that the company cannot sustain such huge losses for long, because it now has just over $100 million in cash and cash equivalents. Also, Aeropostale’s strategies to bring customers back are not working out, which negates the chances of any near-term turn around. Therefore, a potential suitor might not want to lay its hands on Aeropostale, unless they see a possibility of significant returns on their investments, which seems unlikely at the moment. Moreover, if strategic or a financial buyer acquires the company, it will have to deal with the retailer’s huge operating leases. Aeropostale currently has total contractual obligations of over $1 billion, which is enough to explain why no one has come forth with an offer for the company, even when its current market cap is just $200 million.

We believe that buying Aeropostale for a small premium would not be difficult for Sycamore Partners, but running its business afterwards will be an arduous task. This is why it has not decided to take complete control of the company, and instead is working closely with the management.

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