R3: WAG/DRD: Oink Oink

R3: REQUIRED RETAIL READING

February 17, 2010

The history on Duane Reade is comical. I’d be laughing if it did not destroy capital for real investors along the way. If Oak Hill is willing to bail and realize a -45% loss, what does that say about everything else in the pipe?  As we’ve been saying, sell these pigs while you can. The window won’t be open forever.

TODAY’S CALL OUT

Ok… let me get this straight…

First, Duane Reade comes public.

Then it dirties up the P&L at the expense of shareholders.

Then a management-led buyout occurs at depressed prices.

Then Oak Hill and banker du jour convince the 800-lb gorilla (Walgreens) to take advantage of an all time high in the ‘Piggy Banker Spread’ (2s to 10s) to get paid on yet another billion dollar deal that should not be a financial reality.

This madness is so unsustainable.

More Detail on the Timeline

1998: After 6-years under Bain’s umbrella, Duane Reade goes public in 1998 at $20. Peaks 6-9 months later in the $40s.

2001: DRD takes a big hit post 9/11 (where DR has an overwhelming presence). A vey tough draw…

2002-‘03: Company rebuilds, but also front-loads expenses thereby cutting margins in half, and keeping the stock in the teens throughout the economic rebound.

2004: $774mm Oak Hill partners up with DRD management to buy the company for $774mm, or $16.50ps. They double DRD’s debt to $500mm.

2005-‘09: DRD proves to be too levered to navigate through the recession. Loses approx $350mm due to weak ops and elevated debt payments.

2010: Announces sale to WAG for $1bn in cash.

So let’s tally up the scoreboard.

Investors: The only long investors that made out big at any time during DRD’s public history were the ones who were allocated shares in the 1998 IPO at $20 and saw it rise over 6 months to $45. Aside from that, investors largely had negative returns across longer-term durations.

Oak Hill and Management: $774mm plus about $350mm in cumulative losses. Not a very impressive cost basis, boys.

Sure, that might just seem like a -11% return over 5-years – not terrible for this environment.

But there’s this thing called leverage. After accounting for which, the return is -45%.

All of this is hindsight – and Walgreen’s problem now.

But what does this say about the future?

PUNCHLINE

If Oak Hill is willing to bail and realize a -45% loss, what does that say about everything else in the pipe?

As we’ve been saying…sell these pigs while you can. The window won’t be open forever.

LEVINE’S LOW DOWN 

  • In an effort to pre-empt weak traffic and poorly identified fashion trends, Abercrombie noted that gross margins were adversely impacted in 4Q by markdowns taken on Spring merchandise that will now go straight to clearance or outlet stores. While it is never a good thing for a non-price driven brand to take such measures, we note that this is a big step for management to take their lumps up front rather than wait until finding out the goods just did not sell well. It appears that management is realizing that the first markdown is always the cheapest…
  • Fossil management indicated that innovation and new product introductions continue to resonate well with consumers. As a result, these products are commanding higher price points and little price resistance by consumers. In fact, Fossil’s best-selling styles, which are normally around $75, are currently priced at $95 and $105. As a result, the company is seeing healthy increases in average unit retails, even with challenging economic headwinds.
  • While there were some small signs of inflation towards the end of the quarter, Whole Foods noted that inflation will not be a major factor for the company over the next few quarters. At most, management believes inflation could be 100 to 150 bps over the balance of the year. Overall, deflation is also no longer a major factor for the company. The company also continues to benefit from opportunistic buying in areas such as natural meats where supply has recently outstripped overall market demand.

MORNING NEWS


General Growth Says Simon Offer Low, Invites Bidders - General Growth Properties Inc. said a $10 billion takeover offer from rival Simon Property Group Inc. is too low and it will invite others to make bids as it considers options for emerging from bankruptcy. General Growth plans to provide information on the company, including financial projections and data on its shopping malls, to those interested in making bids. Materials likely will be sent out by the beginning of next month, with indications of interest due back within four weeks, the Chicago-based mall owner said today in a statement. “We believe the information we would provide to you as part of this process will enable you to better understand the company, get to a higher valuation, and provide a fully documented offer,” General Growth Chief Executive Officer Adam Metz said today in a letter to Simon chairman and CEO David Simon. The letter was included in today’s statement. Simon offered to buy General Growth for more than $10 billion and combine the biggest U.S. mall owners. About $9 billion of the bid is in cash, Indianapolis-based Simon said in a statement today. General Growth shareholders would get about $9 a share, including $6 in cash, and unsecured creditors would be repaid in full for about $7 billion. Simon said it made its offer public after receiving “no substantive” response from its rival.  <bloomberg.com>

Express Plans IPO - Express Parent LLC, the owner of Express specialty apparel stores, said in a regulatory filing Tuesday that it plans to raise as much as $200 million in an initial public offering. Express became a stand-alone business in 2007 when private equity firm Golden Gate Private Equity Inc. paid $602 million to acquire a 75 percent stake in the chain from Limited Brands Inc. The Securities and Exchange Commission filing said proceeds from the IPO would be used to prepay debt due in 2015, but did not provide details on an IPO date or how many shares would be offered. The total debt is $416.9 million. Teen chain Rue21 and discounter Dollar General both had IPO’s in November. VS Holdings Inc., which operates Vitamin Shoppe stores, went public in October. Express, which has been in business more than 30 years, is the sixth largest specialty retail apparel chain in the U.S, according to the filing. The company targets men and women between the ages of 20 and 30 and operated 573 stores with average square footage of 8,700 as of Jan. 30. The filing said the retailer plans to open on average 30 new stores in the U.S. and Canada every year for the next five years.  <wwd.com>

Puma Launches Sports-Infused Mobile Phone - Puma launched its first mobile phone, named the Puma Phone, featuring a number of sports-related features, including applications for runners and cyclists that let them keep track of speed, distance and pace. The phone can also keep track of the number of steps taken and the number of calories burned. A solar panel on the back of the phone can be used to charge it, and it has a 2.8-inch touch screen on the front. The device was unveiled Tuesday at the Mobile World Congress. Among the unique features are a timer that looks like an analog stopwatch, a compass designed to look like something off a yacht and a music player that looks like a record player. The feature lets users spin and scratch a virtual record. More standard features include a 3.2-megapixel camera with an LED flash, A-GPS (Assisted-GPS) and an FM radio. It can be used to surf the Web using HSPA (High-Speed Packet Access) at up to 7.2M bps or 2.9M bps, according to Puma. Puma's first smartphone will be available in Europe first  most other parts of the world soon thereafter. The U.S. launch is uncertain. Pricing also wasn't announced. The device is manufactured by Sagem Wireless and is based on a proprietary operating system. <sportsonesource.com>

PacSun Taps Christine Lee to Succeed Cunningham - Pacific Sunwear of California Inc. has snagged former Urban Outfitters Inc. executive Christine Lee to serve as its senior vice president and general merchandise manager of juniors’ merchandising and design. She succeeds Brad Cunningham, who left the company a few months ago, according to a spokeswoman. In her new role, Lee will oversee all buying, design and merchandising for the juniors’ apparel and accessories offered in the company’s nearly 900 PacSun stores as well as online. “Christine’s expertise in fusing customer insight, fashion trends and brands will enable us to create excitement in our stores and a stronger connection to our female customers,” said Gary Schoenfeld, president and chief executive officer of the Anaheim, Calif.-based chain. “With her previous successes in growing both apparel and accessories, Christine will be instrumental as we reestablish PacSun as a favorite destination for fashion, brands and California-inspired product.” Lee spent nearly 20 years with Urban Outfitters working her way from sales associate to general merchandise manager of women’s apparel and accessories, urban renewal and design, a $300 million business.  <wwd.com>

Stage Stores Appoints Chief Merchant and COO - Stage Stores, Inc. named Richard Maloney chief merchandising officer and Edward Record chief operating officer. Both Maloney and Record will report to Andy Hall, President and CEO. Maloney, 60, joined Stage Stores in October 2008 as the President and Chief Operating Officer of the South Hill Division, headquartered in South Hill, Virginia. Prior to joining Stage Stores, Maloney's 32 year retail career included seven years as President and CEO of the Meier and Frank division of Macy's. As Chief Merchandising Officer, Maloney will oversee all of the merchandising, planning and allocation functions of the Houston Division. In addition, the Chief Operating Officer of the South Hill Division will report to Maloney. <sportsonesource.com>

Dollar General Waltzes Bobby Brooks Into Walmart Territory - Dollar stores are unlikely fashionista destinations, but Dollar General (DG) wants to change that idea. Can its down-home style re-occupy the retail space that Walmart (WMT) and other ex-discounters are abandoning? Dollar General is  getting set to launch the Bobby Brooks line of apparel in two collections later this year–one for women; the other for girls. To hype the launch, the retailer is holding a model search among its employees. The association of Bobbie Brooks with Walmart is germane because Dollar General has aspirations to become more like what Walmart used to be. The company, which has almost 9,000 stores in 35 states, has even been teasing Walmart a bit lately. Dollar General issued an announcement about adding 5,000 jobs shortly after Walmart announced that it was laying off about 11,000 employees. <bnet.com>

Creditors Approve The Walking Co. Reorg Plan - The Walking Company Holdings, Inc. said that the unsecured creditors committee, established as a result of the company's voluntary filing for chapter 11 bankruptcy protection, has agreed to support the company's plan of reorganization filed last week and not pursue other alternatives. "With this positive result, we are now looking to emerge from chapter as early as mid April," stated Andrew Feshbach, CEO of the Company. Working closely with its bank, landlords, vendors, and shareholders, the company has been able to restructure its balance sheet and long-term financial obligations. As a result, the company submitted a reorganization plan on February 2, 2010 to keep 207 of its 214 current store locations open and pay off all of its debts and future obligations to trade creditors.  <sportsonesource.com>

Textile And Apparel Trade Deficit Shrunk In 2009 - Year-end data released by the U.S. Department of Commerce show that the textile and apparel trade deficit fell by 13 percent in 2009. Manufacturing industry trade officials say, however, that the decline was due to the collapse of the U.S. economy rather than any long-term improvement. Commerce department data show the textile and apparel trade deficit amounted to $74 billion based on imports of $90 billion and exports of $16 billion. China accounted for $36 billion of the U.S., imports and only $848 million of U.S. exports, resulting in a relatively minor drop of 4.5 percent in the trade deficit. Apparel imports from the Caribbean nations, which often contain yarn and fabric made in the United States, amounted to $7 billion, a decline of 17 percent. U.S. trade with the North America Free Trade Agreement countries -- Canada and Mexico -- show $9.4 billion in imports, a decline of 11 percent; and $8.4 billion in exports, a drop of 7 percent from 2008. U.S. exports to countries with which the United States has free trade agreements remained a little stronger, dropping by only 3 percent from 2008. <textileworld.com>

Nordstrom, Target Lead In Customer Satisfaction - In the derby to please shoppers, stores like Nordstrom and Target continue to trounce their competition. But overall, online retailers continue to gain, according to the latest American Customer Satisfaction Index (ACSI), indicating that many consumers find shopping online much more pleasing than hoofing it through an actual store: The ACSI, founded at the University of Michigan and based in Ann Arbor, says its index for e-tailers gained a percentage point to 83 (out of a possible 100) compared to offline retailers, which gained a percentage point to 76. In the online group, Netflix jumped 2 percentage points to 87 -- dethroning Amazon, at 86. Newegg fell a bit to 86, while eBay remained at 79. Among brick-and-mortar stores, Nordstrom -- with a score of 83 -- continues to outperform its department-store competition, including Kohl's (79). JC Penney (79), Dillard's (78), and Sears (74.) And while others gained a bit in the group, Macy's, which eliminated more than 7,000 jobs last year, was the lone decliner, with its score falling to 71. Of the discounters, Target -- with an 82 -- soared above Wal-Mart Stores, with a well-below-average of 71.

Barnes & Noble, with an 84, beat Borders, at 81. Costco, with 81, outperformed Wal-Mart's Sam's Club, at 79. Publix continues to lead among supermarkets. And office stores gained somewhat, with OfficeMax climbing 4% to tie Staples, with a 77. And while Home Depot gained 3% to 72, it still continues to lag Lowe's, which climbed to a 79.  <mediapost.com>