Recently, we started a series of articles looking at the changing landscape of Fashion M&A and Private Equity’s (PE) growing interest in the fields of fashion apparel, accessories and footwear. From smaller funds to the very largest PE firms, the focus is to a great extent on companies that have brand equity. At the same time, strategic acquirors–many of whom are under pressure to grow–are also pursuing branded businesses. All of this has elevated the importance of brand equity in M&A. However, while brand equity is very important today and is a key driver of valuation multiples, it is one of many core business characteristics that acquirors prioritize when evaluating an acquisition target.
So, what are the qualities of companies that are in demand?
Brand equity, whether owned or licensed. Brand equity is both desirable and valuable, whether that intellectual property is owned or licensed. While ownership of a brand clearly warrants premium multiples, licensed businesses also attract strong valuations, although generally at lower valuation ranges. In some segments, a strong portfolio of licensed brands may merit multiples that are in line with those of branded companies. Intellectual property is important because it enhances business sustainability — largely because of consumer driven demand, which creates far more bargaining power with retailers and/or the opportunity for direct to consumer distribution. Under the right circumstances, there are buyers who would be interested in private label businesses to meet specific strategic needs.
Strong growth prospects. Acquirors want to buy companies when there is still runway for future growth. Therefore, a target company’s recent growth trends and future growth prospects have a significant impact on the multiples an acquiror is willing to pay. For Private Equity buyers, growth potential is critical because it directly impacts the return on investment and the need to tell a growth story when the business is sold again in four to six years. For strategic acquirers, growth is also very important but lower return on investment requirements and synergies — such as operating leverage, revenue synergies and product or channel diversification — may support the acquisition of a business that is not growing.
Sustainable point of view in product design. Having a sustainable, consistent point of view gives a brand identity and longevity, two aspects that acquirors–whether strategic or financial–crave and often pay high multiples for. Ralph Lauren is notably one of the best examples: His point of view over nearly 50 years, while often tweaked to remain current, has sent a clear, crisp and unmistakably consistent message. While not every company can emulate Ralph Lauren, acquirors will value and seek out brands with a sustainable point of view.
Sustainable gross profit margins. Gross profit margins are a critical element of any fashion business. They are the product of a three-legged stool: Sourcing, inventory management and desirability of product. It is important to buy the product right and to effectively manage inventory purchases, so as not to take on substantial inventory risk. At the same time, the product must be compelling to warrant appropriate price points and sell through at retail, otherwise markdowns will occur resulting in margin compression. Buyers will analyze how sustainable the margins of a business are in the context of profitability and long-term financial viability.
Diversified distribution. Although in today’s consolidated retail marketplace, it is often difficult to avoid customer concentration — material concentration will raise concerns for any discerning buyer. One phone call from a retailer could eliminate a large portion of the business as a number of companies in the fashion sector have experienced with Walmart and J.C. Penney in recent years. Some buyers may never gain comfort with significant customer concentration, others will structure a transaction to provide downside protection or pay less for such a business.
Strong customer relationships. Acquirors are going to examine a target’s customer relationships in the context of business longevity, both with the retailer and end consumer. Questions an acquiror will ask could include: Who within the company manages major retail relationships? Do retail customers trust the company’s ability to deliver quality product on time, and are year-end markdown conversations reasonable? How strong is customer loyalty? Is there a social media presence? Has the company been able to impart a story or an experience to the consumer?
Strong global sourcing capabilities. A valuable target company should be diverse and flexible in its sourcing. But acquirors know that great sourcing relationships with factories are built over years, not over the short term. Buyers will be wary of a “nickel and diming” strategy that results in constant factory changes — as just one mistake can wash away all the savings, and ruin customer relationships. It is also important to have a diversified factory base to eliminate the risk of any one factory holding the company “hostage.” Buyers will be looking for a strong, consistent and reliable sourcing network.
Seasoned management team. A seasoned management team is of paramount importance in transactions. This is especially true for fashion companies as these businesses are largely driven by the people, their creativity and relationships. Private Equity buyers often have no intention of directly operating a business. They generally rely on the existing management team and offer equity participation to the most senior managers. Similarly, strategic acquirors often look for the management team to stay on and operate the acquired business in order to ensure a smooth transition. Additionally, cultural fit is often an essential dimension to getting a deal done and ensuring long-term success, especially in strategic transactions.
In sum, acquisitions that warrant the highest valuations are companies with strong brand equity, sustainable growth and a well-defined point of view. Desired acquisition targets are companies with sustainable margins, diversified distribution, strong customer relationships and robust sourcing capabilities. Lastly, and often most importantly, is the quality of the management team. In order to achieve optimal valuations, companies need to be presented through this framework.
In our next installment, we’ll take a closer look at preparing a business for a sale.
About the Author
Allan Ellinger is MMG’s co-founder and senior managing partner. In addition to his involvement in M&A, restructuring and crisis management, he serves as a strategic advisor to many fashion and consumer product CEOs. He can be reached at A.Ellinger@mmgus.com.
Now in its 25th anniversary year, MMG provides investment banking, strategic and financial advisory services to clients in the retail, fashion, textile, home, and jewelry and beauty sectors. The firm guides owners of both privately and publicly owned businesses through mergers and acquisitions, management buyouts, divestitures, strategic alliances, operational restructurings, valuations and business model analysis.