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Sycamore Tries to End Victoria’s Secret Deal, Raising Solvency Question for L Brands

L Brands Inc. said Sycamore Partners on Wednesday tried to end the agreement to acquire a 55 percent stake in the Victoria’s Secret businesses for $525 million, and that the apparel giant wasn’t having it.

For L Brands, the deal with Sycamore was expected by credit analysts to help the Ohio retail firm reduce its more than $5 billion in debt and focus on the Bath & Body Works business.

The parties entered into an agreement on Feb. 20, but the macro-economic backdrop has changed with the onset of the coronavirus pandemic. There had been some questions over whether the planned transaction would actually close, or whether it was just on hold.

On Wednesday, Sycamore filed a lawsuit in a Delaware chancery court seeking a declaratory judgment that its terminations of the agreement is valid, L Brands said. The apparel firm’s position is that the termination is “invalid” and that it will “pursue all legal remedies to enforce its contractual rights, including the right of specific performance.”

A declaratory judgment is essentially a determination by the court that the termination can proceed, while specific performance, if granted, would require the parties to proceed with the terms of the original agreement, unless otherwise modified.

“L Brands intends to continue working towards closing the transactions contemplated by the transaction agreement,” L Brands said.

Sycamore executives could not be reached for comment.

The February deal is valued at $1.1 billion, with the Sycamore stake estimated at $525 million. L Brands had planned to retain a 45 percent stake in the transaction, which includes Victoria’s Secret Lingerie, Victoria’s Secret Beauty and Pink, the intimates concept targeting younger consumers. As part of that deal, company founder Leslie H. Wexner was slated to step down as chairman and CEO.

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Victoria’s Secret has had its share of troubles and is in need of a turnaround. Taking the company private was expected to help ease some pressures for L Brands, such as $2.5 billion in lease costs for more than 1,000 VS stores.

Jefferies analyst Randal J. Konik has never been a fan of the deal. He noted previously that L Brands’ planned focus on a mall-based business centered on fragrance-infused candles and body sprays wasn’t exactly one of long-term duration, nor is it one that translates well from physical stores to online.

On Wednesday, Konik concluded that private-equity firm Sycamore is making the “smart move” by backing out of the deal.

“Victoria’s Secret was roughly $7 billion of revenue last year, but the category of intimates has been stagnating and competition has been rising for years. As a result, we believe improving Victoria’s Secret results would have been very difficult for Sycamore. In addition, Pink is roughly $3 billion of the $7 billion in the Victoria Secret segment of sales and has seen accelerating declines as well,” Konik said, adding that online sales were declining pre-coronavirus and that the declines will only continue post-COVID-19, which would create significant earnings losses.

The analyst also believes that the Bath & Body Works is peaking, and that sales could see declines as mall traffic patterns shift in a post-COVID-19 world.

Of medium-term concern for Konik is the debt problems at L Brands: “Losses from Victoria’s Secret combined with Bath & Body Works pressures from lower mall traffic and few candle sales make us believe potential medium-term solvency questions are now on the table.”

The analyst said L Brands has $400 million in annual interest expense and upcoming debt payments of $450 million due April 2021, $858 million due February 2022, and $498 million due October 2023.

And while some may think that the private equity firm could be angling for a better price, Konik doesn’t think that’s the case. “The world is permanently changing post-Corona with online shopping accelerating and 1,000-plus store business models becoming extinct,” he said. That means L Brands has an “upside-down distribution model with too many stores,” with both VS losing share in a stagnating category and the Bath & Body Works business too dependent on mall traffic.

“As a result, Sycamore would not be expected to try to complete a deal at a lower price. The deal just doesn’t make sense to us as the world has changed–it’s that simple,” Konik added.