Future of American Eagle still uncertain

Teen clothier viewed as takeover target

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Shareholders in American Eagle Outfitters Inc., the teen retailer headquartered at the SouthSide Works, have been on a bumpy ride over the past several months. The company's stock price has bounced around as it deals with disappointing results and rumors that it might be a takeover candidate.

As the retailer prepares to release fourth quarter results Wednesday, speculation continues that its needs and market conditions might combine to send American Eagle back to the ranks of private companies.

In a report last week assessing overall retail sales, Wall Street Strategies analyst Brian Sozzi labeled the company a "speculative play on a potential takeover."

Thomas A. Filandro, an analyst with Susquehanna International Group, assessed the retailer's status in a late January note after a disappointing holiday season: "We believe patient investors will be rewarded, as either management executes a margin turnaround or the company becomes a private equity target."

The reality is there's a lot of private equity money in the market in search of good investments, said R.J. Hottovy, an analyst with Morningstar Institutional Equity Research. Many funds have a five-year window to use money pooled by investors, and the past couple of years have seen a lot of that sitting out the recession.

"The clock is running out on a lot of these funds that were raised five or six years ago," he said.

That has contributed to stepped up merger and acquisition activity as the recovery takes hold, but it's not the only factor in the speculation about American Eagle.

Morningstar, in a report that Mr. Hottovy co-authored, rated American Eagle among its top 10 takeover candidate investment ideas for 2011 because a private equity deal might address some of the retailer's issues.

"I think the benefit is really that these companies are struggling for that next leg of growth," Mr. Hottovy said.

American Eagle's rivals, Abercrombie & Fitch and Aeropostale, have some of the same challenges, he said. They've taken their core concepts across the country and keep trying to find new ways to produce the sales growth that investors want, sometimes successfully and sometimes not.

American Eagle has seen success with its aerie line of intimate clothing and is starting to build a chain of children's clothing stores called 77kids. But it gave up last year on Martin + Osa, a chain targeting adults past college.

Many retailers, including American Eagle, have begun looking internationally for growth, which can be a tricky project. Under private ownership, there might be less pressure to avoid missteps, Mr. Hottovy said.

He thinks that was a factor is the sale of clothing retailer J. Crew Group Inc., which this week is scheduled to become a private company after shareholders accepted a $2.86 billion buyout offer from private equity investment groups. Other retail candidates for takeover, according to Morningstar, include Office Depot, Barnes & Noble and Williams-Sonoma.

American Eagle is also a good candidate because of its debt-free balance sheet and strong cash flow history, he said. A buyer appreciates a deal that doesn't require taking on a lot of extra debt.

"We think highly of American Eagle's prospects long-term," Mr. Hottovy said, but a short-term step away from the public markets could give it some room to maneuver.

Those looking for hints of the company's plans were interested when American Eagle canceled a presentation at an investment conference in January. Mr. Hottovy described that as a red flag.

If the company does end up accepting a private equity offer -- Mr. Hottovy thinks an offer in the range of $24 to $25 per share for the stock that closed Monday at $15.37 isn't out of the question -- shareholders might get a nice windfall, but the potential impact on the company and its hometown are less clear.

Unlike a takeover by another retailer, which is what happened when the Macy's and Kaufmann's chains merged, a private equity deal is less likely to involve a headquarters move.

Still, "There's usually is some overhead reductions when you do have a private equity takeover," Mr. Hottovy said. The new owners would act almost like consultants, bringing in retail experts to look at how to trim excess fat and improve operations.

No matter what happens, analysts would like to see American Eagle's fashions start hitting the trends better and grabbing the customers' attention.

FBR Capital Markets analysts Liz Dunn and Laurent Vasilescu, in a mid-February report, expressed disappointment with an assortment that included batik-printed knit tops and dresses they considered too faded and too mature for teen girls. The guys side of the store wasn't much better, in their opinion, suffering from "a lack of editing."

Their conclusion: "Our sense is investors are increasingly frustrated with management."

On Monday, the Wall Street Journal reported the company has started actively looking for a replacement for CEO James O'Donnell, who was listed as 69 in last year's June proxy and is preparing to retire.

"If true ... it would be a long overdue and positive decision (perhaps explains the share price spike on Feb. 10)," wrote Mr. Sozzi in an aftermarket report. "Fresh eyes, preferably with a strong merchant background, are badly required on a business that has significant brand equity with target consumers (teens and young adults) but has failed to live up to its full operating potential."

Teresa F. Lindeman: tlindeman@post-gazette.com or 412-263-2018.


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