Republics private equity partners secured a sale in June

Republic's private equity partners secured a sale in June

Private equity firms are playing an increased role in shaping the fashion industry, snapping up brands under a variety of circumstances as trade buyers approach M&A with more caution.

A recent flurry of private equity activity across a number of consumer goods sectors reflects a rising number of secondary buyouts – where private-equity sells to private-equity rather than back to the trade.

In June this year Change Capital Partners sold its controlling stake in fashion chain Republic to another private equity investor, TPG. The deal was worth GBP300m (US$445.5m), trebling the money Change originally forked out in 2005.

The style industry is by no means alone in this sort of activity.

Strategy group Dealogic says some 35% of all private equity deals this year have been 'secondary buyouts' - the highest level in at least a decade.

In more 'normal' economic times, private equity firms are more likely to sell back to the trade, having grown the value of the business, often by driving short-term efficiencies. Trade buyers pick up lean and well-focused assets they can invest in, whilst leveraging industry synergies.

A good example of this kind of investment was Phillips-Van Heusen's (PVH) bold acquisition of Tommy Hilfiger earlier this year.

But when a secondary buyout occurs, the options open to a private equity company to drive value are reduced, by the very nature of who's selling.

Change Capital originally snapped up Republic, which sells brands such as G-Star, Diesel and Firetrap, for GBP105m, in partnership with Republic’s co-founders, Tim Whitworth and Carl Brewins. The retailer’s turnover has doubled in the past five years, from GBP100m to GBP200m, with earnings trebling.

TPG wants Republic's founders Tim Whitworth and Carl Brewins, who retained a 40% share when Change took over in 2005, to continue running the business - maximising its chances to drive further profit. Ten stores and 500 new jobs are slated for this year alone.

These, of course, are not normal economic times. The last 18 months of global economic turmoil have left trade buyers hard to find. Some in the industry have found credit impossible to come by; others are struggling to pay down debt. But there are also businesses out there sitting on cash who are simply less keen to buy.

As the BBC's economics editor Stephanie Flanders pointed out in her blog last week, discussing the relationship between the banks and UK Plc: “It would be easy to miss, in all this debate, that UK Plc is actually in rude financial health. Come again? Yes that's right. British businesses are loaded. In fact, in the first three months of this year, they ran a financial surplus worth more than 5% of GDP.”

Therefore, just because many companies in the UK have cash surpluses does not make them keen to spend it, with many favouring shareholder returns rather than new acquisitions.

Not only is this lack of investment activity by the trade a worrying indictment of what lies ahead – if companies with a cash surplus are not spending now, it says little about their confidence in the economic future – but it also creates a problem for private equity, whose businesses rely on a buy and sell cycle.

Having endured a M&A dry spell stretching back to October 2008, private-equity groups have had to kick-start the sale cycle at the first sign of economic recovery.

“PE (private equity) firms are investors and, as such, speculators,” industry analyst James Amoroso says.

PE firms have watched in the last six months as recovery has slowly taken hold and the valuations of their investments have grown. Many now want, or need, to realise the value.

They will logically decide to sell below the investment’s potential if they cannot find an industrial buyer in order to find another investor buyer, ie private equity.

"They realise they have to leave residual value to make it attractive. So we have a nice round of musical chairs at the moment,” says Amoroso.

But there is a greater risk involved in being the secondary, and sometimes even tertiary, PE buyer as value gets harder to come by. And, only time will tell whether the PE firms have overstretched themselves.