Retail, Wholesale & Distribution

August 2006

Apparel Firms Showing Greater Interest in M&A Deals
Faced with a mature domestic market, an increasing number of clothing companies are beginning to consider mergers and acquisitions as a way to seek further growth. The profit motive is also prompting apparel firms, many of which retain an old-fashioned management structure dominated by their founders and founding families, to find the most effective way to utilize cash assets. If Aoki Holdings Inc. buys all the outstanding shares of menswear store operator Futata Co. for 700 yen per share, it will be able to realize a 5 billion yen profit by dissolving the acquired company. Since Aoki's investment is estimated at 12.7 billion yen, the return on the deal will be nearly 40%. This would be how a buyout fund would think. But Aoki has a different aim. It believes that Futata's acquisition will enable it to exploit the geographical market where the Fukuoka Prefecture-based company does business and generate synergy. Although Futata's profit level is low, it is expected to pay off all its interest-bearing debt during the current year through January 2007, boosting its equity ratio to as high as 84%. Just before the news broke of Aoki's tender offer, Futata's price-to-book-value ratio (PBR) stood at 0.4, a figure typical of companies whose shares trade at low levels despite their sound finances. And Futata is not the only firm in the apparel industry that belongs in this category. Generally speaking, a company controlled by a founder or their family operates conservatively, preparing for an "emergency" by building up rich cash positions and doing all it can to avoid taking on too much debt. This conservative stance enables many clothing firms to maintain sound finances, but it also prevents them from developing new growth markets by tapping their cash reserves. The now-infamous Murakami fund once pressed Tokyo Style Co. to pay more in dividends if the women's apparel manufacturer refused to use its cash holdings to develop new markets and operations. Tokyo Style's retained earnings reached 93.1 billion yen in the year ended February 2006, nearly 70% of its current market capitalization, as calculated on the basis of Thursday's closing share price. Concerned that it might be targeted by an investment fund again, Tokyo Style President Yoshio Takano and other top executives studied the possibility of conducting a management buyout. Given that the Japanese market is mature, however, apparel firms need to make wise investment decisions if they want to survive far into the future. And it is for that reason that more of them are entering into M&A deals. A total of 67 mergers and acquisitions involving Japanese clothing companies were agreed to in 2005, three times as many as four years ago, according to M&A broker Recof Corp. The number of such deals through the end of July 2006 has already hit 31. Fast Retailing Co. Chairman Tadashi Yanai said, "M&A deals (with major players having extensive infrastructure) are essential" if a company wants to grow in a short period of time. The casual wear retailer acquired stakes in Link Theory Holdings Co. and Cabin Co. to tap into the market for high-end clothing items, which are not handled by its Uniqlo chain. It also inquired about the possibility of buying out Hong Kong-based retailer Giordano International Ltd., whose business model was studied by the businessmen who later established Fast Retailing. The Japanese retailer generated 46 billion yen in operating cash flow in the half year ended Feb. 28, against an investment cash flow of 1.3 billion yen. This means that the retailer added more than 30 billion yen to its cash holdings during the six months. "We want them to invest the money rather than retain it and lower their return on equity," an official at a foreign-based brokerage said. Onward Kashiyama Co. acquired the U.K.-based Joseph Ltd. group, including its management rights, in 2005. "(We did it because) we will not be able to survive on our existing brands alone at a time when overseas rivals are establishing operations in Japan," President Shigeru Uemura said. There seems to be a greater perception among clothing firms that they can "buy time" through M&A deals that allow them to acquire brands and access to established business territories at a single stroke. The time is coming in the apparel industry when the wise use of cash holdings will be of critical importance. (The Nihon Keizai Shimbun, August 11, 2006)