While many analysts have chosen to focus on American Apparel’s (APP) extensive debt burden, I am taking a contrarian viewpoint on this company. With over $600 million in annual revenues, American Apparel could be the next big takeover story.
Although American Apparel is currently undergoing extensive restructuring and another equity issuance, the company has tremendous brand exposure and it has done an excellent job extending its platform internationally. While further restructuring would be necessary in the case of an acquisition, my research shows that the acquirer could potentially receive significant synergies. According to my model, incorporating these synergies could produce a valuation for American Apparel over $2 per share instead of the measly $0.50 that the firm is currently trading at. While earnings have been negative recently, the company trades at .15 times sales, showing just how little confidence investors have in a turnaround. But as many great investors say, it is time to buy when most others are afraid to do so.
The assumptions included in this synergy estimate are a base case reduction in cost of goods sold due to increases in scale and lowered operating expenses due to the consolidation of two companies SG&A expenses, among other operating costs. Other synergies could be achieved through restructuring the lease agreements or perhaps moving locations to more up and coming areas as opposed to renting prime real estate. In the end, this is another example of a heavily-shorted stock where short sellers have forgotten to take a close look at the contrarian argument. It sure seems that the folks on the short side of this will feel some pain in coming months.
The list of potential acquirers is endless but would likely include retail apparel giants which are currently under-leveraged or which have a less then ideal amount of debt. The acquisition of American Apparel could create an opportunity to leverage operations which could have exponential upside. A couple of companies that come to mind as potential suitors are H&M (HNNMY) and Gap (GPS). Both of these companies have huge retail apparel businesses and relatively low debt positions. Both companies could also purchase American Apparel without too much trouble and both would likely reap massive synergies from this acquisition. Another possibility would be that a private equity firm executes a buyout to take American Apparel private in order to restructuring and cut costs. Even an activist hedge fund could establish a large enough position in the company to get a seat on the board and force change. Anyway that you look at it, I see potential for strong upside for a large buyer.
The risks involved here include the fact that American Apparel may not be willing to be taken over. I have heard many interesting stories about the company’s CEO, Mr. Charney, and I am not sure how willing he would be to give up control. On the other hand, a hostile takeover would certainly not be out of the question, considering that the company’s entire equity float is under $100 million.
I feel confident that American Apparel will have a successful turnaround, especially considering the synergy potential that the company may offer to the right acquirer. Synergies this extensive will not be left on the table.
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