Cherokee Suits Up for a Sale

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According to the ever-changing Wikipedia, the Cherokee tribe performed rain dances "to both induce precipitation and to cleanse evil spirits from the earth."

Well, this time Cherokee (Nasdaq: CHKE), the apparel distributor, is doing the dance, hoping for a downpour of buyout offers. The company is bringing in Goldman Sachs to help it explore "strategic alternatives" that may very well smoke out a suitor.

If you don't know Cherokee, with its fat 8.7% yield and similarly plump margins, you should. The company markets products under its familiar Cherokee, Sideout, and Carole Little brands. Cherokee apparel is all over cheap-chic Target (NYSE: TGT). Mervyns stocks Sideout. Carole Little wear can be found at TJX (NYSE: TJX). Cherokee's wares are also big sellers overseas, in chains like England's Tesco and Mexico's Comercial Mexicana (OTC BB: CDCUF.PK).

Because Cherokee outsources the manufacturing of its branded apparel, the company's thin overhead creates fat margins. Through the first nine months of the year, it generated a profit of $13.6 million on $32.9 million in royalty revenues. That's a chunky 41% in net profit margins. It must be nice to print money for a living.

Granted, the results were slightly below the company's performance during the same three quarters a year earlier, but you can afford to be mortal with badonkadonk margins like that.

So why would this company want out? Is it afraid that its quarterly dividends will be unsustainable, forcing Cherokee to slash its payout after several years of hikes? Is the apparel industry outlook so bleak that Cherokee feels that a larger company would be able to build on its proven brands and envious margins?

Who would want in? You can cross off all of the juicy retail chains that partner with Cherokee. Becoming an appendage of one retailer would crush its chances of staying on at the others. More likely, suitors would come from other apparel-brand brokers like Iconix (Nasdaq: ICON), or private equity firms who can milk more out of Cherokee's brands.

Investors need to tread carefully here. Cherokee is certainly attractive, but there's sometimes a dark side to the pursuit of strategic alternatives. When companies like Gap (NYSE: GPS) and Build-a-Bear Workshop (NYSE: BBW) spend too much time on the block after retaining investment bankers, investors begin to wonder if they're the ones stuck holding damaged goods. Cherokee's margins would have to fall a long way for it to be considered a problem child, but you never can tell whether that "rain dance" is ultimately about the rain, or about the evil spirits that a buyout would wash away.

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