Men's Wearhouse Goes It Alone by Going Upscale

Mens Wearhouse (NYSE: MW  )  rejected a buyout offer on Sept. 17 from smaller rival Jos A. Bank Clothiers (NASDAQ: JOSB  ) . The company has been adamant that it will not be bought; in fact, it even ejected founder George Zimmer from the Board after he pushed for a sale to private equity. Can the company justify going it alone by going upscale?

Two upscale buys
In a press release explaining why the offer was rejected, the main reason the company cited was the accretive potential of its purchase of bespoke mens brand Joseph Abboud in July for $97.5 million. The company is reportedly eyeing a deal for prestigious shoemaker Allen Edmonds as well.

Both buys would raise the average ticket and attract a new category of customers.The company has always longed for the custom of men like fictional GE exec, Jack Donaghy, of 30 Rock.

Men's Wearhouse reported disappointing results and guided lower in September days before the offer from Jos A. Bank, thereby having some justification in calling the offer "opportunistic." Most notably, Men's Wearhouse reported that tuxedo rentals were down. Tuxedo rentals comprise almost a quarter of sales for the company, and they have a huge gross margin of 85%.

As important as tuxedo rentals are, the company would obviously prefer a higher end customer for the remaining 75% of the business. That business has 1,143 stores in the US and Canada under the Men's Wearhouse, Men's Wearhouse and Tux, K&G, and Moores Clothing brands. It also sells ladies career wear, children's clothing, and corporate uniforms in the US and UK.

The company is expanding those higher margin tuxedo rentals, having just signed a five year extension with David's Bridal. It is also increasing its Big and Tall offerings. Earlier this year the Street was pleased to learn that the company had engaged Jefferies to sell its lower margin K&G stores, which were a multi-year drag on Men's Wearhouse's profits.

Men's Wearhouse has a 1.60% yield at a 28.00% payout ratio. The short interest at 6.9% has grown over the last month.

A different strategy
Jos. A. Bank, the manufacturer and retailer of men's apparel, has 603 stores in 44 states. Sales cracked the billion dollar mark for the first time in April,  but as the Men's Wearhouse rejection letter said, Jos. A. Bank, "has had three consecutive quarters of declines in revenues, margins, and earnings."  Meanwhile, Menn's Wearhouse reported $2.5 billion in sales for the last year. 

Although Jos. A. Bank has its own luxury lines, Signature and Signature Gold, its strategy going forward is different from that of Men's Wearhouse. Instead of going high end, Jos. A. Bank is featuring newer, tailored Fit and Slim Fit offerings for business. Suits are a major and infrequent purchase for most men. CEO R. Neal Black said of the strategy, "Our opportunity is to turn over their wardrobes and replace what's hanging in their closets with updated fits." 

Its stock is trading close to 52 week highs. The short interest has declined considerably to 17.10%, down from 36.30% earlier in the year. Clearly, the market likes Jos. A. Bank's gumption in trying to buy a bigger rival.

The company had been under pressure to do a deal, any deal, as one percent stakeholder Beacon Light Capital urged in an open letter to the Jos. A. Bank board on Aug. 13. The letter charged that the stock could be worth $70 a share if the board unlocked value through strategic acquisitions. The letter also noted that the company has been hoarding cash, warning that Jos. A. Bank could have 40% of its market cap in cash by year end.

Yet, BeaconLight Capital still believes in the company:

"At 6 times consensus EBIT expectations for the year ending January 2014, the company trades at nearly a 30% discount to its peer group. Additionally, 6x times EBIT is the lowest multiple of any retailer publicly listed in the United States with a market capitalization over $250 million."

Its EV/EBITDA now stands at 7.57, higher than Men's Wearhouse at 7.16.

Both companies have several competitors vying for the $130 billion menswear market in the Americas.These include Macy's, Perry Ellis International (NASDAQ: PERY  ) , Fifth & Pacific, and Philips Van Heusen.

Upstart upside
Of these five-star CAPS rated companies, Perry Ellis International may have the most upside with much more international exposure than its menswear rivals.The company is expanding its presence overseas, and will soon be opening a store in Beijing.

Of its business, 85% comes from menswear and 30% of that comes from the Perry Ellis designer lines. The company has a strong three year record of rising comparable same store sales, as I noted in a recent strength, weakness,opportunity and threat analysis.

Perry Ellis has very low price to sales and price to book ratios of 0.31 and 0.80, respectively. It also trades at a low EV/EBITDA at 7.22. The stock is   down 6% over the last year.

With indirect retail exposure to 58,000 retailers that carry its apparel and far fewer brick and mortar stores (just under 50) than Men's Wearhouse and Jos. A. Bank, Perry Ellis looks better to me than either of its competitors.

The Foolish takeaway
Men's Wearhouse probably will prosper by going upscale, and the Jos. A. Bank offer was definitely "opportunistic." Although the deal might have created a much stronger company, it won't happen any time soon. However, Perry Ellis looks to have more upside than both rivals with more international exposure and a lower valuation.

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