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The Future of Men's Wearhouse

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Last month menswear retailer Jos. A. Bank (NASDAQ: JOSB  ) offered to buy rival Men's Wearhouse (NYSE: TLRD  ) for $2.3 billion, or $48 per share. This represented a 36% premium over the previous closing price. Shares of Men's Wearhouse immediately shot up. However, it didn't take long for Men's Wearhouse to reject the offer, stating that it significantly undervalued the company.

Since then, the situation has certainly not been short of drama. With Men's Wearhouse CEO Douglas Ewert reportedly considering a range of strategic options, it seems that some sort of deal may be inevitable. Here's a rundown of the likely scenarios.

Scenario No. 1 -- merger with Jos. A. Bank
Jos. A. Bank is smaller than Men's Wearhouse, with a market capitalization of $1.4 billion compared to about $2.3 billion for Men's Wearhouse. Jos. A. Bank has stated that financing will come from its own cash, new equity capital from P/E firm Golden Gate Capital, and debt financing. It's unclear exactly how much debt will be taken on, but it will likely be considerable compared to the market cap of the new, merged company.

This merger would certainly create a menswear powerhouse, and the removal of competition between the two firms could lead to higher margins in the future due to reduced promotional activity. Cost savings and synergies are another benefit, and it seems like this deal would make a lot of sense.

Large shareholders from both companies reportedly support the deal, with a few owning significant portions of both companies. The price, $48 per share, is likely a premium to the fair value of Men's Wearhouse. Last year the company earned $2.55 per share, and this year weak earnings promise to drive that number lower. At about 20 times the full year earnings estimates, $48 per share seems like a high price to pay.

It may be worth it though, due to the reasons stated above. This is probably the most likely scenario, and the price may ultimately end up being in the $50s.

Scenario No. 2 -- taken private by P/E firm
Another possibility is a private equity firm taking Men's Wearhouse private. Plenty of small apparel retailers have garnered the interest of private equity this year, from teen retailers like Aeropostale to shoemaker Crocs. Men's Wearhouse has been a consistently profitable company for the last decade, even during the financial crisis, and this attribute is no doubt attractive. The big issue, however, is price.

The goal of these private equity buyouts is typically to wait a few years and then either sell the company or reintroduce it as a public entity. However, given Jos. A. Bank's $48 per share offer, any buyout would likely be well into the $50s. It's hard to imagine buying a company like Men's Wearhouse at 20 times earnings and turning a considerable profit -- it's not exactly a fast growing company.

I think that a P/E buyout is unlikely, unless the current talks fall apart and the stock falls back into the $30s.

Scenario No. 3 -- filling a gap
Other than Jos. A. Bank, what other company could possibly be interested in acquiring Men's Wearhouse? I would argue that The Gap (NYSE: GPS  ) would actually make a lot of sense.

The Gap is already fairly diversified, with five brands which collectively appeal to a large swath of consumers. Old Navy focuses on the low-end, the namesake Gap stores are aimed at the mid-range customer, and the higher-end Banana Republic captures the wealthier consumer. Along with this, Athleta offers active wear while Piperlime is an online-only option.

While the Banana Republic sells suits, it doesn't focus on them. Men's Wearhouse could offer a distinct new business for The Gap. The Gap's size, with a market capitalization of about $20 billion, makes absorbing Men's Wearhouse less challenging than it would be for a smaller company like Jos. A. Bank.

This is obviously just speculation, but I wouldn't be surprised if The Gap or a similar company puts in a bid.

The bottom line
Jos. A. Bank's offer of $48 per share is a great deal for Men's Wearhouse shareholders, and I suspect that some kind of deal is going to happen. Whether it's Jos. A. Bank or a different company is an open question, but I can't imagine the Men's Wearhouse board turning down an offer in the $50s. If they do, expect the stock to tumble.

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Timothy Green

Tim is a value investor focused on finding high-quality companies selling for well below intrinsic value. His background in physics helps him stay rational when the market is behaving strangely.

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