Ragging on Rag

Upon learning last night that Rag Shops (Nasdaq: RAGS  ) was about to be acquired for a modest premium, I thought I had nailed the perfect headline -- RAGS to Riches. However, while looking under the hood, I stumbled across more rags than riches.

Whenever I come across a buyout, I tend to focus on the merit of its acceptance. Is it a fair price? Obviously you're going to get some shareholders bellyaching that the acquiring company isn't paying enough no matter how high the price, but let's get real here. If a company is being bought out at a premium to where it's trading at, then it's already willing to outbid Mr. Market.

The Rag buyout by Sun Capital Partners at $4.30 a share in cash is definitely a premium to the stock's $3.37 close yesterday afternoon. However, angry Rag investors may be quick to point out that the stock was trading higher than $4.30 a year ago and that it briefly topped the buyout mark as recently as March.

But the deal has a funny smell to it because insiders and large shareholders were privy to Sun's advances since they had entered into a deal to sell a 56% controlling block in the company to Sun Capital. No, I'm not alleging that they turned around and gobbled up shares to profit even further from the deal. The last few weeks of trading volume are as ho-hum as the company's sleepy trading history. However, by unloading a majority stake to Sun at the same $4.30 price, it will clearly dissuade a third party from trying to enter into a bidding war for the arts and crafts retailer.

I'm not saying that Jo-Ann Stores (NYSE: JAS  ) , A.C. Moore Arts and Crafts (Nasdaq: ACMR  ) , or Michaels Stores (NYSE: MIK  ) would be chomping at the bit to scoop up a small rival mired in stagnancy. Rag has been officially on the auction block since February, and it's not as though there was a long line of suitors waiting outside. Further sullying its dowry was the fact that the company also announced that it would have to restate its earnings lower this year after lowballing the accruals on its employee health plan.

However, one has to wonder why Sun and the shareholders that are already on board to unload the company at $4.30 a stub couldn't just float the offer out there. Even though the chance that another potential acquirer was waiting in the wings was remote, these prearranged weddings feel more like shotgun weddings.

Are you handy with arts and crafts? Would you rather knit than nitpick? What exactly is macrame? All this and more in the Crafty Fools discussion board.

Longtime Fool contributor Rick Munarriz has been in a Rag Shops store before. He doesn't remember whether he spent more or less than $4.30 while there. He does not own shares in any companies mentioned in this story.

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