Why Abercrombie & Fitch Is Shopping for a Buyout Offer

In this segment from the Industry Focus: Consumer Goods mergers and acquisitions extravaganza, the team discusses the deterioration of the once high-flying mall-based apparel chain Abercrombie & Fitch (ANF -0.04%). In the past several years, consumers have come to to shun the retailer's large logos and provocative marketing. Now on its last legs, Abercrombie is seeking out a buyer.

A full transcript follows the video.

This video was recorded on May 30, 2017.

Vincent Shen: Kicking off our discussion for today, we have recent reports that American Eagle Outfitters is considering a potential acquisition of its apparel rival, Abercrombie & Fitch. These are both apparel brands focused on teenage and young adult consumers, with stores largely located in malls all across the country. So, retail weakness and headwinds have been in the headlines quite often and discussed on the show. We have a series of bankruptcies from other mall-based chains hit the news recently, including Wet Seal, Aeropostale, American Apparel and BCBG. And with the Coach-Kate Spade deal announced a few weeks ago, we're also seeing some consolidation in the apparel space, as well. So, Asit, there are a lot of moving pieces and potential suitors right now who are pursuing this deal, and I would like to cover this one at a time. To start things off, can you give us a quick rundown of what has been going on in Abercrombie? The stock enjoyed a $7 billion market cap a decade ago, and has since declined to about a tenth of that size. Annual revenue peaked at $4.5 billion. That is down to $3.3 billion last year. What happened?

Asit Sharma: One of the things that you and I talked about in regards to retail companies is having a market that's strong enough to pull your product through. Retailers who are focused on the teen segment work with fickle fashion gods. Going back to the weekend briefly, I went with my family and saw the Pirates of the Caribbean. The gods of the sea are fearsome, there's curse after curse, and you have trouble, sitting in the theater, unraveling which curse is directed at whom and how do they break it? But they're nothing compared to the fashion gods, especially where teens are concerned. The fashion gods are brutal. This company has been in an industry in which it enjoyed a long surge of interest in mall-based traffic, and teens propelled that for years. As you and I discussed many times, online has shifted the retail landscape. Mall traffic has disappeared, and Abercrombie & Fitch, along with many of its retail brethren, is locked into long-term operating leases and purchase commitments for material and leases that are based in malls, which are quite expensive, not very lucrative if you're trying to break them. It's stuck in this fixed cost position with that smaller traffic base.

On top of that, the company has had to try to move with the fashion trends, and it's been out-hustled by the fashion-forward fast fashion houses like Zara, which have a lower economic footprint, a lighter capital footprint, change their fashions much more quickly. So it's really a victim of a couple of these larger forces. Operationally, the company has done a decent job. It was always somewhat profitable. That profit margin has now declined to near flat. But it's in a fairly liquid position. And a little bit later, we'll get into the differences between liquidity and solvency, which is speaking to Abercrombie & Fitch's long-term future. Basically, we're looking at entrenched trends that this company is trying to battle against with not a bright outlook looking forward.

Shen: Thanks, Asit, that's a really great rundown of what the company has been facing. I think, as you mentioned, it's really important to note that Abercrombie & Fitch is not alone in this. We've mentioned some of the other chains that have declared bankruptcy or closed their doors. These are headwinds that a lot of these mall-based stores are facing. Abercrombie, for four years running, the revenue has declined about 6% to 9% each year. I'd like to run down a list of different things that management has tried to do to face declining traffic to its stores, but also the changing trends.

It has recently announced that it will be closing dozens of its stores, about 60 of its U.S. locations. In 2014, they tried to rebrand, going from the big logos on its clothes, seeing that now, places like Zara and H&M, these fast fashion houses, they give you less branding and logos on their clothes so that you can design your own style, that seems to be what's popular with their customers. So, rebranding itself a few years ago, changing the look of its fashion. They're trying to market to older shoppers, moving away a little bit from their core teenage base. And they've also recently ousted Mike Jeffries, who was the former CEO who kind of put Abercrombie & Fitch on the map, taking over the brand in the early 90s when it was part of The Limited conglomerate. They've also implemented other changes to its executive team and the board of directors. One thing I will note in terms of bright spots for the company, it's not all bad, in that they have their Hollister business, which is actually, at this point, a bigger part of revenue than the namesake Abercrombie & Fitch brand is. But that has at least managed to maintain flat same-store sales.

So, you can see, even in this situation, flat is better than the double-digit same-stores sales declines that they've seen with the Abercrombie brand. They also recently announced a wholesale partnership with Asian e-commerce retailer Zalora, to sell its merchandise, which I thought was an interesting way for the company to expand its international reach.