Shares of Abercrombie & Fitch (ANF -2.03%) popped 10% last month, according to data provided by S&P Global Market Intelligence, on hopes that the struggling teen clothing retailer will be acquired.
The company announced on May 10 that it was in preliminary discussions with "several parties" regarding a potential deal that could result in a sale of the company. Those parties included apparel chains Express (EXPR -0.82%) and American Eagle Outfitters (AEO 0.85%), according to The Wall Street Journal (subscription required).
On May 24, the Journal went on to report that American Eagle was working with private equity firm Cerberus Capital on a joint bid for Abercrombie & Fitch. As such, American Eagle has emerged as the most likely buyer, though other suitors are still rumored to be exploring a deal.
Abercrombie & Fitch stock has pulled back in June. The retailer posted first-quarter results that highlighted its ongoing struggles with sales down 4% year over year, including a 10% plunge in comparable-store sales at its core Abercrombie brand. Moreover, the company's net loss worsened to $61.7 million, or $0.91 per share, compared to a loss of $0.59 per share in the year-ago period.
Like many traditional retailers, Abercrombie & Fitch is besieged by a maelstrom of declining mall traffic, heightened competition, and the staggering growth of e-commerce. In turn, its stock -- even after gains in May -- has shed about 80% of its value since 2011.
So even if a deal is consummated, Abercrombie & Fitch investors may not necessarily be enjoying a large buyout premium. The retailer will likely be forced to close more of its stores in the years ahead -- which will further reduce sales -- while wage inflation and intense competition continue to pressure margins. Any potential acquirer will no doubt factor these risks into its purchase price.
Even at its currently depressed trading the company is more expensive than it appears. While it has more than $100 in net cash on its balance sheet, net debt amounts to about $3 billion when accounting for its substantial off-balance sheet financial obligations in the form of operating leases, thereby making it one of the most heavily indebted retailers. At a time when leverage and financial strength are of dire importance to retailers who are locked in a fight for survival, these burdensome commitments may make Abercrombie & Fitch less appealing in the eyes of a potential buyer.
Abercrombie & Fitch knows this, and the company made sure to note that there was "no assurance" that a deal would be completed. Traders who wish to speculate on an acquisition may therefore be playing with fire, and long-term investors may be best served by avoiding Abercrombie & Fitch altogether.