It's the kind of news that traders love to hear: Last week, Claire's Stores (NYSE:CLE), a major jewelry retailer, announced that it has hired Goldman Sachs to explore "strategic alternatives" (deal-speak for "selling out"). Still, although Claire's would be a good candidate for such a transaction, the move is far from guaranteed.
In fact, since July, the stock has had a good performance. It's gone from $25 to $33.36 and it appears that a part of this has been because of buyout rumors. On Claire's Friday announcement, the stock increased nearly 5%. Then again, private equity firms (funds that buy companies) have been targeting retailers such as Michael's Stores, The Sports Authority, Burlington Coat Factory, Linens 'n Things, and so on.
So, what would make Claire's attractive to a private equity firm? First of all, the company generates strong cash flows and has no outstanding loans on its balance sheet. In fact, the company has been buying back its stock ($200 million over the past year).
In other words, a private equity firm would have plenty of room to load the company up with debt. With interest rates low and investors looking for competitive returns, the credit markets have been extremely liquid, making it fairly easy to raise the debt financing.
Furthermore, Claire's dominates its teen market niche; competitors like Delia's (NASDAQ:DLIA), Hot Topic (NASDAQ:HOTT), and Tween Brands (NYSE:TWB) simply don't have Claire's breadth. And this competitive position has allowed it to develop strong gross margins (roughly 54%).
But the big issue is timing; with the holiday season upon us, it would be tough to get a deal done by the end of the year. Also, shouldn't the company focus on its operations in this most important quarter of the year?
In other words, buying Claire's stock on the possibility of a buyout is fruitless for now. Patience makes a lot more sense.
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Fifty-four Motley Fool CAPS players pick Claire's to outperform the market. Five say it will underperform. Where do you stand? Join more than 14,000 fellow investors in the Fool's new stock-rating service and let your voice be heard .
Fool contributor Tom Taulli does not own shares mentioned in this article. He is currently ranked 380 out of 14555in CAPS.
