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Why a Merger Will Not Help These Retailers

By Lawrence Rothman - Mar 19, 2014 at 12:45PM

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Unless there is a clear path to a renewal of growth, investors should hold off on purchasing Men's Wearhouse even though it is nearing a deal for Jos. A. Bank.

This Fool thought the Men's Wearhouse ( TLRD ) and Jos. A. Bank Clothiers (NASDAQ: JOSB) deal was dead after the latter decided to purchase privately-held Eddie Bauer. However, the deal has been inked. Does this mean investors should sign on and purchase shares of either one of these companies?

Unless you are a professional investor who bets on the success of takeovers, neither company looks very appealing right now.

The saga concludes
Men's Wearhouse and Jos. A. Bank agreed to terms in which the former will acquire the latter for $65 a share. This comes about after Men's Wearhous bumped its offer for the rival clothing retailer to $63.50 a share. However, this was contingent on Jos. A. Bank dropping its agreement to buy Eddie Bauer. Many thought this deal, with an initial $825 million price tag, would make the purchase too rich for Men's Wearhouse.

 

The deal comes about after Jos. A. Bank resisted earlier overtures.  Of course, it did not hurt that investor Eminence Capital, which owns shares of both Men's Wearhouse and Jos. A. Bank, has stated that it prefers the acquisition of the latter instead of the pursuit of Eddie Bauer.

A combination that does not add up
The Men's Wearhouse and Jos. A. Bank combination should make investors think twice before committing funds. A deal between the two retailers will not fix the slowing growth that each one faces. Sure, there will be cost savings as duplicate functions are eliminated. Store closures will undoubtedly comprise part of the savings since both retailers operate in many of the same malls. While cost-cutting does offer immediate benefits, it is hard to see how a combined company will accelerate its top-line growth.

At Jos. A. Bank, comparable-store sales dropped 8.5% and diluted earnings per share fell by 30% to $1.28 for the first nine months of the year. Net income dropped 30%, or $15 million, to $36 million. It might be tempting to blame charges related to the Men's Wearhouse affair, but these legal and professional fees only added up to $1.2 million.

Although free cash flow was negative $36.6 million while the retailer burned through $52.1 million in the year-ago period, it would be better to examine free cash flow after the company reports its key fourth-quarter results.

Cash from operations has also seen a downward trend over the last three years. In 2010, Jos. A. Bank reported operating cash flow of $106.2 million, and this had shrunk to only $84.5 million in 2012.

Men's Wearhouse is also confronting slowing growth. For the first nine months, comparable-store sales were up just 1.6% for its namesake brand, which accounts for two-thirds of its total sales. It reported negative comps for its Moores and K&G brands. Diluted earnings per share dropped 12.6% to $2.29. This came about despite share buybacks which lowered the share count by about 1.5 million shares, or 2.8%.

Free cash flow for the first nine months of 2013 fell despite lower capital expenditures. Operating cash flow declined by almost $7 million to $159.4 million, and free cash flow was $76.4 million, which was below the $78.3 million generated in the year-ago period. In addition, Men's Wearhouse spent nearly $96 million in cash to acquire JA Holding, the parent of Joseph Abboud.

In 2012, Men's Wearhouse saw operating cash flow jump. Cash flow from operations was $225.7 million, $62.9 million more than the figure from the prior year, although capital expenditures also rose by $29.6 million. This led to free cash flow of $104.3 million versus $71 million in the prior period.

Foolish final thoughts
Jos. A. Bank's shares trade at a price based on the potential takeover price and the stock is not an investment at this point, but a speculative bet. It is best to leave the purchase and sale of shares to M&A arbitrageurs that speculate on the success and failure of mergers and acquisitions. Men's Wearhouse's stock price also jumped on the news, but investors should wait until there is evidence of renewed growth before considering the shares. The stock trades at a hefty 24 times earnings, a rich price considering the challenges of renewing the retailer's growth.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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