On May 27, 2014, after news broke that it closed a $150 million round of funding with Sycamore Partners, shares of Aeropostale (NASDAQOTH:AROPQ) shot up 15% to close at $3.92. Although this does not negate the 25% decline the business's shares experienced on May 23, it does imply that maybe the company's situation isn't as bad as investors initially thought. Following this deal, there are two definitive winners that have come out of the woodwork. The first is Sycamore Partners, but the second is a company investors might have never guessed: L Brands (NYSE:LB).
Aeropostale has been in serious trouble
Time has not been particularly kind to Aeropostale. Over the past five years, the company has seen its revenue fall by 6% from $2.2 billion to $2.1 billion. Despite increasing the retailer's number of locations in operation by 16% from 952 locations in 2009 to 1,100 by the end of 2013, an aggregate comparable store sales decline of 12% negatively affected operations.
From an earnings perspective, Aeropostale's situation has been even worse. During this same five-year period, the company saw its net income of $229.5 million turn into a net loss of $141.8 million as lower sales and margins were coupled with deleveraging expenses associated with its fall in comparable store sales.
One of Aeropostale's most serious problems has been its access to cash. While management has not claimed any sort of liquidity problems yet, the fact that cash and cash equivalents have fallen to $106.5 million from $347 million five years earlier should be concerning to the company's shareholders. In its most recent earnings release, the situation deteriorated further, with cash and cash equivalents falling to $24.5 million.
In an effort to shore up its balance sheet, management began talking with Sycamore Partners. On March 13, they announced that it had signed a letter of commitment with the firm to increase its access to cash. According to the terms of the agreement, Sycamore Partners will extend to Aeropostale a five-year $100 million term loan facility bearing a 10% interest rate.
Additionally, the retailer will have access to a $50 million, 10-year facility with a 0% net effective cost of capital rate. Both loan facilities are senior to common stock, which means that the investment firm would have the rights to the company's assets upon bankruptcy, second in seniority to lenders in some assets and first in seniority to other assets.
Another stipulation of the deal involved Sycamore Partners receiving preferred shares of the company. The stock, which can be converted to shares of common stock at a price of $7.25, would give the firm the right to acquire up to 5% of Aeropostale's common shares. In the event that the company sees a strong turnaround, this single component could be the biggest win for Sycamore Partners.
There's one more winner hidden in the shadows
At first glance, it appears as though the big winner from all this wheeling and dealing is Sycamore Partners. While it is true that the company will probably see a strong return if Aeropostale can improve its operations, another beneficiary of the deal will likely be L Brands.
You see, another part of the financing deal between Aeropostale and Sycamore Partners stipulates that the retailer must purchase at least $240 million worth of product from a company called MGF Sourcing each year for the next ten years. After digging around, the Foolish investor will find out that MGF used to be entirely owned by L Brands until the company sold 51% of its stake to Sycamore Partners in 2011 for $124 million.
Since the sale, L Brands has maintained its 49% piece in the business. In 2013 alone, the company received a dividend distribution from the entity in the amount of $64 million. While the financials of MGF are not publicly disclosed, even a small 5% profit margin split between L Brands and Sycamore Partners could net the retailer Other Income (pre-tax) of $58.8 million or more over the next decade.
Right now, Aeropostale is struggling to survive. Due to changing industry conditions, the retailer seems to be on the verge of failure but the support the business is receiving from Sycamore Partners may turn things around. In the event that the company does fail in the future, everybody will be out something but a successful turnaround would result in all players benefiting.
While it's likely that Sycamore Partners will see the most upside from its deal with Aeropostale, possibly the best way to play the situation is to consider investing in shares of L Brands. In addition to seeing revenue and earnings rise 25% and 102% respectively over the past five years, the company has the potential to benefit from Aeropostale's turnaround while carrying practically none of the risk associated with it.