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J. Crew's tidy turnaround story

Posted by: Aaron Pressman on June 20, 2006

Preppie clothing fixture J. Crew is going public next week (symbol will be JCG) after a star CEO, Millard Drexler, came in and turned around a sinking leveraged buyout. Texas Pacific Group took the company private back in 1997 but results in the 21st century suffered after J. Crew opened too many stores too quickly and lost its reputation for fashion and quality.

But how’s this for an unusual, perhaps even unique, show of faith, by an LBO firm in 2006: Texas Pacific Group not only didn’t take any multi-hundred-million-dollar “special dividends” out just ahead of the IPO, the firm is actually putting $73.5 million back in alongside IPO investors. It almost defies imagination after the pillaging of so many reverse IPO deals. You almost want to buy the shares just to support the idea.

Drexler, who arrived in 2003, has worked some of the same magic on J. Crew that he used to build The Gap (GPS) into an industry giant. Drexler’s Gap expansion included new lines like GapKids as well as new branded stores like Old Navy. At J. Crew, he’s just added a kids line called Crewcuts and is opening a new chain of hipper women’s clothing stores under the “Madewell” name.

So far, it’s working. For the year ended January 28, 2006, revenue rose 19% and operating income more than doubled. The company’s net loss, due to hefty interest and preferred share dividends, dropped to $10 million from $114 million the year before. Had the IPO occurred prior to the fiscal 2005 results, J. Crew would have shown net profits of $52 million.

After spending a few years closing stories, J. Crew opened 6 in 2005 and plans to open as many as 35 stores a year in the future. So after three years of declining same store sales from 2001 through 2003, sales rose 16% in 2004 and 13% in 2005 under Drexler. The company’s operating margin doubled to almost 8% — still far below top retail clothing merchants like Abercrombie & Fitch (ANF) at 19% or Chico’s (CHS) 21%.

Ok, so how’s the valuation? Expected to price at $15 to $17 a share, the company’s S-1 prospectus says 56.9 million shares will be outstanding after the offering, giving the company a stock market value of $850 million to almost $1 billion plus remaining debt of $352 million. There’s a little cash but say the enterprise value is about $1.1 to $1.3 billion.

So, to the funny numbers. Trailing 12-month pro forma net income was about $70 million, or about $1.13 per fully diluted share. That’s a p-e of about 15, right around the Gap’s and Abercrombie’s current p-e or half Chico’s. On an enterprise value to sales ratio, J. Crew weighs in at right about 1 versus 0.77 at the struggling Gap, 1.6 at Abercrombie’s or 3.24 at Chico’s. Although it’s tough environment for higher-end retail with investors worried about a consumer spending slowdown, you might come to the same conclusion as Texas Pacific and decide that investing with Drexler is a smart proposition.

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