Kellwood rejects $544 million bid

NEW YORK (Fortune) -- The Kellwood Company today rejected a $21 a share cash offer from Sun Capital Securities Group, signaling that the company, which makes clothes under the Calvin Klein, Baby Phat and Nautica labels, feels confident enough in its prospects to play hard to get.

At first glance, it might seem absurd for Kellwood to walk away from an offer that represents a 18 percent premium over the stock's recent closing price of $17.67, especially given the company's myriad problems. Like other apparel makers, Kellwood has been hurt by department store consolidation, which has reduced the number of stores selling its goods and put a squeeze on margins. Also suffering are rivals the Jones Apparel Group (Charts, Fortune 500) and Liz Claiborne (Charts, Fortune 500).

But on closer inspection, it is hard to rationalize Sun Capital's offer as a fair one. Kellwood's board, advised by Banc of America Securities, concluded the company could deliver greater value to shareholders by sticking with its strategy of breathing fresh life into its core brands, expanding new, higher priced labels and better controlling costs.

For all its problems, Kellwood (Charts) is still a sizeable player, generating $1.2 billion in annual sales. At nearly $544 million, Sun Capital's offer values Kellwood at less than four times estimated earnings before interest, taxes, depreciation and amortization. The going rate for similar apparel companies is roughly six to eight times cash flow, analysts said.

Put another way, the offer prices Kellwood roughly equal to where the stock was trading in February 2003, suggesting that no value has been created over the past four years despite the fact that Kellwood has completed some $633 million worth of acquisitions during that period.

"It's a low ball offer," said Susan Ding, an analyst with Standard & Poor's. S&P placed Kellwood's ratings on watch with negative implications after Sun Capital's offer was made public Sept. 18, over concerns that the private equity firm would load the company up with even more debt.

As of the second quarter, ended Aug. 4, Kellwood had $852 million in liabilities, somewhat offset by $699 million in cash, receivables and inventory.

Investors never seemed to buy into the idea of an imminent deal. Kellwood's stock price has traded in a rough range of $17 to $19 for the last 21 days, below Sun Capital's bid. As of Wednesday afternoon, shares were up 29 cents or 1.64 percent to $17.96.

Accepting Sun Capital's opening salvo is not the only option open to Kellwood. Even though the company is not likely to receive a rush of competing bids, there is reason to believe Sun Capital will raise its offer. The private equity firm has already amassed a 9.9 percent stake at an average price of $28 a share.

If Sun Capital thought Kellwood was worth almost $29 back in April, when it started accumulating its position, surely the company is worth more than $21 today, especially following a recently announced restructuring that is expected to generate $30 million in cost savings beginning in the latter half of 2008.

Another possibility is to sell the company's assets off in pieces.

Industry executives who are familiar with Kellwood's business, and who spoke on the condition they not be named, said buyers would line up for parts of Kellwood, including its Gerber children's wear business, dress shirt maker Smart Shirts and American Recreation, a maker of outdoor gear.

Though the company could be unwound easily enough, since many of its divisions continue to operate independently and have yet to be integrated into the whole, observers say this scenario is least likely given the time and complexity of finding buyers for Kellwood's many parts.

The company would also face lots of competition from the Jones Apparel Group and Liz Claiborne, both of which are sliming their portfolios by divesting dozens of brands.

Perhaps the most likely outcome is for Kellwood to continue to go it alone. While the consumer appears to be moving into a downswing and Kellwood continues to feel pressure from department stores, this scenario is not as gloomy as it sounds.

Chief Executive Robert Skinner, who by most accounts inherited Kellwood's troubles from his predecessor, has moved to cut costs and upgrade the company's brands away from the moderately priced labels that have been hardest hit as department stores replaced them with privately-branded goods.

At the same time, Skinner has made several well-positioned acquisitions, including Vince, a contemporary clothing line sold in upscale stores like Saks Fifth Avenue, and Hanna Andersson, a children's clothing retailer.

On the cost side, Skinner recently announced that he's reducing the number of operating divisions to 8 from 12, and switching to a pure licensing model for the Phat Farm brand of urban clothing, which will provide an immediate boost to earnings by eliminating inventory and production costs.

Sure, there is a risk that Kellwood's plans to remake itself could unravel. The company's stock recently cratered when Kellwood surprised analysts by reporting a $66 million second quarter loss, well below expectations.

Contrarians argue that much of the bad news is already priced into the stock. "What people are missing," said Todd Slater, of Lazard Capital Markets, "is that this company is doing a lot of things that will start to pay off."