Children's Place puts itself up for sale

NEW YORK (Fortune) -- The Children's Place is considering putting itself up for sale, following a sharp decline in its stock price, the result of a string of bad news that includes the dismissal of its chief executive and the resignation of its auditor, Fortune has learned.

The Secaucus, N.J.-based retailer of children's clothing has put out feelers to potential suitors, according to two people familiar with the company's plans. Any discussions are in the early stages and there is no certainty that the board will decide to proceed with a sale, these people cautioned.

Though Peter J. Solomon was said to have made overtures on behalf of the Children's Place (Charts) to potential suitors, the investment bank said that it has not been hired to advise the company on a possible sale. The Children's Place declined to comment.

One person who might be interested in buying the company is Ezra Dabah, the longtime Children's Place chief executive, who resigned late last month, over allegations that he violated the company's code of conduct. Dabah, who retained a board seat and who, along with his family, is the largest shareholder, is believed to be considering a bid for the Children's Place, though a decision as to whether to proceed with an offer has not been made, sources said.

Tensions between Dabah and the board erupted after Deloitte & Touche threatened to withhold approval of the company's financial reports if Dabah remained in his post, setting in motion a chain of events that eventually resulted in his resignation, two sources said. Deloitte & Touche on Thursday said it would not stand for re-election as the company's auditor. The Children's Place said it is in discussions with a nationally recognized accounting firm, which it expects to engage shortly.

Though Dabah stepped down willingly, he grew increasingly frustrated with the company's portrayal of his departure. In a letter to the board's chairman Sally Frame Kasaks dated Oct. 11, Dabah accused directors of issuing "misleading and disparaging press releases" that amounted to an assault on his integrity. He also suggested that his departure was the result of a "power play" by certain members of the board.

Once a high flying company, the Children's Place has stumbled over the past year as it faced investigations into options backdating, disclosures that some of Dabah's stockholdings and trades did not comply with disclosure rules, and a high-profile dispute with The Walt Disney Company with whom it has an agreement to operate Disney Stores. The problems bedeviling the company are likely to complicate any deal. Potential suitors will need to feel comfortable that the books are sound, a prospect made more difficult given that the company has not filed quarterly reports with the Securities and Exchange Commission since June 2006.

Another sticking point is the Disney agreement. To resolve Disney's accusations that it was in breach of contract, Children's Place this summer agreed to invest $175 million to remodel 234 Disney Stores over the next five years, meaning that it will likely lose money on the deal for the foreseeable future.

But exiting the agreement is costly. Margaret Whitfield, an analyst with Sterne, Agee & Leach, estimates that Children's Place would be on the hook for $93 million in minimum royalty, breach of contract and other fees plus "hundreds of millions of dollars" to unwind store leases. Should Children's Place change hands, Disney would have a say in approving the new owners.

The appeal for potential bidders is an opportunity to scoop up a major name in children's clothing for a bargain price. Children's Place shares have tumbled 68 percent in the past 12 months, making it one of the cheaper stocks in retailing, trading at 9 times 2008 earnings estimates and one-third of sales.

The suitors eyeing Children's Place, which operates 899 of its own stores and 328 under the Disney (Charts, Fortune 500) banner, see an opportunity to improve the company's operating performance, which has suffered from a series of merchandise missteps. Inventory has piled up on store shelves - an increase of 25 percent per square foot by some analyst estimates - despite a dip in sales at stores open at least a year of 3 percent in September.

Analysts recently slashed earnings estimates for fiscal 2007, and some worry that operations could deteriorate further before showing an improvement. JPMorgan analyst Brian Tunick wrote in a research note that operating margins fell to 2.2 percent during a difficult period back in 2002, lower than its current level of 2.8 percent and far below a peak of 4.6 percent seen in 2003.

Any acquisition of the company would likely result in a wholesale overhaul of management. Many observers say cleaning house could be the best thing for Children's Place, which at times has been run more like a family business than a publicly traded company. Until his resignation in September, Dabah had served as CEO almost since his family bought the company in 1989. (It went public in 1997.) He remains on the board and along with other family members owns about 18 percent of Children's Place outstanding stock.

Also on the board is Dabah's father-in-law Stanley Silverstein. The board recently censured his sister-in-law Nina Miner, who serves as chief creative officer, for "irregularities in expense reimbursement practices."

The Dabahs have a long and not always pristine history in the garment business. Ezra, along with his father Morris and brothers Haim and Isaac, founded Gitano Group, which road the 1980s designer jeans craze before flaming out amid federal investigations into customs violations, insider trading and accounting irregularities.

Morris and four other executives agreed to pay $1.06 million to settle with the SEC. Gitano was later sold to Fruit of the Loom.