With rumors swirling that crafts retailer Michael Stores Inc. might be getting ready to file for an IPO, this seems like an opportune moment to talk about what’s involved in going from a privately held chain to a publicly-traded company.
Michaels’ current owners, Bain Capital and the Blackstone Group, tried to orchestrate a $500 million IPO last spring, after buying the retailer in a $6 billionat the height of the market in 2006. That deal got scrapped.
But the climate might be getting better for retail IPOs, according to a recent report from professional services firm PwC. Michaels’ financials also seem solid. In the fourth quarter ended Feb. 2, Michaels reported a 1.7 percent increase in same-store sales, an 8.5 percent increase in net sales and gross margin growth of 0.8 percent.
NREI sat down with several industry experts, including Morningstar Director Peter Wahlstrom, Kantar Retail Chief Knowledge Officer Bryan Gildenberg and Jones Lang LaSalle Executive Vice President Walter Wahlfeldt, to talk about how to time a retail IPO and how going public might affect portfolio management.
An edited transcript follows:
NREI: What macro-economic conditions are necessary for a successful retail IPO?
Peter Wahlstrom: The first thing that’s very helpful is a more favorable economic backdrop. It’s hard to raise money in an environment like 2008 or 2009. I think that it’s certainly a lot healthier environment today than it would have been just a few years ago. Some of the bigger [economic] issues have been addressed in some way, so that investors are more comfortable with taking a risk. Of course, there is never going to be a perfect Goldilocks scenario, there are always going to be uncertainties.
Bryan Gildenberg: In the end, the decision to go public is deeply rooted in two things: the long-term future of the company and what in the short-term is best for the owners. What you are looking for is a time when there is positive existing momentum, as well as forward-looking momentum, which is why we are seeing more retailers thinking about IPOs. My suspicion is that the valuations a retailer would see at that time are probably stronger than at other times. Right now, for U.S.-centric retailers, there is a reasonable amount of confidence both in the short-term and long-term prospects.
Walter Wahlfeldt: It’s critical to time the market to your specific use. This quarter has been kind of a crazy quarter—you’ve had new tax laws put into place where consumers had less dollars in their pockets. If the discretionary income is critical, timing for an IPO might not be good.
NREI: On a company level, what are legitimate reasons for going public?
Bryan Gildenberg: I would say first, that there is no real correlation between great retail and being publicly traded. I think the largest privately held retailer in the world is Aldi, and Zara is private as well, so there are great examples that you don’t need public financing in order to grow. I think that the advantages for a publicly traded business are probably three things. One is access to different kinds of capital that would benefit someone who’s on a growth trajectory. Two, for an established business like Michaels, is that an IPO brings an element of focus on short-term performance, which can be quite helpful. And third is that it allows you to attract a broader range of talent. If I am trying to bring in great management, not on the highest level, but on one level below, it would be difficult to do without stock-based compensation.
Peter Wahlstrom: If you wanted to take a company public, there are a couple of different ways you can tell a story. Number one is Michaels, which has been around for a while, has a very large footprint, is very well run and [operates] in the pretty established hobby market, which is large and where Michaels is the leader.
The other would be a younger, emerging chain growth story, with a company that has a brand new retail concept that is opening new store doors. Maybe they are going into multichannel retailing or going international. That would be another reason to sell a story that investors would be more likely to gravitate toward.
Walter Wahlfeldt: The main reason always given is that you need a large influx of capital to grow the concept at a very good pace. And when it’s private investors, they are often looking ahead to an IPO. They are going to say, “I’ve put enough of my own cash into it, it’s time for an IPO.” With our clients we are definitely seeing examples of both existing retailers and a couple of startups working on IPOs—really, more than we’ve had in 10 years. If you look at the market right now, timing is good for many of them. The stock market is riding a nice wave and there will hopefully be money that will flow into these IPOs.
NREI: Can you recall an example of a retailer that misjudged the timing for an IPO?
Walter Wahlfeldt: Yes. I was with Briazz in 1997 and 1998 and it was trying to go public. At the time, Briazz was based out of Seattle, a lot of our management [people] were former Starbucks people and it was a very European concept—coffee, sandwiches, kind of like Pret-A-Manger. The problem with launching a concept that was really based on being in Central Business Districts is that timing-wise, the office market was collapsing. You’d open a store and the customer base surrounding that store was eroding quickly. It was a very, very tough time to launch an IPO. Briazz finally went [public] in 2001 and it did not perform well. It eventually went into bankruptcy.
NREI: In terms of store openings/store closings, what should retail companies expect when they go public?
Walter Wahlfeldt: If you are an investor, whether it’s a startup or an existing brand, the investors are going to look for profitability of the stores. If it’s a startup, and those stores are showing a good growth curve, but they are not yet at 10 percent profitability, that’s okay. If it’s a stabilized retailer and their portfolio is very mixed in terms of performance, you are going to have to explain to an analyst why you are growing stores when your performance is mixed or why you are not closing stores.
If you are an existing retailer, capital spend is one of those things themarket looks at. If you just put a lot of capital in, they are going to ask: ”Why did you do that?” If you remodel the stores, they will ask “Why?” If you are an existing chain and you spend a lot of capital, investors want to know why you spent that amount and what do you get for it.
There is a science to this. What most retailers do is they prepare well in advance, they are going to have to live under that discipline at least six months before an IPO. They are going to dramatically reduce operating costs, reduce salaries to bring them in line with the industry, travel and entertainment expenses are going to be dramatically reduced. And I you are a startup, pre-IPO, you want every store to be a home run. You might slow down a little bit if you are not 100 percent confident in any stores.
Peter Wahlstrom: You’ve got a balance of long-term investors and short-term traders. That could add to near-term volatility, particularly when only 20 percent of the shares are sold to the public market. There are some instances when a company is mature and it may need to either cut back on the number of stores it operates or invest in some bigger-ticket items, which could [cost] millions or even billions of dollars, and it may not be something that near-term investors would swallow. If you’ve got a multi-year renovation program, it could be better done privately.
Bryan Gildenberg: A big measure analysts use to access businesses like Michaels is comp store sales. If you, as a retailer, have not trained yourself to ruthlessly track comp store growth, I wouldn’t go public. I think one of the great virtues of not being publicly traded is the ability to make decisions that might not be popular with investors.
NREI: What are your expectations for the success of a Michaels IPO if it goes through?
Peter Wahlstrom: In general, Michaels is one of the largest and most established players in a very fragmented market. The economic environment seems okay, the company’s operating model seems good. Still, it’s very competitive. From a timing perspective, the company was taken private at the peak of the market, so it would be interesting to see what valuation the sellers are looking for. And it will be interesting what kinds of changes the current owners have made.
Bryan Gildenberg: Other things being equal, they should be all right. If you are Michaels and trying to sell the store to investors, crafting is still a retail experience—practically speaking, I don’t always know what I will need until I get there and that kind of store is a pretty good story. The challenge for Michaels is that you are never 100 percent confident in any business that spends a lot of time in Wal-Mart’s crosshairs. And now there are newer business models that are going after some of their product categories, like art supplies. That’s a different competitive pressure, but they are a well-run business.