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Where Do We Go From Here?

Photo courtesy of MMG

The post-COVID-19 restructuring wave will be unlike any we’ve seen

The fashion industry has experienced three major waves of consolidation over the past 30 years: the first in the late ’80s through the early ’90s, the second in the aftermath of the dot-com bubble through 9/11 and the most recent one during the Great Recession of 2008–2009. The COVID-19 pandemic will result in a new surge of mergers and acquisitions (M&A) activity, but this wave will look different than those we’ve seen in the past for a number of reasons.

First, this economic downturn is far more severe than any other we’ve experienced in our lifetime. Second, the crisis has hit both the demand and supply sides simultaneously, with mandatory closures impacting both retail stores and their vendors for months and leaving retailers and brands facing complex pressures they’ve never had to deal with before. Third, many founders and leaders of emerging companies are too young to have ever had to navigate a major economic downturn during their career. Accordingly, they have no experience managing a business through a crisis this profound.

These factors will leave a swath of fashion businesses in a particularly vulnerable spot. Many companies that had been severely struggling pre-crisis will almost certainly now file for bankruptcy protection under the cover of COVID-19, which will likely have a lesser long-term effect on their reputation than filing during the good times would have had. Marginal retailers unable to appeal to or attract customers and those with weak balance sheets and significant debt burdens will likely be forced to significantly downsize or liquidate. Many direct-to-consumer (DTC) companies, brands and wholesale vendors may face the same fate. Even some marquee retailers will fall victim to the pandemic’s effects on the economy.

It’s therefore unsurprising that companies with a history of active buying are already showing increased interest in opportunistic acquisitions. Experienced serial acquirers are currently plying the waters, looking for strategic opportunities to round out their businesses and replace volume they’ve lost from retailers forced to downsize during the pandemic. But other potential acquirers are also seeking opportunities. In the coming M&A wave, it won’t be only the well-established players that are looking to buy — there will be a broad range of potential acquirers looking for the right target at the right price.

COVID-19 has revealed a range of vulnerabilities across fashion. Fashion companies facing a range of challenges will be targets for M&A post-crisis. Some of these companies will find that their sales have dropped to an unsustainable level. Others will be cash-strapped. Privately held businesses that have personal guarantees to a lender in place and therefore must consider selling their assets to a strategic buyer in order to exit more easily from the lender.

Still others will be digitally-native DTC brands that may have spent years seeking a path to profitability. In the past, venture capital and private equity firms were willing to fund these brands’ losses, nurturing their growth patiently while planning for a significant return on investment eventually. But these firms will now be far less willing to finance young brands that offer more promise in terms of technology and marketing than they do in terms of product, a strategy that was already falling out of favor pre-crisis and that now appears even less sound.

Also, as the coronavirus crisis continues, retailers will push back as much economic responsibility as they can onto their vendors, whether through chargebacks or by negotiating reduced prices for inventory. The CEOs and owners of vendor companies must anticipate the negative impact of that pressure on their operating income and gross margins and have a plan in place to deal with reduced or delayed payments or, in the worst-case scenario, no payments at all.

Hundreds of companies in these and similar situations will need to seek strategic solutions, which may include filing for bankruptcy and attempting to sell their business to a third party that can help prop up the company’s economics.

Experienced acquirers know that speed and decisiveness are key. M&A transactions can benefit both parties, but in the coming months, potential sellers will have to be prepared to make tough, objective decisions about their future. Meanwhile, potential acquirers will need to have a knowledgeable team in place, be able to move fast and know when to say no and move on, as company leaders that are experienced, deal-savvy buyers know that speed and decisiveness are key.

These serial acquirers have the know-how and human resources to quickly perform due diligence, negotiate deal terms, close transactions and successfully integrate businesses. Their experience in getting deals done gives them a significant advantage over firms with little experience negotiating and completing deals, companies that may not be willing or able to move as fast as their peers with more practice. Speed is crucial because retailers and brands will need to salvage as much seasonal business as they possibly can following the shutdowns they experienced during the first and second quarters.

Regardless of experience, all companies seeking acquisitions as a result of the crisis need to be prudent buyers, and even those that have historically paid premiums to purchase companies will want to take advantage of the current economic situation to get as much bang for their buck as possible.

The most important things to look for in an acquisition target are a sustainable business model, a point of view, a real, commercial reason to exist and the right cultural fit. Other factors to consider include a relevant and complementary product mix, a strong brand persona, technology and marketing strengths, a diversified distribution network, a talented management team, a strong and flexible supply chain and solid margins that have been consistently maintained. The target company’s back-end is less important, as it will more than likely be absorbed by the acquirer.

In the retail and fashion space, this crisis will undoubtedly accelerate the convergence of heritage and legacy companies with DTC businesses and emerging brands and wholesale businesses that have a DTC component. For consolidators, these businesses will provide defensible market share and technology infrastructure. For the DTC companies, emerging brands and wholesalers, the acquirers will provide operational infrastructure and financial stability in return.

Even companies that have not made acquisitions in the past are looking to buy businesses that offer complementary products and distribution channels, DTC components and technology and marketing strengths that will help them maximize their e-commerce businesses and compete better with Amazon, Walmart and other online marketplaces.
These nontraditional potential acquirers include: privately-held companies that haven’t wanted to pay a premium to buy businesses that were overvalued in the past, but that now may be discounted; private equity firms that will push their portfolio companies to strategically acquire businesses on their own; DTC brands with healthy balance sheets that want to buy other DTC companies to scale their businesses and add complementary products and new customers and vertically integrated businesses looking for acquisition targets to enhance their marketing or reach new consumer audiences.

The coming wave of consolidation activity in fashion will look much different from the previous waves we’ve witnessed over the past 30 years. It will impact a much wider range of companies on both the buyer and seller sides and surface some new industry leaders. It’s likely that the next G-lll Apparel Group or PVH Corp., whether publicly or privately held, will emerge in the wake of the pandemic. These new leaders will be seeking acquisition targets that simply cannot make it through the post-crisis period on their own, and they will be looking to get as much value as they can.

The winners in this competitive period of restructuring will be those that are best prepared to move quickly and decisively. In this environment, it’s important to remember that business leaders who don’t make timely decisions about their company’s future may find that someone else is making those decisions for them.

Allan Ellinger is co-founder and senior managing partner of MMG Advisors, a boutique investment bank with a 30-year history of successfully managing financial transactions and providing strategic business advisory services to companies across the retail, fashion and consumer sectors. Led by former retail industry senior executives with decades of combined operational experience, the firm has a unique ability to identify and leverage consolidation opportunities that bridge traditional and new retail.

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