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December 20, 2006

Endeavor Aquisition Buys American Apparel and Northlake Buys Endeavour

Following the news that American Apparel is being purchased by Endeavor Acquisition Corp. (EDA), I decided to take a small position in EDA for client accounts. EDA is a blank-check company that went public about one year ago by raising $130 million. Blank check companies go public and then look to make acquisitions. For EDA, American Apparel is the choice. And it's a good one.

My target on EDA is $10-12 based on my initial expectations for revenues to rise 30% in 2007 and EBITDA to grow by 35%. This target assumes EDA/American Apparel would trade at a similar multiple to other high growth specialty apparel retailers serving teens such as American Eagle (AEOS) and Urban Outfitters (URBN).

Background on American Apparel

American Apparel operates 140 stores in 11 countries and also sells through its Web site at AmericanApparel.net. The company sells basics, targeting a young demographic with a progressive message. American Apparel does not use sweatshops in the Far East. All of the company's products are made in Los Angeles. Wages are relatively high at $8-15 per hour and benefits are provided to workers including health care and English classes. American Apparel competes with Abercrombie & Fitch (ANF) and American Eagle Outfitters (AEOS) as well as other specialty apparel companies targeting teens, young adults, Generation X and baby boomers.....

The company has grown rapidly and is projected to have 2006 sales of $275 million and earnings before interest, tax, depreciation and amortization (EBITDA) of $30 million. According to the Wall Street Journal, sales in 2002 were just $30 million.

EDA intends to accelerate American Apparel's growth rate with a target of 800 stores in several years. EDA will supply capital and management expertise and help beef up enterprise systems such as inventory management. EDA will also increase the professional management depth to support the rapid expansion of the store base.

The Details Behind the Deal

EDA is paying about $385 million for American Apparel composed of 32 million shares valued at $250 million, the assumption of $110 million in debt, a cash bonus pool of $2.5 million and 2.7 million shares reserved for company employees.

Prior to this deal, EDA has 20 million shares outstanding, $125 million in the bank and no debt. Following the deal, there will be about 55 million shares outstanding, $110 million in debt and $120 million in cash. With EDA shares trading at $8.25, up about 10% following the deal, the total enterprise value is around $450 million, putting the multiple of current EBITDA at 15. Assuming an aggressive 30% growth rate in 2007 would lower the multiple closer to 11. Taking away the cash on the balance sheet that will be spent on store expansion leaves the 2007 multiple around 13. Price to sales is under 2x excluding cash.

How EDA + American Apparel Stacks Up vs. Competitors

As a comparison, based on data at Yahoo! (YHOO) Finance provided by Capital IQ, ANF trades at 7.5x trailing 12-month EBITDA and 1.9x sales, while AEOS trades at 15.5x trailing 12-month EBITDA and 2.7x sales. Urban Outfitters (URBN), which might be the best comparable from a concept and target market standpoint, trades at 17x EBITDA and 3x sales.

Jumping on This One Ahead of the Analysts

Given the growth rate, I think EDA has reasonable valuation. I also think it is a valuation that will attract Wall Street analyst coverage, especially since American Apparel is a hot brand in the always exciting specialty apparel industry. Over the next few months, I'd expect new analyst coverage with buy recommendations to be bullish for EDA shares.

Risks

There are some risks. First, American Apparel uses sex to promote its brand. This has caused problems for ANF in the past and has already brought some notoriety to American Apparel. The sex issue is a further risk at American Apparel because its founder, Dov Charney, has been sued for sexual harassment and is outspoken about the use of sex as part of his company's strategy. His controversial attitudes and actions have already attracted negative media coverage. Second, specialty apparel, particularly targeting younger demographics, is a very competitive industry. It is difficult to maintain a competitive edge and keep your brand fresh and in favor with a fickle consumer base. Finally, current concerns about weakening consumer spending and signs that apparel sales this holiday season are mediocre create a macro risk.

Posted by Steve Birenberg at December 20, 2006 12:26 PM in eda