Children's Place: Could Ascena Retail Group Come Knocking Next Year?

PLCE

Children’s Place: Could Ascena Retail Group Come Knocking Next Year? Tim Heitman – Investing 501 : Long Term Value Investing : May 21, 2014

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PLCE 1 Children’s Place: Could Ascena Retail Group Come Knocking Next Year?

Disclosure: Disclosure: I am long PLCE, ASNA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Summary  Ascena Retail Group management has stated numerous times that their goal is to become a $10 billion revenue company.  Acquisitions are a major component to this goal and the company has created an operational platform to allow for a “plug and play” acquisition strategy.  Past acquisitions provide an insight for the criteria of potential acquisition candidates. Children’s Place’s business model fits well with those criteria.  A reasonable case could be made that PLCE could be acquired for $57 to $81 a share by the end of 2015.  This is a speculative theoretical exercise; any investment in PLCE should be made on the merits of the company as a standalone entity.

It has been said that there is "no substitute for experience" in investing and we find that to be true. One thing that experience in investing helps with is allowing the investor or analyst to recognize when opportunities with similar characteristics to successful investments present themselves. While working for a hedge fund a couple of years ago, two companies that we invested in, Tween Brands and Charming Shoppes were acquired by Ascena Retail Group at substantial premiums to our cost basis. I had done an analysis of Charming Shoppes that included analysis of a possible acquisition by Ascena Retail Group (ASNA) and was lucky enough to be proven mostly correct on the analysis and the valuation. ASNA's acquisition criterion is very clear and I believe that Children's Place's business model makes the company an attractive fit for ASNA.

In this article, I will discuss the strategic rationale for an acquisition of Children's Place (PLCE) by ASNA and possible valuations. I think it is helpful for less experienced investors to learn how to analyze a company on many levels and think of numerous investment outcomes (including what Marty Whitman calls "resource conversion" activities). Mario Gabelli and Longleaf Partners often talk about their investments in terms of "discounts to Private Market Values (PMV)" and this is one type of PMV analysis. To be clear, this is purely a theoretical exercise for illustrative purposes only. I have no knowledge of any pending deal or conversations between the two companies. No one should invest in a company solely based on the possibility of an acquisition and I will also discuss the many reasons why a deal wouldn't happen.

Background

Ascena Retail Group's Mission Statement: "Serve our shareholders and create value by becoming a family of leading retail concepts with $10 billion in sales and top tier profitability." In 2011, Dress Barn Inc. changed its name to Ascena Retail Group. The reasons were more than cosmetic. At the same time, the company changed its capital structure to a multi-brand holding company. Some of the reasons given in the proxy statement for the change were: 1. Seamlessly incorporate future acquisitions. 2. Provide for shared services.

3. Autonomous management of brands. 4. Provide us with greater strategic, business and administrative flexibility, which may allow us to acquire or form other businesses, if and when appropriate and feasible, that may be owned and operated by us, but which could be separate from our current businesses.

Ascena made its first acquisition in 2004, acquiring maurices on Nov. 17th, 2004 for approximately $320 million. Since the acquisition, maurices has more than doubled its sales and stores. The acquisition helped ASNA diversify into smaller towns that had much less competition for fashion clothing for women. In 2009, ASNA acquired the struggling Tween Brands (TWB) for approximately $410 million in ASNA stock. At the depths of the Great Recession, TWB was struggling and had perceived potential liquidity problems. ASNA used its large cash balance to pay down TWB's debt. ASNA saw the long-term value in being the #1 player in the tween girl space in off mall locations. The Justice and Brothers stores have become the major driver in ASNA's growth plans for the future.

After becoming a holding company, ASNA acquired Charming Shoppes for nearly $900 million in 2012. The rationale for this transaction was to acquire the Lane Bryant brand that was a leader in the "plus size" space. ASNA saw the long-term value in being #1 in the women's "plus size" category.

After analyzing these three acquisitions and listening to investor presentations and having conversations with management over the years, the criteria for an acquisition by ASNA becomes clear. With only $5 billion in sales and public admission that management wants the company to grow to $10 billion in sales and generate a 10% operating margin, it is obvious that acquisitions will have to play a major role in achieving that goal. Below are what we feel some of the most important aspects that a company must bring in an acquisition.

Leading competitor in its markets, ability to bring in new customers or markets to ASNA and low direct competition.  Acquired company is usually #1 in market share  This helps maintain pricing power and increase margins  Provides ability to position brand in a differentiated way from competitors

Source: Company 8K, Apr. 2013

Strong Price/Value proposition with high fashion content.  Reduces substitution options for customer  Lessens need to compete solely on price and increases gross margin opportunities

Source: Company 8K, Apr. 2013

Significant off mall presence  ASNA has traditionally focused on B and C malls and strip centers for store locations  This means lower rent payments, which helps margins  Also reduces the number of direct competitors

Opportunity to grow the store base over time.  Each of the three companies ASNA has acquired has the potential to grow to over 1,000 stores.

Use "plug and play" holding company operating structure to realize cost synergies, yet maintain management autonomy at the brand level  Company leverages its "shared services" division to reduce total operating costs.  Maintains separate headquarters for each brand to allow management to manage each division to its individual strengths.  Eliminates redundant distribution centers.  Leverages direct sourcing to lower unit costs of product.

Strong presence in E-commerce  ASNA recognized the importance of E-commerce in driving margins and incremental sales long before it was the "next new thing."

Summary of ASNA acquisitions  Acquisitions have been spread out over different geographies, household income levels, demographics and end markets.  Market leadership, price/value and fashion are common denominators.  maurices  Small markets (25k-100K population)  17-34 year old  Major competitors are big box retailers, with low fashion component.  Tween Brands  Only retailer exclusively focused on tween girls and fashion  #1 market share (higher than Wal-Mart)  7-12 year olds  Main competitors such as Wal-Mart, Target and JC Penney with low fashion component.  Charming Shoppes  Lane Bryant #2 behind Wal-Mart in "plus size" market share.  Leading specialty retailer in "plus size"  Majority of locations off mall  30-45 year old target market

Source: Company 8K, Apr. 2013

Strategic rationale for PLCE acquisition It is no secret that specialty retailer stocks are one of the most hated and worst performing groups in the market today. The reasons given for their performance are also well-known. High teen unemployment, poor Christmas sales, bad weather, fashion misses, no one goes to the malls anymore and people only shop on line, etc. After all, companies with no liquidity issues don't trade at 4-6X EV/EBITDA because things are great or perceived to be getting better. And we have made our own mistakes in retail. But, we still look at stocks at or near 52 week lows and not 52 week highs, which brings us back to PLCE. We have thought for years that the company would make a nice fit for ASNA and revisiting the company today reinforces that feeling. While we think an investment case can be made that PLCE is valued attractively for acceptable returns as a standalone company with a few positive developments, the purpose of this article is to go through an analysis of the rationale of an acquisition of PLCE by ASNA. The term "private market value" is used quite often by value investors. There have been several articles on SA (here and here for example) that discuss it. Mario Gabelli is probably one of the most famous practitioners of this type of analysis. Here is our attempt to figure out what PLCE's PVM might be.

What characteristics of Children's Place's business model make it an attractive acquisition candidate for Ascena? Almost every "cheap" stock at some point seems to become a "takeover candidate" or "activist target." While "cheap" is often a prerequisite of being attractive to a potential suitor, it cannot be viewed in

isolation as the only factor. PLCE generates about $1.8 billion in sales and $165 million in EBITDA. The enterprise value is approximately $780 million. The company has struggled to generate sustained positive comp store sales growth (five out of the last six years have produced negative comps) and gross and operating margins have contracted over the last four years. After all, stocks don't get "cheap" if they were outperforming their peers. What follows is our analysis of the attributes of the PLCE business model that we think ASNA might find attractive for its own business model.

Solidifies #1 position in children Justice has the number one position in terms of market share in the 7-12 year old tween girls market with approximately a 10.5% share. PLCE is the only other pure play public company that has a top seven spot with 4%. In addition, PLCE's target customer is generally younger on average than Justice (but there is overlap) and the company is very strong in the infant to 10 year old market. This market is not really served by Justice, so an acquisition of PLCE would not only boost ASNA's market-leading position in tween girls, but give the company exposure to a clientele that eventually could grow up to be a Justice consumer. PLCE has 6.7 million members using its loyalty card who account for 65% of the company's sales. The loyalty program would augment ASNA's 3.4 million maurice and 7.4 million dressbarn customer databases. These customers could be marketed to in such a way as to create a "customer for life" situation. After all, infants always get older and they are future customers of all of the other ASNA brands. Creating an emotional connection with the parents and children at an early age can increase the value of that customer over time as they continue to shop at other ASNA brands. In addition, there are probably opportunities to put PLCE clothes in Justice stores (similar to their strategy of Brothers) and vice versa or create co-branded off mall locations.

Expands international exposure and off mall presence Since the US market is saturated and shrinking in some cases in terms of store counts, retailers are looking to expand internationally to generate revenue growth. ASNA has 23 Justice and 15 maurices stores in Canada. PLCE has 133 stores and a distribution center in Canada. In addition, PLCE has 34 franchise stores in the Middle East and expects that to grow to 65-70 in 2014. Acquiring PLCE would give ASNA more scale in Canada (PLCE gross margins are higher in Canada than the US) and an international franchise presence that could be used as its growth platform outside of North America. In ASNA's 10K the company stated that, "We plan to continue our global expansion during Fiscal 2014, and will continue evaluating other international opportunities for our family of brands."

While PLCE does have a significantly higher number of stores in malls compared to ASNA's brands, it should be pointed out that, of the 190 stores opened since 2009, 95% have been opened in non- mall/outlet locations. In addition, the majority of the 125 announced store closings by PLCE are occurring in malls. This strategy makes sense considering that PLCE's main competitor in the mall Gymboree is often located next door to its stores, making competition intense. This is something ASNA tries to avoid when possible.

Store Lane Children's Justice maurices dressbarn Catherines Ascena Combined Type Bryant Place

Strip 23% 47% 54% 72% 84% 52% 12% 43% Center

Malls 56% 31% 39% 7% 14% 32% 54% 37%

Outlet 10% 15% 5% 22% 1% 11% 12% 11%

Lifestyle 11% 7% 2% 0% 1% 5% 22% 9%

Total 100% 100% 100% 100% 100% 100% 100% 100%

Store Lane Children's Justice maurices dressbarn Catherines Ascena Combined Type Bryant Place

Strip 223 370 475 592 333 1993 133 2126 Center

Malls 546 243 343 55 55 1242 598 1840

Outlet 93 119 40 179 5 436 133 569

Lifestyle 109 56 19 4 188 244 432

Total 971 788 877 826 397 3859 1107 4966 Note: PLCE store descriptions are from March 2014 presentation and differ from 10K.

Continues company's focus of offering a compelling price/value proposition with emphasis on fashion. A key element of ASNA's brand strategy is to offer a strong price/value proposition for the customer, but without sacrificing the emphasis on fashion. This strategy helps the company differentiate itself from the big box competitors and helps the company avoid price wars on basics to drive traffic. Earlier in this article we included slides that show where ASNA feels it belongs on the fashion/value matrix. The company constantly strives to be in the upper middle corner, which is more fashion and reasonable price. By emphasizing fashion and value the company tries to maintain an ongoing relationship with the customer and give the customer a reason to buy from their brands and not competitors. While PLCE has also tried to emphasize fashion, its success over the last few seasons has been mixed at best and the company has continued to shift between basics and fashion. This confuses the marketing message and the customer and increases pressure on gross margins. We believe that PLCE can benefit from ASNA's merchandising expertise and drive higher initial market ups and gross margin. Below are a few examples of comments made on PLCE conference calls (emphasis mine):

Q4 2013: What we've done in the newborn part of the business, which we really think about as 0 to 24 months, is we have invested significantly in the sleepwear pieces of the business, and it cut way back on the fashion elements of the business. And that is clearly working for us. And I think it really speaks more to what that customer is looking for.

Q3 2013: From the answer to the accessories miss, we had some fashion misses in our hat department and in our hair department. I think looking back on it, it was just a little bit too similar to LY. I think we've got the mix of basic fashion and seasonal basics right there. I think the product is on trend. And I think that when you look at what we're becoming known for, I think we're starting to be able to keep kids in our brands just a little bit longer than we have been able to in the past. And how we did that is really minimize some of the dress-up and fashion items that we had, and really, get back to basics and more play wear inspired looks, more casual looks, more end use.

Q2 2013: When you look at the fashion quotient of the back to school, we made some significant changes this year in our fashion assortment. And when I speak of fashion, I speak of, really, the girls side of the business because the boys is so key-item driven at this time of year and just in general. And what we did with the girls business this year, if you look in the store, is at much more wear now. So you see a lot more short sleeves, a lot more 3/4 sleeves, a lot more "first day of school" looks, if you will, versus delivering heavy sweaters and long-sleeved product in the month of August.

Strong presence in e-commerce The new buzz word in specialty retail is "Omni-channel" distribution and marketing. Every retailer is touting their new strategy on how they are going to drive new business through E-commerce. Both ASNA and PLCE have been emphasizing-commerce for years. YTD in FY2014, ASNA E-commerce is now 10% of sales. Since 2005, PLCE has grown e-commerce sales by a 28% CAGR to approximately $250 million in sales. Both companies are nearing completion of upgrades to their distribution and IT systems to further enhance their capabilities. ASNA recently consolidated its distribution facilities to dedicate one facility solely to e-commerce shipments. This part of the business seems to be a nice addition to ASNA's already strong and growing e-commerce business.

Lane Children's Justice maurices dressbarn Catherines Ascena Bryant Place

E-commerce % of 8.3% 14.4% 7.3% 4.0% 11.5% 8.7% 14.0% Sales

Opportunity for margin improvement Most acquisitions have a "margin improvement" or "synergies" component to them. For example, ASNA believes that they can take out $50 million of Charming Shoppes' $80 million in shared services costs. There are also synergies to be derived from more direct sourcing. The holding company structure was created specifically with these types of savings in mind.

Sales EBITDA Margin Gross Margin Buy/Dist SG&A/sq ft Occ % Adj GM

TWB $918.00 $47.00 5.1% 54.4% $250.00 $75.00 27.2% 29.3%

CHRS $1,992.00 $100.00 5.0% 50.0% $340.00 $61.00 17.1% 33.0%

PLCE $1,765.00 $170.00 9.6% 37.1% N/A $93.00 N/A 37.1%

ASNA $4,800.00 $470.00 9.8% 56.2% $822.00 $64.00 17.1% 38.8%

PLCE does not breakout its buying/distribution/occupancy costs that are allocated to cost of goods sold so it is hard to estimate potential savings available to ASNA. However, we can calculate SG&A per square foot and see that PLCE's metric is substantially above ASNA. A 10% savings in SG&A per square foot would result in $50 million in savings. If shared services costs as a percentage of revenue were similar to CHRS, at 3-5% of revenue that would be another $40-$90 million in potential savings. While $90-$140 million in savings seems large (considering EBITDA is only $160-$170 million for PLCE) we think there is ample room for savings and the plug and play acquisition model could achieve them.

PLCE already direct sources 95% of its goods, so it is unclear how much savings can be achieved using ASNA direct sourcing contacts. However, gross margins have declined by 500bps since peaking in 2008, through a combination of occupancy deleveraging and lower markups and higher mark downs. The US gross margin has always been lower than the Canadian operations and there does seem to be room for improvement in margins. The combination of lower costs, a successful transformation of bringing outlet margins up to company average by boosting the percentage of product designed for the outlets (as opposed to using them to clear outdated merchandise) and better fashion merchandising expertise could improve gross margins over time.

Finally, PLCE owns a 700K square foot distribution center in Alabama. ASNA has recently consolidated its DCs into one to support all the brands. The company could sell or lease the distribution center to achieve additional savings.

Acquisition price ASNA has done three acquisitions:  Before synergies, generally in the 7-8.5X EV/EBITDA range.  GYMB a direct comp was bought for 7.9X EV/EBITDA by private equity (which may have less ability for cost savings at the G&A level vs. ASNA platform).  The median multiple used in the merger analysis of ASNA targets has been about 8.1X

Representative Transaction Multiples EV/EBITDA MULTIPLE

TWEEN BRANDS 6.9

CHARMING SHOPPES 8.0

MAURICE 8.5

GYMBOREE 7.9

DEB SHOPS 7.8

WHITE HOUSE 10.0

HOT TOPIC 7.0

TRUE RELIGION 6.5

RUE 21 9.2

MEDIAN All ACQUISITIONS 8.1

Basic assumptions Assuming PLCE can generate EBITDA in the range of $160 million to $180 million on an ongoing basis, a transaction multiple of 6-8X EV/EBITDA would value the company between $950 and $1.5 billion. This would be the largest transaction ASNA has ever done. Enterprise Value $Mill EBITDA $Millions $160 $170 $180

Multiple

6 $960 $1,020 $1,080

7 $1,120 $1,190 $1,260

8 $1,280 $1,360 $1,440

Scenario 1  Sales are approximately $1.7 billion for 2014 and 2015 (WS is at $1.8B in 2015)  EBITDA is $160 million in 2014 and $170 million in 2015  CFO flows through at 85% of EBITDA (low end of last 4 years)  Cap Ex $82 million in both 2014 and 2015  All FCF stays on balance sheet  $24M in dividends.

EBITDA $ Millions $160 $170 $180

Multiple

6 $57.27 $60.00 $62.73

7 $64.55 $67.73 $70.91

8 $71.82 $75.45 $79.09

Scenario 2  Sales are approximately $1.7 billion for 2014 and 2015 (WS is at $1.8B in 2015)  EBITDA is $160 million in 2014 and $170 million in 2015  CFO flows through at 95% of EBITDA (average of last 4 years)  Cap Ex $82 million in both 2014 and 2015  All FCF stays on balance sheet.

 $24M in dividends are paid out

EBITDA $ million $160 $170 $180

Multiple

6 $59.09 $61.82 $64.55

7 $66.36 $69.55 $72.73

8 $73.64 $77.27 $80.91

Reasons why a deal may never happen As exciting as it is to play "matchmaker" in the corporate M&A world, the reality is there are no guarantees that deals that appear to make sense ever happen. There are many reasons why ASNA and PLCE may never get together. Below is a non-exclusive list of reasons a deal may never be consummated. There are certainly many others, including macro that could come into play.

Maybe need to stay focused on own brands While management is held in high regard in the retailing industry, the company's brands have not been immune to the problems in the specialty retail market and performance at Dress Barn and other brands has been inconsistent. We think that management is always focused on improving its current brands first and making acquisitions second. Both Tween Brands and Charming Shoppes acquisitions were opportunistic and made when the companies were either in some distress or had recently suffered poor operating performance that was driven more by internal, rather than external factors. After reaching the company's 10% operating margin goal in FY12, the company has taken a significant step backwards since then. After backing out acquisition and restructuring costs, the overall corporate operating margin has fallen to around 6-6.5% as Lane Bryant and Dress Barn have struggled to reach expected profitability. Same store sales, which had been relatively strong for the past few years in the flat to +5% range, have turned negative YTD in FY2014. ASNA's presence in B & C malls appears to be a drag on the company at this point.

2014 YTD 2013 YTD 2013 2012 2011

Revenue $2,463.00 $2,375.00 $4,715.00 $3,353.00 $2,914.00

Adj Op inc $147.00 $154.00 $300.00 $318.00 $290.00

Op Margin 6.0% 6.5% 6.4% 9.5% 10.0%

Revenue 2014 YTD 2013 YTD 2013 2012 2011

Justice $806.00 $800.00 $1,407.00 $1,307.00 $1,150.00

Lane Bryant $526.00 $489.00 $1,050.00 $120.00 $ -

maurices $492.00 $465.00 $918.00 $853.00 $777.00

dressbarn $482.00 $473.00 $1,021.00 $1,038.00 $988.00

Catherines $156.00 $147.00 $319.00 $36.00 $ -

Op Inc

Justice $100.00 $146.00 $183.00 $174.00 $130.00

Lane Bryant $(7.00) $(35.00) $(30.00) $(10.00) $ -

maurices $52.00 $57.00 $107.00 $103.00 $104.00

dressbarn $(5.00) $(16.00) $30.00 $57.00 $56.00

Catherines $7.00 $2.00 $10.00 $(4.00) $ -

Total $147.00 $154.00 $300.00 $320.00 $290.00

Op margin

Justice 12.4% 18.3% 13.0% 13.3% 11.3%

Lane Bryant -1.3% -7.2% -2.9% -8.3% n/a

maurices 10.6% 12.3% 11.7% 12.1% 13.4%

dressbarn -1.0% -3.4% 2.9% 5.5% 5.7%

Catherines 4.5% 1.4% 3.1% -11.1% n/a

Total 6.0% 6.5% 6.4% 9.5% 10.0%

Increases exposure to malls As we mentioned earlier, in spite of PLCE's attempt to reduce its exposure to malls by closing over 100 stores by next year, the company still has over 50% of its store base located in malls (most likely a higher percentage in A & B malls than ASNA, which means higher rent costs). And the company's main competitor, Gymboree, often has a store within close proximity. However, the acquisition would lower ASNA's percentage of malls stores located in B & C malls, which have struggled on a relative basis. ASNA generally likes to acquire brands with less than 1,000 stores in order to grow the business over time. PLCE has 1,100 stores and is shrinking the store base.

Low birth rates The birth rate in the United States has been declining for over 55 years. From its peak in 1955 at 25%, the birth rate has steadily declined to 12.6% in 2012. From 1995 to 2008, the birth rate was fairly stable

between 14.0% and 14.4%. However, since the Great Recession, the birth rate has dropped to an all-time low of 12.6%. While the magnitude of the drop looks significant, the reality is the number of new births is still relatively large at 3.95 million births a year and only down 350 thousand from its recent peak of 4.3 million in 2007. Birth rates are a lagging indicator in the sense that current births are based on decisions made at least 9 months ago (No snickering please). Therefore, it is possible that recent apparent improvements in economic factors could increase the confidence in couples to have a child. It is interesting that 36% of millennials aged 18-31 still live with their parents and that cohort has shown a steady decline in birth rates since 2000 (no sarcastic comments please!!).

Millions YOY Birth Rate

2012 3.952 0.0% 12.6%

2011 3.953 -1.2% 12.7%

2010 3.999 -4.0% 13.0%

2009 4.130 -2.1% 13.5%

2008 4.247 -1.6% 14.0%

2007 4.316 1.2% 14.3%

2006 4.265 3.0% 14.3%

2005 4.138 14.0%

Decline in births slowing

Source: CDC

Crown Crafts Presentation April 25th, 2014

Lack of new sourcing opportunities One of the shared services that ASNA tends to utilize after an acquisition is its direct purchasing sourcing. One of the places where ASNA has been able to increase its expected savings after mergers was its ability to increase the amount of product that is sourced directly from manufacturers. The company is able to lower unit costs by eliminating the middle man. PLCE has been transitioning to a more direct sourced model and current 94% of purchases are direct sourced.

ASNA could just buy Gymboree In late 2010, Bain Capital acquired PLCE's peer Gymboree for approximately $1.8 billion. The company has sales of $1.24 billion and EBITDA of $120 million. The company is highly leveraged, with about $1.1 billion in debt, giving it a debt to EBITDA ratio of over 9X. PLCE, in contrast has $230 million net cash. While Gymboree is currently free cash flow positive, another severe downturn could impair the company's ability to meet its obligations. ASNA might view acquiring a distressed Gymboree as a better long-term investment than acquiring PLCE.

Goal of $10 billion in revenue has no definitive time frame for achievement. Management has stated that it believes that ASNA can achieve $10 billion in sales (about the size of L Brands (LB) or Ross Stores (ROST)) and have "top tier" profitability, which is defined as a 10% operating margin. With $5 billion in sales currently, it is clear that if ASNA is to achieve this goal sooner, rather than later, the company needs to make at least one acquisition to get to that scale. However, management is conservative and patient and has been very opportunistic in its acquisitions. Unlike some companies whose business model is based on continuously making acquisitions, ASNA has only made three acquisitions in the last ten years. Acquisitions are an important part of its long-term strategy, but are really secondary to running its existing businesses. Therefore, buying stock in PLCE hoping for a "resource conversion" within the next year or two as an investment strategy seems unwise.

ASNA will not generate any free cash flow in 2014 as it completes major upgrades to its distribution and IT facilities. Utilizing its cash balances and free cash flow to reduce acquisition debt is an integral part of its strategy. Therefore, unless something significant would happen to PLCE's valuation or operations in the near-term, we think ASNA would wait until its cash balances and free cash flow increase, which would be in 2015. Even then, there is no reason ASNA would have to acquire PLCE in that time frame. In addition, PLCE may see other more attractive opportunities arise sooner that it could decide to pursue. The company is noticeably light in men's fashion, but has started to rollout the Brothers concept in Justice. The company could focus on other aspects of small town merchandising where it sees little competition to augment the maurices division.

Deal would be largest in company history The price tag for the acquisition would be between $950 million to $1.4 billion before using PLCE's cash balances. This would be the largest acquisition in the company's history. ASNA/PLCE could have $600- $700 million in cash combined by the end of 2015, reducing the need to do a highly levered transaction. Assuming the company would like to have a $100 million cash cushion and the multiple on their stock was not sufficiently high enough to use as currency the way they did in the Tween Brands acquisition, ASNA would need to raise $400-$900 million in debt.

Enterprise Value $Millions EBITDA $160 $170 $180

Multiple

6 $960 $1,020 $1,080

7 $1,120 $1,190 $1,260

8 $1,280 $1,360 $1,440

More assumptions:  Assuming ASNA generates $200 million in FCF in 2015, the combined company would have approximately $700 million in cash by end of 2015.  Assume $150 million cash cushion.  Debt $400-$900M  Interest rate 7%  Interest $30-$65 million  PLCE EBITDA $160-$170 million  Cap Ex $70M  Interest $65M  EBITDA covers Interest and cap ex before synergies  Synergies could produce $50-$100M in EBITDA  Very hard from the outside to determine exact savings potential.

Summary While the focus of this article was an analysis of ASNA's acquisition strategy and how PLCE could fit into it in the long-term, an investment case could certainly be made for each company on their own as a standalone company. Both companies trade for EV/EBITDA multiples of under 5.5X, which usually isn't sustainable in the long run for companies that have low or no leverage and historically generate meaningful free cash flow. Both companies carry normalized free cash flow yields of at least 7-10%. Both companies are leaders in their market segments and changes in same store sales comps in aggregate tend to change significantly less than teen and women's retailers (minus 2% to plus 2% generally). PLCE has $10 per share in cash and a $100 million (10% of market cap) stock buyback in place. For further research, here is an article on ASNA and here is one on PLCE. Readers are encouraged to use this article as a starting point, not an ending point.

Investing in a company's stock simply on the hope of an eventual takeover is not a strategy we endorse. However, we do believe that looking at various "resource conversion" options as part of the investment process is a productive exercise. One of the benefits of being in this business for over thirty years is having the ability to recognize risks and opportunities that have occurred in the past. Having been fortunate to have two companies acquired by ASNA, we are familiar with their acquisition strategy and criteria. Just because a potential acquisition "seems" to make sense to us, that doesn't mean it "does" make sense to either party. Howard Marks talks about "second level thinking." Second level thinkers are usually thinking about multiple concepts and scenarios. This is just one scenario we can envision and realizing that Mr. Marks once said, "The future is unknowable and unpredictable and improbable outcomes happen all the time."

Additional disclosure: Business relationship disclosure: Investing 501 is a pair of analysts with over 60 years of professional investment experience. This article was written by Tim Heitman, one of our Founders. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.