Leveraged Buyout Case Study of Abercrombie & Fitch An evaluation of Abercrombie & Fitch’s potential as a LBO target, seen from a Private Equity funds perspective MASTER’S THESIS Authors: Supervisor: Martin Larsen Oskar Peter Bardh Cand.Merc. Applied Economics & Finance Standard Pages: 117 Kasper Flemming Rasmussen Cand.Merc Finance & Strategic Management Characters: 270.549 Date: 15/05-2017 Bardh & Rasmussen Master’s Thesis 2017 Executive summary The low interest rate environment in today’s market has fueled the amount of investments related to private equity, as general partners have developed their ability to identify good companies with large opportunities for value creation. In addition, PE funds have after the financial crisis, to a much larger extent, been applying a more strategy driven approach to create such value. A company representing such opportunity, is the once so popular American teen retailer Abercrombie and Fitch (A&F). The purpose of this thesis has thus been to evaluate A&F as a potential target, by applying the LBO model and determine if such buyout could result in an acceptable return from a PE firm’s perspective. After a thorough analysis of both A&F and its environment and through the implementation of different strategic initiatives, we have concluded that A&F, as a LBO target, would provide a satisfactory return, from a PE funds perspective, if the investment where to be exited within four to eight years. Key Words Abercrombie & Fitch; Leveraged Buyout; Private Equity 1 Bardh & Rasmussen Master’s Thesis 2017 Table of Contents Executive summary.................................................................................................................................................................. 1 1. Introduction ........................................................................................................................................................................... 5 1.1 Problem Statement ...................................................................................................................................................... 6 1.2 Delimitation .................................................................................................................................................................... 6 2. Methodology .......................................................................................................................................................................... 8 3. Presentation of Abercrombie and Fitch .................................................................................................................... 11 3.1 Intro ................................................................................................................................................................................. 11 3.2 History ............................................................................................................................................................................. 11 3.3 Company Performance ............................................................................................................................................. 12 3.4 Current ownership structure................................................................................................................................. 14 3.5 Choice of A&F as a LBO Target .............................................................................................................................. 15 4. Literary Review .................................................................................................................................................................. 17 4.1 PE & LBO Characteristics ............................................................................................................................................. 17 4.2 Corporate Governance & Value Creation .......................................................................................................... 18 4.2.1 Financial Engineering ....................................................................................................................................... 19 4.2.2 Operational Efficiency ...................................................................................................................................... 20 4.3 Deal structure............................................................................................................................................................... 22 4.4 Returns............................................................................................................................................................................ 23 5. Strategic Analysis ............................................................................................................................................................... 25 5.1 Macroeconomic environment ............................................................................................................................... 25 5.1.1 Political ................................................................................................................................................................... 26 5.1.2 Economic ............................................................................................................................................................... 27 5.1.3 Socio-cultural ....................................................................................................................................................... 29 5.1.4 Technological ....................................................................................................................................................... 31 5.1.5 Environmental ..................................................................................................................................................... 31 5.1.6 Legal ........................................................................................................................................................................ 32 5.2 Industry Dynamics ..................................................................................................................................................... 33 5.2.1 Threat of entry .................................................................................................................................................... 33 5.2.2 Bargaining Power of Customers .................................................................................................................. 34 5.2.3 Bargaining Power of Suppliers ..................................................................................................................... 34 5.2.4 Threat of substitutes ......................................................................................................................................... 35 5.2.5 Industry Rivalry .................................................................................................................................................. 36 5.3 Market analysis ........................................................................................................................................................... 37 2 Bardh & Rasmussen Master’s Thesis 2017 6. Financial Analysis .............................................................................................................................................................. 41 6.1 Analysis of financial drivers and other financial posts ............................................................................... 41 6.1.1 Revenues................................................................................................................................................................ 41 6.1.2 Costs ........................................................................................................................................................................ 43 6.1.3 NWC and Inventory Turnover ...................................................................................................................... 44 6.1.4 Liquidity ratio ...................................................................................................................................................... 46 6.1.5 EBITDA margin ................................................................................................................................................... 47 6.1.6 ROIC ......................................................................................................................................................................... 48 6.1.7 Free Cash Flow .................................................................................................................................................... 51 6.1.8 Treasury Stock .................................................................................................................................................... 51 7. Internal analysis ................................................................................................................................................................. 54 7.1 Purchasing and Production .................................................................................................................................... 54 7.2 Distribution and customer service .....................................................................................................................