How Many Retailers Can Be Taken Private? (BIG, BJ, JAS, JCG, AEO, ARO, DG)

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Shares of Big Lots, Inc. (NYSE: BIG) jumped more than $5/share just before closing yesterday on a report from Bloomberg that the company may sell itself to a buyout firm.  If the report pans out, Big Lots joins BJ’s Wholesale Club Inc. (NYSE: BJ) as the latest in a string of either announced or potential retail buyouts. It’s not too hard to see the rationale behind these deals. However, reasons for buying the discounter or the big box store are a little harder to tease out.

Bloomberg reports that Big Lots has received interest from private equity firms Thomas H. Lee Partners LP and Bain Capital LLC. Private equity firm Leonard Green & Partners LP has agreed to purchase Jo-Ann Stores Inc. (NYSE: JAS) for $1.6 billion. Green has also teamed up with TPG Capital on a $3 billion offer to buy J Crew Group, Inc. (NYSE: JCG).

What makes retail attractive to private equity? Perhaps the biggest component is brand. A strong brand, such as Jo-Ann or J Crew, continues to attract customers, even if sales fall during periods of economic weakness. Once the economy perks up, the thinking goes, consumers will return to their favorite brands.

The good brands also maintain their value and, provided the private equity firm doesn’t screw things up, can be sold again in a few years for a nice profit. Demand among consumers for Jo-Ann and J Crew should continue to be strong.

Let’s not forget about Dollar General Corporation (NYSE: GD) yet.  It is not a takeover candidate and likely will not be.  It was taken by private in a private equity buyout and then was refloated as a public company all over again.  A trend to watch…

But what about Big Lots and BJs? What value do these chains bring to the table that would justify price tags north of $3 billion? In the first place, there’s real estate. Big Lots operates 1,389 stores in 48 states. The company had more than 40.5 million square feet of store space at the end of 2009, with an average of nearly 30,000 square feet per store.

BJ’s operates 189 stores from Maine to Florida. The average store size is 113,000 square feet, and the company owns or leases about 1.7 million square feet of logistics facilities.

Besides real estate, the two retailers do offer some brand power, though not as strong as either Jo-Ann or J Crew. BJ’s operates in large population markets, but with limited geographic reach. Big Lots is spread more widely, but the smallish store size could be problematic.

The bigger problem that Big Lots and BJ’s face is whether or not they can keep their customers as the economy improves. This is a bigger problem for Big Lots because it plays at the very low end of the market. Brand loyalty based price is not a long-term winner.

We looked at other potential acquisitions in the retail space a few weeks ago.  If a private equity firm were indeed looking for a retail play, it seems that either American Eagle Outfitters, Inc. (NYSE: AEO) or Aeropostale, Inc. (NYSE: ARO) could both be had for about the same price as BJ’s or Big Lots and are better deals simply because of brand strength.

Big Lots has given back some yesterday’s gain, at $38.92 in afternoon trading, down from an intra-day high of $39.10.

Paul Ausick