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EXCLUSIVE The Deal: J.Crew Fit for Possible 2014 IPO After Sponsor Dividend

NEW YORK (The Deal) -- J.Crew Group Inc., the specialty retailer of preppy threads, could go public as early as 2014 if the public markets continue to be receptive, said two sources familiar with the company.

Both sources said that an initial public offering was always going to be the likely exit for the company.

The New York-based apparel chain, whose patrons famously include President Barack Obama's family and is led by legendary merchandiser and chief executive Millard "Mickey" Drexler, declined to comment.

J.Crew has been a portfolio company of TPG Capital and Leonard Green & Partners since it was taken private in a leveraged buyout in early 2011 for $2.86 billion. In 2014, its private equity backers will have held the company going on four years.

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And the company this month placed $500 million of PIK toggle notes to pay a dividend to its PE owners.

Dividend recapitalizations are often a harbinger of an IPO, one source said, comparing it to the situation at Burlington Stores Inc. before its October debut.

And, while yet-to-be-public Apparel Holding Corp., to be renamed Vince Holding Corp. after its debut, didn't do a dividend recap, it like J.Crew and Burlington, also needs an IPO to get its leverage down.

Raising debt to pay a dividend to allow private equity backers to recoup some, if not all, of the equity sunk into the buyout, can take about a month. The proceeds from the ensuing IPO can then be used to pay off some of that debt. By recovering some or all of the equity, firms have more flexibility on how they execute their exits.

And if a company is taken public, optically, it is beneficial to the company if proceeds from an IPO go toward reducing debt, rather than into selling shareholders' pockets. Shareholders, by keeping their stakes, are seen as participating with confidence in the company's future performance - something potential investors like to see when weighing whether to buy shares in a newly listed company, a source suggested.

PIK toggle notes tend to be a more expensive form of debt. J.Crew, for example, will have to pay almost $39 million in incremental interest expense to service the $500 million in notes, cutting into free cash flow, said Scott Tuhy, an analyst at Moody's Investors Service Inc. who tracks the retailer.

Because of the higher interest rate, an event that will allow the company to quickly pay off that kind of debt is desirable.

J.Crew's PIK toggle notes have two years of call protection, meaning that the company could be locked into servicing the debt for the two-year period before the retailer is allowed to retire it.

But according to Tuhy, J.Crew can call the debt early under certain circumstances with proceeds from an equity offering at a specified price. So proceeds from an IPO might allow the clothing retailer to quickly pay down those notes.

That may be necessary, because adding $500 million in liabilities increases J.Crew's total debt to nearly $2.07 billion, or about 5.8 times EBITDA. And that's if one goes by the way J.Crew calculates its EBITDA - $355 million for the 12 months ending Aug. 3 - by not subtracting stock compensation expense and sponsor management fees, for example.

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