The Deal: dELiA*s Wins Over Investors With Turnaround Plan

NEW YORK ( The Deal) -- Teenage girls' clothing retailer dELiA*s ( DLIA) is greasing the wheels of its turnaround effort with a two-part capital raise that brought in a total of $37.6 million, an amount that is higher than the company's shareholders had expected.

The company's second largest shareholder Whitney Tilson of T2 Partners LLC was initially befuddled when he got wind of dELiA*s plans.

"The real question was, why were they raising so much money?" Tilson asked himself when he saw the two-part raise's total price. "It was obviously highly dilutive. They didn't need that much money -- they probably could have raised half as much," he said.

However, after a one-on-one meeting about the capital raise with dELiA*s' new CEO Tracy Gardner, Tilson was sold on the offering and purchased 2.2 million shares at $1.05 each.

Tilson pledged his continued faith by participating in the latest common stock offering, which raised $15.8 million when it closed on Wednesday, July 31 -- higher than the anticipated $13.7 million.

Last week, dELiA*s announced that it raised $21.8 million in 7.25% convertible notes, which the investors plan to convert into 20.7 million shares of common stock upon shareholder approval.

Tilson explained that the note offering was simply a way for Gardner, board chairman Michael Zimmerman, and Zimmerman's investment firm Prentice Capital LP, to participate in the capital raise without causing compliance problems for the insider-buyers. Prentice is dELiA*s' largest shareholder.

"Effectively, they're just buying the stock on the same terms I was -- I think it was fair," Tilson said, adding that he doesn't anticipate any issues securing shareholder approval for the conversion of notes to stock. "While it was highly dilutive, the fact that the stock didn't go down very much says that the market is correctly assessing a dramatic reduction in the risk of this company."

The New York-based teenage girls' clothing retailer reported disappointing results for the quarter ended May 4, with revenues down by nearly 15% after years of consistent losses, but Tilson believes Gardner has what it takes to effect a turnaround.

Gardner's track record at Gap Inc. and J. Crew Group Inc. is stellar, and she has already laid out concrete plans for much-needed improvements to dELiA*s' operations and sales margins, Tilson said.

Tilson is dELiA*s' largest outside shareholder, and dELiA*s is the third-largest position in his portfolio at 8.9%, after AIG Inc., which accounts for 11.1%, and Howard Hughes Corp., which is at 9.3%. dELiA*s just barely edges out Warren Buffet's Berkshire Hathaway, which comes in fourth at 8.1%.

After his meeting with Gardner, Tilson was comfortable with the logic of doing a larger-than-expected capital raise. "The reason they raised money is that they've lost money consistently for the last four to five years and burned through the cash on their balance sheet," Tilson said, describing dELiA*s as a "money-losing company with a perilously weak balance sheet."

In its latest quarterly financial report, filed on June 18, the retailer listed only $3.64 million in cash on its balance sheet as of May 4. dELiA*s reported a $9.22 million net loss for the quarter ended May 4 on net revenues of $35.17 million, down 14.6% from the previous year's quarter. The report listed the company's assets at $82.05 million and its liabilities at $49.85 million.

"It's not like they were going to file for bankruptcy next week, but they clearly need to fix the balance sheet and give Tracy Gardner some flexibility," Tilson said, adding, "In one or two quarters, this company could have been in real, there's plenty of liquidity no matter what happens."

Another reason dELiA*s raised more money than expected was to minimize the legal and banking fees associated with raising capital. For a small company, it makes more sense to do one large raise rather than undertaking a few small raises and having fees taken out each time, Tilson said.

Besides Gardner's track record, the market segment dELiA*s is targeting with its direct-mail catalogs, Web site and retail stores gives Tilson confidence in its growth prospects.

"Apparel retailing is a ridiculously competitive business, but the particular niche that dELiA*s is in is less competitive," Tilson said, adding, "there's still a lot of low-hanging fruit."

Gardner has already identified changes that should improve the comapny's operations and sales margins quickly, Tilson said. For example, in clothing retail, tops, or shirts, are more profitable to sell than bottoms, or pants and skirts, and most retailers account for this discrepancy by stocking tops and bottoms in a three-to-one ratio, Tilson explained.

However, dELiA*s used to stock merchandise with a one-to-one ratio--something Gardner changed when she came on board, Tilson said.Furthermore, although dELiA*s sends out 20 million catalogues per year, it was not sending one out during the retail-bonanza week after Thanksgiving. Tilson said a post-Thanksgiving catalog is in the works this year.

Merchandising was also a problem for dELiA*s. Tilson noted that instead of designing great clothes and telling factories to make those clothes, dELiA*s was buying from generic lineups that factories pitched to them and stocking clothes that were also available elsewhere. The retailer is now working on new designs, with some slated to appear in the back-to-school collection and the bulk of the design effort coming in for the holiday collection.

"There's a many-month lead time to get new clothes out," Tilson explained. He expects Gardner to bring in new talent to help right the ship in the next few months.DELiA*s shares closed up nine cents, or 6.3%, to $1.50 on the Nasdaq Wednesday, giving the company a market capitalization of $47.91 million.

--Written by Lisa Allen

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