On Monday morning hedge funds Engine Capital LLP and Red Alder LLC said they sent a letter to the board of directors expressing disappointment that discussions with management had not led the company to explore a sale.
In response, the New York-based parent of the Ann Taylor women's apparel store chains said in a statement it "welcomes open communications with its shareholders and values constructive input toward the goal of enhancing shareholder value. Our board and management team are committed to creating value for all Ann Inc. shareholders, and we will continue to take actions to accomplish this goal and position the company for growth and success."
Red Alder and Engine Capital collectively own more than 1% of Ann's outstanding shares, they said.
The activists' main argument is that the company is undervalued, which prompted the firms' investment; they noted that the retailer trades at 5.5 times Ebitda.
Ann, the hedge funds, said, had a list of attributes that would be attractive to private equity, such as consistent performance, ability to improve margins, significant free cash flow, high brand recognition and size. As a result, current credit markets would likely allow PE firms to borrow around 5 times Ebitda at attractive rates.
The letter said a number of leveraged buyouts over the last few years have valued specialty apparel retailers on average between 8 times and 9 times Ebitda.
Red Alder and Engine Capital claimed that Ann could be worth between $50 to $55 per share to a private equity acquirer - a 40% premium to the current stock price.
Ann closed at $37.52 per share on Friday, and was up on Monday by about 3.8% in morning trading to $38.95 per share on the news, giving it a market cap of roughly $1.8 billion.
The two hedge funds also noted in the letter that PE firm Golden Gate Capital had recently become the company's largest shareholder. That, according to the investors, was one of many factors adding to their push for the retailer to explore sale possibilities.
The two shareholders said they would begin to talk to potential buyers and encouraged PE firms to indicate their interest in an LBO.
Alternatively, a leveraged recap of the retailer would also be attractive to shareholders, though not as lucrative as a sale. The activists' letter said Ann could easily borrow $600 million, approximately 2 times Ebitda, for about $36 million a year in interest payments, repurchasing a third of the shares at $40 each.
"The board cannot have it both ways, at the same time arguing that a $52.50 per share sale would undervalue the business and not buying back a significant number of shares in the context of $40 per share. If the board does not have the confidence to lever the Company reasonably (approximately 2x EBITDA) to buy back a third of its shares outstanding, then it cannot argue that a sale at $52.50 per share is not the best outcome for the shareholders," the letter stated.