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January 18, 2007

Endeavor Acquisition Due Diligence

Last week I had an opportunity to talk with Elizabeth Haynes of Haynes & Company Consulting about the acquisition of American Apparel (AA) by Endeavor Acquisition Corporation (EDA). Haynes & Company Consulting is a management consulting organization specializing in retail. Elizabeth's insights are especially valuable because she has spent time working on Wall Street and her company has completed projects for hedge funds.

Elizabeth was very positive on American Apparel and has not been surprised by the quick rise in EDA shares. She feels that EDA bought American Apparel on the cheap for two reasons. First, a traditional IPO was probably going to be difficult due to the controversy surrounding the company's founder and CEO Dov Charney. Second, by offering shares and a controlling interest in EDA, Charney would get back any discount on the deal with price appreciation.

For the next year or two, Elizabeth feels that AA's growth plan is likely to succeed....

Geographic expansion into smaller cities outside the super-major urban centers has succeeded for other trendy, teen-oriented retailers and the company's focus on basics should ease geographic expansion. Furthermore, with just 143 stores, the expected rapid expansion of the store base will set up favorable same store sales performance as the young store base matures. Finally, Elizabeth believes the company's wholesale t-shirt business reinforces the strength and positioning of the company's brand with the target audience by putting high quality t-shirts into distributors reaching the teen, indie, and urban customer base.

Longer term, Elizabeth identified a few challenges AA may face. First, sustaining store traffic may prove difficult with a relatively narrow focus on basics. Second, conversion rates of traffic to buyers may prove challenging as basics tend to last a long while in most wardrobes. Third, the competitive advantage the company has maintained with its Los Angeles only manufacturing may falter as the company's rapid expansion plans may require overseas sourcing. AA has benefited greatly from its ability to keep inventory fresh, limit markdowns, and respond quickly to fashion trends by having its manufacturing so close to its retail stores. If the company doubles or triples its store base, maintaining an LA only model may prove impossible.

EDA shares have moved up sharply since the announcement of the American Apparel acquisition, rising close to 30% from initial post deal trading levels. I still think a target in the mid to upper teens is very plausible if the company hits the growth goals for 2007 and 2008 outlined in the merger filing. I think the easy money available due to the cheap deal price and odd deal structure has been made but plenty of upside remains and I am sticking with my long position. Special thanks to Elizabeth Haynes for helping me out.

Posted by Steve Birenberg at January 18, 2007 09:17 AM in eda