The last few weeks have been difficult for many retail stocks – and particularly challenging for investors in the recent IPO of Express Inc. (EXPR). After being offered to the public at $17.00 per share, the stock has lost about 15% of its value and hit a new low in light trading Wednesday morning. Express is a specialty apparel chain with 573 retail locations spread across the United States. Originally a part of Limited Brands (LTD), the majority of the company was purchased by Golden Gate Private Equity Inc. in 2007. The IPO is the first step for the private equity company to cash in on its 3-year investment.
The IPO was managed by Merrill Lynch / Bank of America (BAC) and Goldman Sachs (GS). With such a diverse retail and institutional platform, one would have expected the shares to be placed in the hands of long-term investors and priced at a discount to allow for an initial increase in the share price. But the environment for retail stocks has been extremely difficult and institutional investors have been offloading risk at a steady pace this month. At this point it seems that the selling shareholders got the better end of the deal – liquidating part of their position at $17.00 per share.
According to the terms of the prospectus, there were roughly 16 million shares sold to the public of which 10.5 million were primary (sold by the company to raise capital) and 5.5 million were sold by private shareholders. However, when looking more carefully at the deal, this statistic is a little misleading…
Express essentially DID receive $170 million in proceeds from the deal which it used to reduce outstanding debt. However, it should be noted that the outstanding debt is actually owed to several subsidiaries of the private equity firm that purchased the brand in 2007. So after passing briefly through Express’s balance sheet, the funds will then be distributed to the selling shareholders in the form of a debt repayment. Express will be left with $368 million in long-term debt and roughly $67 million in cash. The pro-forma balance sheet has stockholders equity at $89 million – which implies a 413% debt to equity ratio – not exactly a solid balance sheet.
But despite the shaky circumstances with which this stock began its publicly traded days, I expect EXPR to find a floor near $14 and begin to trade higher. One of the primary reasons is because only a small portion of the stock was actually liquidated in the IPO transaction. Sixteen million shares were sold to the public, but the number of shares outstanding is closer to 89 million. That means Limited Brands and Golden Gate Private Equity still hold the majority of the stock and will see the market value of their investment rise and fall with the fortunes of the stock.
Once a private equity firm has begun to liquidate its position, they usually don’t wait too long to follow up by selling the remaining shares. With the negative reaction to EXPR’s stock there is even more of an incentive for the company to find a “graceful” way of exiting this position. So it may sound counter intuitive, but one of the best ways for Golden Gate to liquidate the rest of its position is for the company to step in and support the price of EXPR – and if they are going to take this action they need to act quickly!
Supporting the stock at this time when the market is attempting to rebound will be key. If EXPR begins to trade back towards the $17.00 IPO price and holds a stable pattern, then Golden Gate stands a better chance of selling its remaining shares in a secondary offering. But if the stock is allowed to fall from here, there will likely be no market for quite some time. So the stakes are high and the amount of capital at risk is not trivial.
It may be a little too cute on the trading side, but with retail names showing some relative strength over the past few days, I expect EXPR to be good for a trade higher. The potential return is somewhere in the neighborhood of 10% to 12%. But this can be painted against a relatively low-risk backdrop. If I were to enter the trade later this week, I would place a stop just below $14.75 or so – exiting the trade if the rebound in EXPR doesn’t take place immediately. Setting up a short-term trade in an improving market with capped risk is one of the better ways to play a short-term rebound and I think the general negative sentiment in the retail area could be temporarily lifted as the illusion of financial stability comes back into this market.
Full Disclosure: Author does not have a position in any stocks mentioned in this article.