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From Home Furnishing Business

Sharing the Wealth

By Home Furnishings Business in on May 2007 Furniture has never been a particularly glamorous stock category on Wall Street, but it€™s attracted big attention from private equity firms on both the vendor and retail sides of the industry.

Twenty years ago it seemed Heilig-Meyers was snapping up independents right and left, but in more recent years,
furniture has seen some major retail operations sell outright or majority shares to outside investors: Berkshire Hathaway€™s thoroughbred stable of Jordan€™s Furniture, Nebraska Furniture Mart, R.C. Willey and Star Furniture come to mind.

In 2005, Stamford, Conn.-based Saunders Karp & Megrue acquired 70 percent of Bob€™s Discount in Manchester, Conn. Sun Capital Partners has Wickes of Wheeling, Ill.; Norcross, Ga.-based Nationwide Furniture; and earlier this year acquired contemporary retail specialist Design Within Reach of San Francisco, as well as selling Mattress Firm of Houston to Boston-based private-equity firm J.W. Childs and a management team.

Also this year, the four-store Bensalem, Pa.-based Mealey€™s Furniture and Mattress was acquired by Parallel investment partners in Dallas.

That€™s a partial list.

Selling a piece of, or all of their pie is not something a lot of retailers want to talk about, judging by the number of stores that declined comment for this article, but furniture stores that get bought fall into two general categories: those in trouble, and those who, despite a sluggish retail environment, have strong management and good market share.

What€™s My Motivation?

€œMany of these investors are trying to pick up assets at very reasonable prices. For them it€™s a value game,€ said Laura Champine, home furnishings analyst in the New York office of Morgan Keegan & Co., who noted a fire-sale mentality to some of the deals. €œIt€™s not an acknowledgment that business is good (in furniture retail), they€™re hopeful they can get a bargain and at some point turn it around. And it€™s not as if everything€™s getting bought up€”Storehouse liquidated, after all.€

For retailers in trouble, Champine said bringing in outside ownership is typically the last straw.

€œLots of times it€™s to pay down their own debt. It€™s to provide financial solvency and buy some time to turn it around,€ she said. €œUsually it€™s something store owners will do when they€™re getting to the end of their rope.€

Jerry Epperson, managing director with the Richmond, Va.-based consulting and investment firm Mann, Armistead & Epperson, worked on the deal that recapitalized Lombard, Ill.-based Harlem Furniture through a deal among private equity firms Bear Growth Capital Partners, Pouschine Cook Capital Management, Mercantile Capital Partners and Harlem Chief Executive Officer Bruce Berman.

He believes that a lot of the outside investment in furniture retail has not involved €œfire sales.€

€œA lot of the companies we€™ve seen sell a stake in recent years have been successful, well-managed companies€”take a Harlem or Bob€™s Discount, they want to grow the business,€ he said. €œSome of these retailers have managed very respectable returns. There are a lot of companies out there you don€™t read about every day that really aren€™t interested in the whole world knowing what they€™re doing.€

Private equity€™s cash infusion offers even solid retailers a very valuable commodity€”liquidity.

Retail €œis under a lot of duress, and even at companies with consistent records, their earnings are down,€ Epperson said. €œWe have some well-capitalized furniture retailers that don€™t have any cash. They have too much inventory, and they€™re over-extended.€

€œTheir first reason is access to capital. Second, some retailers are interested in going public, but they aren€™t really ready and they need a sophisticated investor who can lay the groundwork. Third, they have no next generation they€™ll pass the business to, so there€™s a real desire to build the next management team.€

Epperson also noted that private equity firms interested in furniture have another reason for looking toward the retail side of the industry: €œWith manufacturing, there€™s too much of a challenge, because they don€™t know where that production will end up.€

Acquiring Good Management

While some retailers look to outside investors for help running the company, well-managed businesses that don€™t need a complete overhaul hold more attraction to private equity that€™s in search of more than a bargain. Berkshire Hathaway, for example, doesn€™t go for turnaround situations, and its furniture retail portfolio reflects that philosophy.

€œThose were obviously not fire sales,€ Champine said. €œBerkshire Hathaway doesn€™t buy companies to replace management€”they buy good management. I€™d say they would be very attractive to any retailer they approach.€

R.C. Willey was doing fine on its own when it was acquired by Berkshire Hathaway, said Jeff Child, president, but had compelling reasons for the deal.

€œThe main thing was considering the stability of the company€”that no matter what happened with the family, the company would be stable,€ he said. €œThere also were a lot more family members who were involved in the business at the time, some of who were not that interested in the furniture business. It was a win-win situation for giving those family members who didn€™t want to continue in the business a way out.€

R.C. Willey benefited from its own strong business when it came to shopping for an ownership partner.

€œWe were pretty particular because we weren€™t in a position where we just had to do it,€ Child said. €œWe wanted someone who€™d allow us to continue the model we had, that we€™d still be involved , and that as long as we were profitable there wouldn€™t be much outside interference in the way we like to do business. (Warren Buffett) basically said, €˜You continue to run it the same way you€™re doing it now.€™ If it hadn€™t been announced, a lot of our employees wouldn€™t have known about the transaction, it was that seamless. We could afford to be choosy and so could Berkshire Hathaway.€

While Child noted that best practices input from Berkshire Hathaway was an added bonus, the real benefit of the partnership was for the retailer€™s approximately 3,000 employees.

€œThey€™re proud to work with a Berkshire Hathaway company, and they know that if something happens to the (Child) family, the company will still be here,€ he said. €œThere€™s a huge psychological and pride factor in our case.€

While replacing management is sometimes unavoidable, Sun Capital Partners has a strong preference for working with existing owners, said Chris Metz, managing director for the Boca Raton, Fla., private equity firm. (In addition to Wickes, Nationwide and Design Within Reach, Sun Capital also has a 5 percent stake in Pier 1).

When considering a furniture retail acquisition, Metz said Sun Capital uses the same criteria it would for any investment.

€œWe look for a company with a good brand and recognition in its marketplace, and a good market position, good market share; and a company that needs our in-house management expertise, on that may have been under-managed,€ he said. €œOur preference is to work with the existing management team, though in some cases you need to augment that. Sometimes, you just have to replace the management, but that€™s not our first choice.€

The Right Fit

For retailers considering selling a controlling interest to an outside party, it€™s important that both sides€™ goals are compatible, and that retailers put the details of any agreement under a microscope, and understand the potential downside.

€œIf their goal is to simply raise capital, there are a lot of options€”if they sell (ownership) it€™s important that whoever they find as a partner brings some kind of value to the existing business,€ Metz said. €œThey need to make sure they€™re dealing with a reputable, experienced partner, particularly when it comes to their expertise in their industry. And they need to understand their role in the going concern. Will they be a silent partner, or take an active role managing the business?€

Champine said it€™s hard to make blanket recommendations, but that one thing is for certain for the seller€”someone else will have the last word.

€œThey need to understand that they do give up control,€ she said. €œPrivate equity is notorious for bringing in someone they think is a better manager, and that can be difficult for (an owner) who€™s been an entrepreneur.€

Childs at R.C. Willey said the relative advantages and disadvantages of selling a stake depend in large part on the retailer€™s outside investor.

€œYou are going to lose some of the economy to do for whatever you want€”for good or for worse,€ he said. €œPerform your due diligence, and know exactly what you€™re signing. I have a friend whose family ran a bottling company, and they were told they€™d keep running it after they were acquired. Within minutes of signing the agreement, the family was fired. The whole process can be fraught with danger.€

Champine predicted that more furniture retailers will examine agreements with private equity companies.

€œThere€™s more to come,€ she said. €œAs much as it seems there€™s been a lot of moving of the chess pieces, we€™ve just seen the beginning.€

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