Sun Capital may get more than it bargained for with Kellwood

For Sun Capital, acquiring Kellwood - the maker of Calvin Klein sportswear and Phat Farm urban apparel - may turn out to be the easy part. Turning the business around is likely to be far tougher.

After five months of not-so-friendly courtship, Sun Capital finally has the prize in its sights. A deal looks imminent, providing that a majority of Kellwood’s (KWD) shareholders tender their stock by tomorrow, a likely outcome given that several large investors have indicated their support for the $21 a share offer. After previously rejecting Sun’s bid twice and then telling shareholders to make up their own minds, Kellwood’s board today came out in favor of the proposal, which values the company at $543 million based on the number of shares outstanding as of Nov. 3. Kellwood also agreed to terminate its cash tender for up to $60 million in senior notes, further paving the way for a deal. Kellwood’s shares rose 39 cents, or 1.9 percent, to $20.92.

If the tender is successfully completed, it would bring to an end one of the odder takeover battles on Seventh Avenue, a world where hostile deals are still a rarity. “Nothing about this deal was by the book,” said Louis Meyer, an analyst with Oscar Gruss & Son.

And questions persist. Why would Kellwood’s board agree to an offer of $21 a share in February when it deemed that same offer inadequate in September? And why would Sun Capital want to acquire one of the weaker competitors in an apparel industry going through an enormous shakeout? With stronger players like Liz Claiborne (LIZ) and the Jones Apparel Group (JNY) struggling to survive, the prospects for Kellwood - which derives the bulk of its revenue from out-of-favour moderate labels like Sag Harbor - look bleak.

Let’s start with the first question. Back in September, Kellwood’s board was confident that the company’s management could execute on its turnaround plan, which included an upscale repositioning with the acquisition of trendy labels such as Vince, known for its sweaters sold at Saks Fifth Avenue and Hanna Andersson, a children’s brand. Then the economy unravelled and the turnaround was suddenly much harder to achieve. So Kellwood’s board went shopping for an offer that would beat out Sun Capital. No offers materialized, and with a recession looming if not already here, Sun’s proposal looked a lot more attractive.

The foot-dragging approach of directors has not won a lot of fans on Wall Street. “The board’s job is to stand up and make the call, and this call should have been made long before today,” Meyer, the analyst, said.

With Kellwood nearly in its grasp, how does Sun Capital plan to keep the apparel maker from sinking further? The stock is down 33 percent from its July high and would be even lower if not for Sun’s interest. So far the private equity firm isn’t saying much, beyond this statement issued today by Sun Capital Vice President Jason Bernzweig: “We are prepared to commit substantial resources beyond the purchase price to build Kellwood’s business.” Sun Capital Spokesman Richard Hurwitz declined to elaborate.

What that likely means is an investment in the higher-tier brands such as Vince and Hollywould, another contemporary clothing maker, and a consolidation of the ailing moderate labels. “I could see them cutting costs, improving the supply chain and consolidating divisions — all things that can be done more easily as a private company than a public company,” said Paul Charron, the former Chief Executive of Liz Claiborne who is now an advisor to Warbug Pincus.

But building those upscale brands into sizeable businesses is going to take a long time. When Kellwood bought Vince in 2006, it said the brand was on track to do $45 million in sales. Even if Kellwood doubled the size of the business over the past two years, Vince would still only account for a fraction of Kellwood’s nearly $2 billion in overall revenue. “I’m not sure how Sun is going to fix this company, beyond doing what management was already doing,” Meyer said.

The fate of that management, including Chief Executive Robert Skinner, is so far unclear. “Our intention is to work with the management to turn around the business,” Hurwitz said. But no one is ruling out the possibility of an executive shake-up if results don’t materialize. As for a more radical makeover such as a break-up of the company, don’t bet on it. No analyst that I’ve talked to estimates that the sum of the parts is worth more than the whole.

Sun Capital acquired its roughly 11.4 percent stake in Kellwood at a price that averaged in the high $20-a-share range, considerably more than it is paying for the remainder of the stock. By that measure, it appears as if Sun is getting a bargain. Given the state of Kellwood’s business and the health of the apparel sector, this deal may turn out to be not such a good buy after all.