1/5/2011
By Brian Sozzi, Research Analyst

The peculiar happenings in the retail sector have truly ratcheted higher in the last six months.  BJ's Wholesale (BJ) is fending off buyout advances from a major shareholder (Leonard Green).  Jo-Ann Stores (JAS) is on the verge of being removed from the public's eyes, thanks to a significant premium paid by, you guessed it, Leonard Green.  How can one forget J Crew (JCG), which put into motion a much criticized $3 billion transaction with TPG and Leonard Green in the back half of 2010. 
Today the odd happenings continue to swirl.  Bloomberg reported that Sears (yes, you read that correctly...Sears) and Urban Outfitters (URBN) are weighing potential bids for J Crew.  While history suggests we can't rule anything out when a company becomes fixated on a target, I would be surprised if Urban Outfitters makes a bid for J Crew, and think Sears runs the risk of losing Mickey Drexler and his team if it tries to scoop up the accessible luxury retailer (I just can't imagine J Crew shop in shops inside a Sears anchor location).

Seeing as we have coverage on Urban Outfitters, I will take a brief moment to outline why a deal is unlikely to occur.  However, i do note that in a wild set of circumstances, if J Crew does join forces with Urban Outfitters, it will give the eclectic retailer a higher income customer base (less college kid more 25-35 year old), more mall-based stores, and greater leverage over suppliers at a time of input inflation.

Why this is looking like a no-go:

* Significant balance sheet leverage required.
* Consumer spending lines are blurred; a person buying a sweater at J Crew may steal a sale from Urban Outfitters or Anthropologie (whose assortment mirrors J Crew's).
* J Crew does not offer Urban Outfitters international exposure.  Urban is actively expanding into Europe, and is keen on entering the Far East by 2012-2013.
* Urban Outfitters has an affinity for developing its own brands.
* J Crew is a lower ROA business, and the addition would jeopardize Urban's long-term 20% operating margin target.

Brian Sozzi
Wall Street Strategies

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