Copyright 2008 Ayesha N. Hafeez, Anatas Chobanov,Kyle Sparger, Manh Vu Duc and Erin Young.

Do not excerpt or copy any material without explicit written permission from all the authors and Professor Mark Sharfman. Ignoring or otherwise not upholding this notice in addition to violating US copyright law is a violation of the University of Oklahoma student code concerning plagiarism.


Acquisition of Chico’s:                 MBA Capstone Project 


Ayesha Hafeez  Erin Young  Kyle Sparger  Manh Vu Duc  Nasko Chobanov 

Table of Contents



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realigning product mix. If successful. vigorous competition. resulting in a short operating cycle. The retail apparel industry is characterized by rapid business cycles. We also found that Chico’s has recently pursued an overly-aggressive expansion strategy. a wholly-owned subsidiary of Berkshire Hathaway (BRK). The company places special emphasis on customer service and building brand equity. extended supply chains. The industry is characterized as having most of its manufacturing processes located in foreign markets in order to take advantage of their lower cost structure. Corp. the stock market has historically placed a high premium on Chico’s. 5    .Executive Summary As the consulting team for Ace Whippo Widgets. We recommend that AWWI should acquire Chico’s with an optimal offer price of $3. AWWI should use a combination of cash and an open-market buyback and stock swap of Berkshire Hathaway Class B stock. This provides Chico’s with the ability to take advantage of attractive investment opportunities that may arise. These similarities make AnnTaylor an acceptable alternate candidate. We believe that if Chico’s were to halt its aggressive expansion strategy. The company is a direct competitor of Chico’s and shares many common feature. we expect to implement our postacquisition strategy. In addition. improving marketing effectiveness. closing Soma Intimates as a separate store. it would save considerable capital investment which could then be redistributed to investors or other superior projects. (AnnTaylor). Should the acquisition of Chico’s fail. Companies are currently experiencing difficulties due to the declining economy. Given these competitive strengths. the industry is highly concentrated with many companies producing rival products. Chico’s has historically generated strong operating results and profitability. which includes halting expansion. and declining same-store sales growth. we recommend that AWWI pursue AnnTaylor as an alternate candidate. However. The industry’s product line changes every season as customer fashion preferences change quickly. We found that Chico’s market value is currently attractive. and Soma Intimates (Soma) to target different market segments with mid. Chico’s has been performing well compared to its competitors. such as similar market capitalization. Financially. Because of low barriers to entry. and strong performance indicators. Chico’s sells women’s apparel and accessories through its brick-and-mortar stores and websites. resulting in reduced revenue and same-store sales. The company operates multiple brands such as Chico’s. an ineffective marketing campaign. AnnTaylor Stores. the company has a zero-debt capital structure and a strong liquidity position. (Chico’s) and its industry to determine the financial health of the company and whether it represented a good acquisition candidate. we have identified areas that need improvement. including a mismatched product mix. Inc. and reintegrating the Soma product line into Chico’s other stores. White House| Black Market (WH|BM). Inc. resulting in a projected internal rate of return of 57%. we conducted an analysis of an alternative acquisition candidate. and international trade regulations. and low barriers to entry. Chico’s manages inventories and receivables effectively. This exposes the industry to exchange rate risks.26 per high-income levels. a strong financial position. Its current market capitalization is roughly twice its one-year pro forma adjusted free cash flow. we conducted a comprehensive analysis of Chico’s FAS. (AWWI). in the event that our attempt to acquire Chico’s should fail.

Currently.1 The company has grown into 642 company-owned Chico’s locations targeting women 35 and older with mid.chicos. 2007 Annual Report. 2-3  4 Chico’s FAS. high-income levels. 2007 Annual Report. Product extension is an important component of Chico’s business strategy as the company focuses on maintaining its brand image of having “distinctive clothing and                                                          1 2 Chico’s FAS. the company has 70 Soma locations targeting similar “fashion conscious” customers as Chico’s and WH|BM.jsp?id=39  Chico’s FAS.3 Seasonality in the fashion industry refers to the fact that each year. 2007 Annual Report.2 Chico’s does not manufacture its products but creates in-house designs and works closely with independent vendors to develop new designs in order to keep up with seasonality and changes in the fashion industry. the company does not plan to acquire any new subsidiaries but plans to continue introducing product extensions that align with its current product lines. Last. pg. there are four distinct fashion seasons requiring markedly different product characteristics. Inc. Website: http://www. pg. information pertaining to loyalty programs. Inc. pg. Chico’s has a “multi-faceted” growth strategy that encompasses internal infrastructural adaptations and external expansion via acquisitions and new-store development. It has also developed technology systems to obtain SKU-data. It also has 332 company-owned WH|BM locations targeting women 25 and older with mid. 2  3 Chico’s FAS.Introduction Chico’s started in 1983 as a small high-income levels.4 In order to prepare itself for future growth. 4  6    . the company has increased the number of direct-to-consumer and management employees. and point of sale data. selling sweaters in Florida before adopting the Chico’s name in 1985.

Inc. respectively. 4  Chico’s FAS. an evaluation of Chico’s strengths. a financial analysis evaluating the five ratio family trends.”5 This approach. 2007 Annual Report. Sales associates receive special training in order to create a pleasant experience for the customer.4M and 2. an analysis of Chico’s closest competitors on the basis of product lines. Inc. Chico’s increases its repeat sales through customer rewards programs for Chico’s/Soma and WH|BM. In addition. a valuation of Chico’s as an acquisition candidate. Training includes fashion advice regarding outfits and jewelry. and learning the preferences of repeat customers in order to serve them more efficiently. pg.1M members. in 2007. which had 2. in which Chico’s operates. weaknesses.                                                          5 6 Chico’s FAS. and an evaluation of AnnTaylor as an alternative acquisition candidate. AWWI’s acquisition strategy and post-acquisition recommendations. opportunities. coupled with the company’s customer service and loyalty programs. pg.6 The following analysis discusses five aspects of the environment and the industry. and threats (SWOT).complementary accessories. 6-7  7    . is viewed as a major advantage for Chico’s. 2007 Annual Report.

Industry Analysis Overview The retail apparel industry is highly competitive with many companies trying to steal market share by creating a product that is perceived by the customer as fashionable and trendy. Based on 55 economists’ forecasts in The Wall Street Journal (WSJ). which has caused decreased profitability for retail companies. summer lines have been designed and approved. consumers spend money and buy new products. when the economy declines. The industry has fast-paced business cycles that make it difficult for companies with the wrong product mix to correct the problem. 1. Consumer spending has decreased. retail apparel companies are operating in an economic recession. This is due to the fact that when winter clothes are in the stores. who depend on consumer sales. needs. consumers tend to spend less and save more. the wrong product mix can be detrimental to a company’s profitability during a particular season. the Gross Domestic Product (GDP) is predicted to decline through the first half of 2009. and perception in this industry due to the potentially high bargaining power of the end consumer.1 Economic Environment The state of the economy has a large impact on the retail apparel industry. When the economy does well. Companies must find a way to continue to develop a coveted product while at the same time maintaining current expense levels. but. and next year’s fall lines are being conceptualized. spring lines are being manufactured. such as customer service.1. companies have to find other ways to differentiate their product from the competition. Currently. Business strategies revolve around the customer’s wants. with a small recovery 8    . In addition. Thus.

8 Currently.8% and forecast 1.0% from August 2008 to September 2008.html?project=EFORECAST07  7 9    . the trade surplus in services increased 9.10 The immediate deflationary environment can force a decrease in gross operating margin for companies. while imports decreased by 5. Further. http://www. Companies have difficulty decreasing labor wages and other contractually-defined costs. the deficit in the current account decreased to $56. Bureau of Economic the CPI decreased by 1%. can give a measure of inflation by taking the percent change in CPI.wsj. http://online. Exports decreased by 6. consumer spending has declined and is expected to continue to decline.9 In October 2008.2% over the same period. However.7 The United States has a trade deficit. projected increases in unemployment will continue to put pressure on the consumer’s ability to spend.html?project=EFORECAST07  8 U. which measures average price of consumer goods and services purchased by households. lower energy                                                          The Wall Street Journal.wsj.1% over the same period. In Census Bureau U. 2008.html?project=EFORECAST07  10 The Wall Street Journal. The trade deficit in goods slightly decreased by 2. Additionally. but they are forced by the market to decrease prices.S. WSJ economists expect inflation to end the year at 2. as will increasing consumer interest rates. which means that imports into the United States are greater than exports from the United States.wsj. In addition. 2008. some of these problems may be offset by increased purchasing power from deflation as well as an increase in disposable income from lowered energy prices.6% over the same period.pdf  9 The Wall Street Journal.8% by December 2009. http://online. Economic Forecasting Survey: November.1B in August 2008. Economic Forecasting Survey: November.S. The Consumer Price Index (CPI). 2008.2% by June 2009 and 1. U. However. In addition.census. Economic Forecasting Survey: in the second half of the year. http://online.5B in September 2008 from $59. the United States is in a period of Department of Commerce.

and the deflationary environment is likely to put pressure on Chico’s gross margins.html?project=EFORECAST07  12 U.usda. Department of Agriculture.wsj. North American Free Trade Agreement (NAFTA). signed in 1994. resulting in the removal of all restrictions on the import of textiles and clothing. will remove the majority of trade barriers by the end of 2009. labor laws must be considered.S. Economic Forecasting Survey: November.12 In 1995. http://www.fas.asp  13 World Trade Organization. 1.13 Additionally.11 Recently. The decrease in consumer spending is likely to translate to lower sales. the U. Canada. 2008. potentially lowering the input costs for producers that outsource manufacturing to. and Mexico. UNDERSTANDING THE WTO: THE AGREEMENTS.S. Because Chico’s sells commodity items.costs directly benefit industry because decreases in energy prices reduce transportation and other costs. A decrease in energy costs may buoy Chico’s operating results but is unlikely to fully offset the aforementioned decrease in consumer spending. The Fair Labor Standards Act in the United States specifies an employee minimum wage and regulates overtime pay                                                          The Wall Street Journal.htm  11 10    . http://online. other Regulatory Environment There are several trade regulations that are important to consider as part of the regulatory environment. Dollar has been appreciating against other currencies.wto. http://www. or import from. The North American Free Trade Agreement (NAFTA) between the United States. the World Trade Organization’s “Agreement on Textile and Clothing” phased in a reduction in import the continuing decline in the economy is likely to have a significant effect on Chico’s operating results. The Agreement fully matured in 2005.

Enterprise Resource Planning (ERP) systems are critical to a company’s ability to remain competitive. and provide communications within and without the company has forced even technology averse companies to invest in technology just to keep abreast of the competition. A well-designed ERP system can provide a company transparency into its supply chain and speed up and improve decision making. 2007 Annual Report. 1. In the context of a supply chain. Compliance Assistance ­ Fair Labor Standards Act (FLSA). Because efficient supply chains are critical to companies operating within the retail apparel industry.3 Technology Environment Technology has become a critical infrastructural component of operations within the industry. Guatemala. The ability of technology to automate record  15 Chico’s FAS. provide decision support or automate decisions. http://www. ERP systems provide the ability to automate record keeping at selected points throughout the supply chain and then use business-specific rule sets to provide decision automation and support. These regulations. 22  14 11    . Other companies embrace technology and find ways to use it to create strategic advantage or to level the playing field. pg. can result in litigation and large penalties for companies. and the United States. free trade without quotas is critical to the company’s global supply chain and operations. Real-time data on the disposition of                                                          U.S. NAFTA is also very important to Chico’s operations because the company maintains “cut and sew” shops in Mexico.15 The regulatory environment in which Chico’s operates has the potential to be detrimental to the company’s operations and profitability if trade restrictions were to increase. Inc. if violated. Department of Labor.and youth employment requirements.dol.14 Because Chico’s exports the entirety of its manufacturing processes.

the company must make sure that there are processes in place which will ensure that pertinent data makes its way into the system on a timely basis. the automation and decision support capabilities of the system will not function as expected. orders. and just about any metric the company has identified as relevant is made available with a simple database query. Automated alerts can be generated when exceptions arise.inventory. At best. Without this understanding. 12    . such as placing orders or making payments to suppliers. Additionally.g. a poorly-designed or implemented ERP system could lead to or execute poor decisions. resulting in lost time and money for the company. accounts payable and receivable. an ERP system is virtually useless. Without the appropriate data. Additionally.. At worst. providing real-time information to local managers in order to improve decision making. demand) which can improve supply chain efficiency. the company must ensure that there is a strong understanding of business processes in order to use the ERP system appropriately. Certain decision processes can be automated. It should be noted that ERP systems are only as good as the processes with which they interact. Modules can be implemented to provide “dashboard” style views of company health. historical data can be used to make forecasts (e. Power users can develop their own reports. transportation. reducing workload and the probability of errors in the process. providing managers instant understanding of the status of various parts of the company. this can lead to inefficiency. When implementing and maintaining an ERP system. increasing the speed with which the company becomes aware of and responds to problems.

and in turn are supported by. others can too. However. The Internet provides companies operating in the industry with a new. potential entrants would have to either make large capital investments to develop a physical presence or 13    . Additionally. This makes entry into the market easier in an industry that is already easy to enter. a clever company could use such a website as an automated method for receiving customer feedback. A company with a well-designed ERP system can easily tie the system into an Internet website and have a fully automated online catalog and ordering and shipping process available to its customers 24 hours a day. resulting in intensified competition. This would allow the company to learn which products are likely to cross-sell easily. If one company can easily create an Internet catalog. In the past. companies can use the Internet to increase their sales with relatively little incremental investment. The Internet poses a special problem and opportunity for retail apparel stores. which can increase sales. the Internet also provides potential competitors with an easy way of developing a new marketing channel. Companies that implement ERP systems often fail to recognize that such systems are only as good as the processes they support. Because of this.There is danger that a company will assume that ERP systems are a “magic bullet” which will solve all of their problems. low-cost channel to reach its customers. recording customer interest in various products and which product combinations customers tend to buy. Companies often overlook the importance of processes in the implementation of ERP systems and find that their system does not provide the benefits they expect.

The associate can be made aware of past customer purchases. Once in place.develop a mail-order business. the sales associate can be made aware of special customer issues. This fact requires companies to intensify their efforts to differentiate their products and provide the best value or suffer lost sales as customers flock to their competitors. because consumers can easily cross-check competitor websites. Such a system can provide a sales associate with customer-specific information that allows the associate to make informed decisions on how to interact with the customer. such as past complaints. allowing the associate to present the customer products that are more likely to appeal to the customer’s taste. The system could be part of an ERP or stand-alone. Knowledge of the customer’s past purchases increases the opportunity for crossselling. Prior to the Internet. the system can improve customer interaction or marketing campaigns or track and forecast customer demand. Additionally. Now. the customer can easily browse multiple websites simultaneously and rapidly find the best deals. All of these capabilities improve the ability of the sales associate to create revenue and improve 14    . as the associate can provide recommendations that will complement or be complemented by those past purchases. Additionally. the Internet allows customers to drastically reduce their searching costs. and react accordingly. Companies can also invest in infrastructure and processes that track customer purchases and preferences. a customer would have to visit multiple stores or check multiple physical catalogs to compare prices and products. The Internet allows entrants to bypass these steps and reach interested customers directly with relatively little investment.

such a system can allow the company to develop targeted marketing campaigns. Retail companies with poor technology management will suffer from inefficiencies compared to their competitors and experience lower returns. visit frequency. As such. if a customer moves. or specific products the customer has previously purchased. Technology has become a critical component of any retail company’s infrastructure. For example. Finally. technology has become a cost of doing business. With specific customer information in hand. such as geographic region. It is no longer just a source of competitive advantage.the ability of the company to create a strong relationship with the customer in order to drive revenue in the future. purchase frequency. tracking this information at the customer level can result in better decisions. using simple historical order information can only tell the company which stores have historically demanded a product or type of product. These characteristics can then be used to elicit specific responses from the targeted customer group. such a system can be used to improve management of the supply chain. For example. knowledge of specific customer habits can be used to make better forecasts. demographics. Managers could mine the system for customers with certain characteristics. However. retail company management must pay special attention to their 15    . While historical order information can be used as a good metric for forecasting future demand. that customer’s demand is likely to change to a different store. Making decisions on the basis of this information would result in the appropriate product being redirected to the customer’s new store.

population. November 7.4 Socio-cultural Environment People are moving from urban to suburban areas and “micropolitans” for the clean air. Many people take issue with companies that outsource manufacturing jobs that had previously been held by Americans and sometimes specifically refuse to do business with companies that have done so. Additionally.                                                          16 Killion.nchc. “Micropolitans . outsourcing occasionally creates public relations issues. healthier environment. However. Rick.Life keeps getting better on the Northern Great Plains. less noise.Online.shtml  16    . and less pollution. as well as industry and competitor trends. this issue may not affect Chico’s as much as other companies because they serve a market which has relatively large amounts of disposable income and is likely to be less sensitive to these These increasing healthcare costs directly translate into decreased disposable income for infrastructure. http://www. 2008.cfm?id=9517&section=News  17 National Coalition on Health Care. A WSJ-NBC Survey reported that healthcare was seen as the number one concern for approximately 50% of the U. increasing healthcare costs have become a major issue for the United States. in order to remain competitive.prairiebizmag. Health Insurance Costs. 1. which may lead to decreased profits for the companies that market to them. However. More companies are outsourcing manufacturing to take advantage of low-cost labor and raw materials. Available: http://www.16 This results in changing demographics which companies must consider when determining marketing strategy and store placement.”Prairie Business Magazine. decrease in

increase consumer and worker protections. which began in the United States in 2007. The retail apparel industry has felt a large impact from the financial crisis as consumer discretionary spending has declined in a market where there is fierce competition and plentiful rival products. Additionally.H. involves many different parties. lowered consumer confidence. the Democratic Party increased its hold on both houses of Congress. increasing health care costs result in larger employee benefit expenses due to increasing health insurance premiums.Also. Bush to Democratic PresidentElect B. and increased unemployment.W. and now holds a strong majority in both the House of Representatives and the Senate. The current financial crisis. This change may result in the government taking a more hostile view of business activities. a large number of foreclosures in the subprime mortgage sector. Chico’s must either suffer these additional increases in cost or decrease their employee coverage. Obama. The Democratic Party historically takes a more populist view than the Republican Party and often implements laws that empower unions. which will either lead to decreased operating margins or increased employee dissatisfaction. The new administration faces many challenges. 1.5 Global Environment The United States will experience significant changes at the federal government level as it transitions from Republican President G. many financial institutions have gone bankrupt or have had to be rescued by the federal government. Additionally. It has led to a decrease in consumer spending. 17    . and otherwise increase government regulation of business activities. increase taxes.

 Michael E. it must consider this criteria and work hard to differentiate its products from those of its competitors. Overview The retail industry is highly-concentrated with each company trying to steal market share from competitors by designing and producing a product that consumers perceive as trendy and fashionable. specifically apparel retail. C-TPAT is a voluntary government-industry organization. and the industry cycle turns multiple times per year. These market characteristics make the achievement of consistent abnormal returns difficult. quality.”18 This allows companies to develop a competitive strategy based on their specific industry environment. to continue the analysis of the external environment. Competitive Strategy. Since the majority of the companies import their products to take advantage of lower input and labor costs. rapidly eroding any advantage gained. Thus. New York: The Free Press. joining trade organizations such as Custom-Trade Partnership Against Terrorism (C-TPAT) is one way to gain an advantage. Companies experience difficulty competing in this market because it is difficult to differentiate products.2. 1980. Michael Porter’s Five Forces Framework provides a more in depth look at the retail industry. fit. Porter’s Five Forces Framework Porter’s Five Forces method relates companies to the environment in which they operate using what Porter feels are the “forces driving industry competition. Companies compete on customer service. If a company tries to enter the market and wants to be competitive.  18    . and price. while permitting competitors the opportunity to steal market share at any time.                                                          Members are held accountable for the 18 Porter. size.

Third. However. Direct channels necessarily require less investment while retail store fronts will require considerable capital investment. and the creation of a distribution channel. Entrants will have to make large investments to bring merchandise to market. the analysis will look at the threat of new entrants and how Chico’s is susceptible to companies entering its target market. Fourth. an analysis of bargaining power of the end consumer and between the company and the supplier shall be discussed along with Chico’s position in each case. there will be a discussion of rival products and how Chico’s focus on personalized customer service and product orientation makes it stand out against its competitors. Second. 2. The following analysis will discuss each component of Porter’s five forces framework in detail. Last. First. member companies have reduced inspections on imports. As the channel matures. More importantly. it will look at existing competition and how Chico’s attempts to separate itself from the competition.1 Threats of New Entrants In the retail apparel industry.integrity of their supply chain with regards to security and sound practices. there will be a discussion of the bargaining power of the supplier and how Chico’s is less susceptible to it. there are large economies of scale that give established market participants a distinct advantage over new entrants. including design. The type of distribution channel selected will impact the magnitude of the capital investment necessary to make sales to the customer. there is a constant threat of new entrants into individual market segments. the 19    . Member companies have a special relationship with customs agents and receive priority over nonmembers when inspections are required. manufacturing.

A new company with a small roll-out will have difficulty competing with the financial resources and mature supply chain that Chico’s maintains. The experienced management at the company understands the importance of having a sound supply chain and the cost of changes to any or all parts of the supply chain. and distribution center in place. the majority of retailers use manufacturers in foreign countries to obtain lower-cost raw materials and labor. which revolves around constantly-changing fashion trends. customer service. Companies entering the market will have to compete with not only Chico’s established supply chain. but also with Chico’s highlyexperienced executive management. if not conducted properly. However. manufacturers. Currently. Founded in 1983. they also have established relationships with media representatives. Because Chico’s has over 1000 stores in the United States and 25 years of experience. Another key investment is brand equity. which can be developed through advertising. if a company were to identify a new supplier market providing superior cost 20    . Marketing campaigns and promotions to entice traffic into new stores have the potential to be expensive will experience increasing economies of scale as common infrastructure supports multiple points of sale. A first mover advantage is not likely to be sustainable in the retail industry. high quality products. a company trying to steal market share will have make considerable investments in developing a channel to compete and find a way to differentiate itself from Chico’s established brand. New companies will have to spend a large amount of money in finding the right medium to reach customers and obtaining prime ad locations. Not only does Chico’s have a marketing strategy in place. ineffective. Chico’s has developed a mature supply chain with its designers. and other means.

as Victoria’s Secret is the “it” brand for lingerie. and provides an advantage only in so far as competitors do not join. size. As a member of C-TPAT. fit. the move has the potential to be more sustainable. brand. color. and customer service. if a company’s product is not in line with fashion trends. Product differentiation is the fundamental strategy in the retail apparel industry. but it is very difficult to achieve sustainable advantage due to rapid industry cycles. Custom’s regulatory processes are less rigid. Another non-sustainable advantage is membership in trade organizations that provide expedited customs processes for members. Thus.S. companies can differentiate their product on the basis of quality. Despite this fact. there are low switching costs for consumers if new entrants offer an equal or superior product in this industry. Membership in organizations. spring lines are being manufactured. summer lines have been designed and approved.S. importers. Because of this membership. However. When winter clothes are in the stores. it is almost impossible to correct the problem without a long lag and considerable cost. brand recognition and customer loyalty are important factors 21    . such as C-TPAT. As stated above. U. as competitors will take longer than a fashion season to match the move. is available for most U. Membership in C-TPAT does not prevent companies from entering into Chico’s target market. Chico’s reaps the benefits that some of its rivals fail to obtain. especially when customers receive personalized service or they feel that a company’s brand is the “it” brand. Many consumers are loyal to certain brands. Based on the understanding that Chico’s will maintain integrity in its supply chain.advantages. Chico’s receives preferential treatment in the customs inspection process. and next year’s fall lines are being conceptualized. but it does allow Chico’s an advantage in the import process.

which are important to consider. remodeling existing rental property to meet specific needs can have high input and labor costs as well as opportunity costs for new entrants. companies have to buy the materials that make up the infrastructure of the 22    . Chico’s must maintain and enhance its customer service and ensure that it has the correct product mix to offer to customers. the sales associates are able to cross-sell merchandise by understanding how to combine different clothing pieces and accessories to meet the customer’s specific tastes. Once the property has been developed. Stores are built or space is rented in prime locations. Chico’s has developed loyal customers and has had a continued increase in loyalty club members. In order to make it more difficult for competitors to enter its market. Over its 25 years of existence. Large capital investments in real estate for store locations or the capital to lease and/or remodel property is a major cost to new entrants. as well as provide information to the sales associates regarding repeat customers’ specific fashion styles and tastes. Chico’s stores strive to provide high quality merchandise in many colors and styles with accessories to match. Chico’s strives to differentiate its product through personalized customer service. Consumers have to determine if their searching costs related to finding another brand are lower than remaining loyal to the brand to which they have grown accustomed. Everything depends on which company is a step ahead of the competition in terms of its product offering and perceived fashion trends. which can be an expensive investment. In addition. With this this industry. point-of-sale registers collect data on inventory. In addition. New entrants face large capital requirements and non-capital investments. Its sales associates are trained to be able to determine and provide advice on the fashion needs of customers.

Such restrictions can limit the entrant’s flexibility and require significant capital investment to meet the mall’s regulations. if the store is leased in a mall. As stated above. manikins. in order to sell product in a department store. they have a variable rate attached to their lease. setting up a distribution center to transport the merchandise. hiring new administrative staff to oversee the design and manufacturing of the merchandise. New entrants must find there are large monetary costs to opening a new apparel store to compete against Chico’s. In addition. The non-capital requirements include buying the merchandise to stock the store. a designer could sell their product to third-party department stores. the up-front capital requirements are very expensive and necessary to compete in this industry. and registers. Therefore. such as displays. These are nontrivial tasks in a highly-competitive industry but are necessary to capture market share from existing competitors. Companies will also have to invest in technology and security systems to track the product and monitor the store and its occupants. Leasing and developing a store within a mall might be difficult depending on the regulations and/or restrictions the leasing company has on that property. and launching an advertising/promotions campaign to increase foot traffic into the store. a fashion designer must make considerable investment in developing relationships with department store buyers. However. in fact. the payment structure might be linked to store revenue. This could prove to be very expensive for a new entrant if. when discussing economies of scale. which can be a difficult and lengthy process. Entrants also have to be aware of whether or not there are restrictions on remodeling the leased property. buy or lease a distribution center for its merchandise once it arrives in the 23    . As an alternative.

continue to be expensive in the long run.United States assuming they outsource their manufacturing. As more people become accustomed to shopping on the Web. but. Since Chico’s is already an established brand with a liquid financial position. such as low input costs due to the utilization of foreign suppliers. and Soma in 2006. However. Therefore. but. In addition. many companies have already acquired favorable locations to build stores. most people buy products on the Web from companies with which they are familiar. the company has evolved its website design to be easily browsed by customers. Chico’s has established a call center in which customers can directly talk to a company representative and place an order. who purchase lower-cost raw materials and manufacture the product with cheaper labor than if the product was manufactured domestically. The growth of Internet usage is another potential distribution mechanism for new entrants. the Internet will reduce entry and selling costs. it is less likely to gain considerable sales from the Internet. with brand loyalty in place for Chico’s. The industry has several cost advantages independent of scale. Chico’s launched a website for Chico’s clothing in 2001. with the population migrating from urban to suburban areas and “micropolitans. WH|BM in 2005. 24    . develop a logistics method. it is vital to have a recognized brand which customers associate with quality and fashion. With the Internet operations. it will be expensive for a new entrant to compete against the company in the short-term and. Any entrant can create a website to compete with Chico’s. In addition. without an established brand name.” there are still locations that new entrants can capitalize on in the future. and lease or build store fronts to sell the merchandise.

which is not a sustainable advantage. might have the potential to be a large barrier if the current rules or regulations were to change in the future. nor are there significant tariffs. There are no import quotas on textiles and clothing from foreign countries. experienced management. The fact that Chico’s has a mature supply chain. a large 25    .Any entrant can outsource their manufacturing to foreign suppliers like Chico’s. The Free Labor Standards Act provides the guidelines for minimum wage. overtime pay. and youth employment under the law. There is very little that stops new competitors from entering the industry. None of the regulations would treat either party different than the other. Thus. In the future. as most manufacturing of clothing occurs outside of the United States. Chico’s has an established and effective supply chain in operation. This rule should not be a barrier to new entrants. trade restrictions or increases in tariffs would potentially prevent new entrants into this industry. As stated before. Chico’s does not have any advantage to new entrants in terms of government regulations. but regulations regarding trade. The United States has laws regarding labor and compensation for hours worked. Chico’s is not in a better position than companies trying to enter the market in this respect. but Chico’s has established many advantages which provide some insulation from this threat. Despite being a member of C-TPAT. Government regulations do not present a barrier to entry into the industry. new entrants would first have to establish a working and efficient supply chain. In order to receive the benefits of low input and labor costs. establishing the relationships with the suppliers and making sure the product is of sufficiently high quality is a more difficult task. specifically import regulations. however.

Thus. Fixed costs arise in the supply chain from actually storing the merchandise. in reality. causing declines in revenue. Due to declines in consumer discretionary spending. and distribution costs (warehousing and logistics) to compete in the industry. may only sell the item at a highly-discounted price. Consumers are shopping at discount stores rather than at up-scale specialty stores. considering it would have to create a supply chain. which in turn make high fixed costs more difficult to cover especially when debt is less-readily available. The investment for a new company would be very large. salary. who provide their own machinery and tools. 2.2 Existing Competition Currently. the growth in the highly-concentrated retail apparel industry is stagnant and companies within this industry are competing to maintain and grab additional market share from existing competitors. companies find themselves struggling to adjust to decreased revenues. With each company having the same goal of producing and selling the most fashionable brands each season. one can model obsolescence as a storage cost because every day the store has extra merchandise is one more day that the company might have to mark down the product or send it to an outlet store. the existing competition has to cover other essential operating costs. the company would not receive full price for the item and. develop and open new stores. Additionally. and brand equity make it more difficult for a new company to steal market share. technology.number of operational store locations with sales associates that provide personalized service for the customer. In addition to storage costs. and find a niche that differentiates its product from that of Chico’s. and switching 26    . it is difficult to differentiate products. There are relatively few fixed manufacturing costs due to the utilization of foreign suppliers.

costs are low among existing competitors. However, as stated previously, differentiation can be established though brand recognition, customer loyalty, and customer service. Consumers tend to shop at the stores in which they receive prompt and genuine service under a brand they feel is synonymous with quality. In addition, consumers tend to be creatures of habit and shop at the same stores time and again, especially if the company portrays the qualities specified previously. There is an exception when the economy is in recession, and consumers find themselves with reduced discretionary spending. When this occurs, perceived switching costs vanish as consumers shop where they can get a quality product at a discount price. Increasing production capacity in this industry is relatively inexpensive. Contracting third-party manufacturers involves lead time, due diligence, and line retooling but requires little capital investment on the part of companies doing the contracting. By outsourcing the manufacturing of merchandise, companies can decrease capacity needs or transfer capacity to different producers to cut costs. There are costs for staffing associated with developing product lines, but these costs are manageable and small relative to the large costs throughout the rest of the company’s operations. The exit barriers are lower than those in other industries but more substantial to companies that are highly leveraged than to those that have no financial leverage. Companies will have to buy out of leases, let their leases run out, or, if they own stores, find a way to sell the property in the currently-declining real estate market. Companies also have to continue to pay the fixed costs related to the building until they have reached an agreement for the sale or lease. Companies seek to extract as much profit as possible from the remaining items left in the store after they close. Thus, they may choose to


liquidate the infrastructure, displays, manikins, and registers, with or separate from the property. The difficulty of this task can depend on the location of the store. For example, if the store is leased in a mall, it will be easier to dispose of the infrastructure materials because the next lessee will most likely be in need of some of the materials. In addition, a company that wishes to leave the market has to dispose of excess inventory while at the same time earning as much as possible from the sales on the discounted products. Because all of the companies in this industry have rival products, Chico’s faces vigorous competition. The company maintains its business strategy of producing high quality, fashionable products that can be sold in store fronts by trained sales associates at a premium price. In addition, Chico’s continues to place emphasis on its target

demographic and has attempted to successfully market its product using several different media avenues. Basically, Chico’s focuses on what it does best: purchase and/or design a product that is perceived by its target demographic as the “it” product and continually enhance customer service in the store. This focus provides Chico’s with the advantages it needs to remain competitive within the industry.

2.3 Rival Products
Competition on the basis of rival products is a constant threat in this industry. As previously discussed, each company has the same goal: produce and distribute the most fashionable apparel and accessories. Thus, a major source of competition for the target demographic is related to the designs of current and future product lines and their alignment with consumer tastes and perception of fashion. Maintaining high margins is


difficult in this industry due to the ready availability of rival products. Companies must differentiate themselves in order to preserve their margins. Chico’s focus is to design, purchase, and develop the most desirable product mix as perceived by the customer. To distinguish itself from rival products that are not qualitatively different from its own product, Chico’s spends time training its sales associates to understand fashion dynamics and be able to offer advice, as well as outfit ideas to customers in order to meet customers’ needs. Since rival products are perfectly substitutable, maintaining a high level of personalized customer service distinguishes the Chico’s brand from its competition.

2.4 Bargaining Power of the End Consumer
The individual customer has low bargaining power alone but, collectively, they can be a potent force. Consumers are price sensitive and will switch to rival products if they feel the price is too high or even too low. This is magnified during economic declines but is less noticeable when the economy is booming. Several qualities that attract customers to a company are brand image, quality, fit, and customer service. These characteristics can increase customer loyalty to a particular brand of clothing. The information available to consumers today allows them to have more power than in previous decades. Consumers can run price checks through the Internet before buying the product as well as see which store has the product they are looking for in stock. The increase in information gives the consumer power to seek out and buy the highest quality product at the cheapest price. considerable power. Thus, the consumer is price sensitive and wields


Chico’s entire business strategy revolves around the customer’s perception of the product and its characteristics. and. due to fastpaced fashion cycles. 30    . they must adhere to the quality control requirements of the buyer because the buyer can and will switch vendors rather easily. If consumers do not demand the product Chico’s provides. Second. The main non-monetary expense relates to time.Chico’s is very susceptible to the bargaining power of the end consumer in that the end consumer provides the financial resources that allow the company to continue to operate. By switching vendors a company loses valuable time in which its merchandise would have been produced. it favors the supplier. if they are high. If the vendor wants repeat business. First. Many companies use short-term contracts with independent vendors to get the best deals. it takes time to set up contracts even if they are short-term. The fact that Chico’s entire strategy revolves around the customer magnifies the power of the end consumer.” When switching costs are low. excess inventory will have a higher obsolescence rate as time passes. there might be delays in orders which could ultimately affect the “bottom line. it favors the buyer. as well as the service provided to them at the store level and by other representatives of the company. In addition.5 Bargaining Power Between the Company and the Supplier Merchandise is a large fraction of the buyer’s costs. the company will be left with excess inventory and little revenue to pay its expenses. it takes time to go over quality control and shipping requirements. so the buyer will be price sensitive if a lower-cost supplier is readily available. 2. There are several non-monetary switching costs that must be considered. Thus.

pg. buyers have to be aware of import laws. Thus.19 Companies do not have the access to cheap labor. and quotas than might increase costs or delay shipments of inventory. Because many suppliers are foreign. and India. suppliers gain a small advantage over the buyer. and. China. If one supplier is unable to meet production levels or has quality control issues. Chico’s is less susceptible to the bargaining power of the supplier in that the company maintains a diverse set of suppliers. especially in a global market.In this industry. In addition. most companies do not wish to develop this capability as it would distract them from their core competencies of designing and selling the latest fashions. However. Inc. thus. nor do they have the capacity to manufacture their own merchandise. including manufacturers in Peru. Guatemala. Chico’s should be able to maintain production levels by distributing the desired quota among already established suppliers. In fact. and the United States. low cost raw materials. 22  31    . neither group has an advantage over the other due to informational asymmetries.6 Bargaining Power of Suppliers Suppliers. 2007 Annual Report. The product                                                          19 20 Backwards integration is the act of a company taking over upstream supply chain operations. 2.  Chico’s FAS. it has “cut and sew” locations in Mexico. Turkey. there is little threat of backwards integration. Since there is little threat of backward integration. it is less susceptible to the power of suppliers. Guatemala. regulations. due to Chico’s mature supply chain and diverse manufacturing channels. both groups are privy to all information available in the market. including manufacturing and labor.20 Chico’s purchases the raw materials and provides them directly to the “cut and sew” operations. do not have a lot of power over buyers because companies can find suppliers anywhere.

The fact that the supplier market is highly concentrated is advantageous to Chico’s. as mentioned before. there are many rival suppliers for the companies in this industry to choose from which nullifies the power. Normally. This provides the supplier with some power. If the company chooses to switch suppliers. this would provide the supplier with power over the buyer. the company may begin to search for a new supplier. If a manufacturer does not comply with the company’s policy. Chico’s already has a mature supply chain with a large number of manufacturers in diverse locations. However.produced by the suppliers is extremely important to the buyers whose profitability depends on the success of that product. A company will incur several switching costs when changing suppliers. As stated in the preceding section. This will incur additional costs and delays in shipment of the product to the store. Chico’s is less susceptible to the bargaining power of suppliers due to the fact that there are numerous global suppliers with which it could do business. If the supplier has different operations. Additionally. trying to find a supplier that meets Chico’s requirements may be time consuming and less cost effective than retaining the current supplier. but. but the switching costs involved can mitigate this to some degree. such as the opportunity cost of lost time and various setup costs. then the company will have to spend time working with the supplier to obtain the quality product it desires. Chico’s works hard to maintain quality control within its supply chain. Thus. it can be easy or difficult depending on how similar the operations and manufacturing processes are to the previous supplier used. there are many rival suppliers which decrease the power of the supplier. 32    . however Chico’s retains a considerable advantage in terms of bargaining power. However.

Chico’s pays special attention to specialized customer service in which sales associates are trained to offer advice. Since end consumers have significant bargaining power in the industry. and is currently facing stagnant growth. with regard to suppliers. and cross-selling ideas to the customer. However. This provides the end consumer with considerable bargaining power. companies work hard to carry inventory that is perceived by the customer as the latest fashion. style. and pattern preferences of repeat customers. companies must be aware of what the customer demands in order to survive each fiscal year.Conclusion The retail apparel industry is highly concentrated. Chico’s business strategy revolves around customers’ wants and preferences. sales associates are provided information on color. Existing companies with rival products are constantly competing to steal market share from other companies in the industry. To complete this task. competitive. Chico’s is part of an industry with few barriers to entry. Chico’s has a mature supply chain in place with a diverse group of manufacturers located in multiple countries. 33    . Chico’s focuses on its core business and outsources it manufacturing. Like many companies within the industry. style types. To differentiate itself from the competition. but it positions itself well within its target market and focuses on its core business. In addition. This makes the company less susceptible to supplier power. using its customer database.

3. Competitor Analysis
In addition to considering the environment and industry in which Chico’s operates, one must understand its direct competitors. These firms operate in the same markets and target the same consumers. The firms included in this analysis are Dillard’s, Talbots, AnnTaylor, Coldwater Creek, Christopher and Banks, and The Limited. Understanding of the competitors within the market is necessary to evaluate the strength of Chico’s position within the industry. To further this understanding, we evaluate the size, financial position, and competitive strategy of each of the companies analyzed. It is important to note that the market is addressed by both traditional department stores, such as Dillard’s, and specialty boutiques like AnnTaylor. In general, competitors of each format tend to have similar strategies and initiatives with the primary competitive difference being the ability to consistently execute. As such, it should be understood that the below selection of

competitors is not comprehensive, but many of the issues discussed are readily applicable to competitors of the appropriate format.

3.1 Dillard’s21
Dillard’s is a traditional department store incorporated in 1964. Run by the Dillard family, Dillard’s had $7.5B in revenue in fiscal year 2007, has a nationwide presence, and, as a traditional department store, serves multiple target markets from under one roof. Major identified lines include cosmetics, lady’s apparel and accessories,

21 Dillard’s,

Inc. 2007 Annual Report 


junior’s and children’s apparel, men’s apparel and accessories, shoes, and home furnishing. Dillard’s primarily operates as a buyer-based retailer; it sources and resells nonDillard’s branded products within all of the above-mentioned product lines. In 2002, Dillard’s changed this strategy to include Dillard’s private-label products, which have grown to make up 20% of Dillard’s overall sales. In an effort to improve results and limit exposure to credit risk, Dillard’s sold its credit arm to GE Money Bank in 2004. This move reduced Dillard’s exposure to bad consumer debt and allowed it to focus on its core operations. The agreement was structured in a way that Dillard’s would continue to market the Dillard’s store credit card and receive residual income from GE Money Bank from consumers that continued to use the card. In recent history, Dillard’s has experienced minor gains in revenue but increasing profitability due to reduced interest payments stemming from the retirement of $560M in debt. These increased efficiencies contributed to a trend of improved profitability for several years. However, in fiscal year 2007, Dillard’s was hit hard by the recent market downturn posting net income 80% lower than in fiscal year 2006. As a retail department store that serves multiple market segments, Dillard’s is not a focused competitor in the 35 and older upscale women’s apparel market. While

Dillard’s seeks to target customers seeking upscale products, its multiple product lines and buyer-based strategy reduce its direct impact on the women’s apparel market. Because it sources external brands, Dillard’s has difficulty building the brand loyalty that is critical in this market; primarily, its competitiveness is based on its ubiquitous presence


in the regions in which it operates and its reputation for selling higher-quality products than traditional department store competitors such as JC Penney.

3.2 Talbots22
Talbots is a women’s apparel company incorporated in 1947. It targets women aged 35 and older seeking upscale, high-quality apparel and accessories. Talbot’s seeks to deliver a “current-classic look” with its private label product lines and makes a deliberate effort to ensure that products are complementary to maximize cross-selling opportunities. Talbots operates its retail presence as a boutique format store, which allows it to expand beyond the confines of a mall and operate on “Main Street.” This is in line with Talbot’s more upscale strategy, allowing it to target upscale consumers that may find shopping in a mall undesirable. Additionally, Talbots operates a successful direct

marketing division which contributes 19% of revenue and allows Talbots to directly track some of its customer’s preferences for internal evaluation purposes. In recent years, Talbots has experienced stagnant or declining revenues. Making matters worse, operating efficiencies have declined due to increasing costs stemming from increased warehousing costs, supplier costs, and costs associated with replacing executive level management in an effort to improve performance. Talbots attempted to address the issue of revenues, in part, with its acquisition of J. Jill in 2006. The J. Jill acquisition was primarily intended to increase market share and revenues as it operates in approximately the same market as Talbots (albeit slightly upscale); however, the acquisition has not turned out as planned. In the most recent fiscal year, Talbots had to                                                         
22 The

Talbots, Inc. 2007 Annual Report 


Jill acquisition. AnnTaylor focuses on “updated classic. In addition. Jill acquisition was financed heavily by debt. operating results. Corp. it is primarily a brick-andmortar presence with 929 retail stores. Due to these difficulties. Its product line is comprised of suits. The resulting interest payments have further depressed 3. AnnTaylor operates multiple brands. professional and special occasion dressing. As a result of this process. In reaction.write down assets related to the J. 2007 Annual Report. the                                                          23 AnnTaylor 24 Stores.3 Ann Taylor23 AnnTaylor Stores Corporation is a women’s career and casual wear retailer established in 1945. including Ann Taylor. AnnTaylor targets affluent women and provides them with “updated classic” products. Although AnnTaylor has an Internet storefront.4B of revenue in fiscal year 2007. the company has grown into a national brand and generated $2. 2007 Annual Report  AnnTaylor Stores. Corp. separates. Talbots has expressed a commitment to becoming a more “design-led” company in an effort to differentiate its products in the market and to drive sales.”24 It also pays special attention to strengthening its brand names. Like other companies in the industry. yet stylish. To differentiate itself from other competitors. Started as a primarily East Coast brand. AnnTaylor is experiencing difficulties and negative same-store sales growth due to poor macroeconomic conditions. pg 2  37    . footwear and accessories. Talbots has begun an internal re-evaluation process in an attempt to revitalize the company. the J. LOFT and Ann Taylor Factory.

Coldwater Creek’s product line is made up of privatelabel casual wear. closing underperforming stores.” as has a large decrease in same-store sales in recent years. Coldwater Creek is attempting to address its increasing                                                          Creek. 3. such as Coldwater Creek’s “Spa” concept. Like the rest of the industry.4 Coldwater Creek25 Coldwater Creek is a women’s casual wear company founded in 1986. Coldwater Creek has a penchant for sales innovation. An in-depth analysis of AnnTaylor is located in the alternative acquisition candidate section. We have selected AnnTaylor as our back-up acquisition candidate. It provides casual wear and accessories to women aged 35 and older. and streamlining organizational structure. Founded as a direct marketing company. expanding as both a traditional retail presence and by experimenting with unusual retail formats. Additional efforts to differentiate include early-stage experimental format initiated a restructuring program that includes reviewing the cost structure of the company. and the company seeks to differentiate itself with unique designs and high-quality apparel.15B per year revenues coming from its brick-and-mortar retail stores. The strategic importance of nationwide marketing to Coldwater Creek is unique among its competitors. Coldwater Creek has experienced difficulties in recent years. Increasing costs have cut into its “bottom line. 2007 Annual Report  25 Coldwater 38    . It places a high emphasis on its ability to effectively place advertisements in national publications and allocates resources that reflect this emphasis. Although historically a direct marketing company. Coldwater Creek’s expansion strategy has resulted in the majority (70%) of its $1. Inc. which co-locates a spa with a Coldwater Creek retail presence.

Christopher and Banks is experiencing difficulties due to the macroeconomic environment. attempting to provide a variety of coordinated products. The majority of its stores are located within traditional mall spaces. and Acorn. 3. Christopher and Banks primarily operates a brick-and-mortar presence. Historically. It targets women aged 40 to 60 seeking casual fashion and accessories for work and leisure. To differentiate itself. with relatively little direct-marketing revenue. Corp. Coldwater Creek’s main strength is its willingness to experiment with growth strategies to grow beyond its current position. Christopher and Banks operates multiple retail brands.5 Christopher and Banks26 Christopher and Banks is a women’s apparel company founded in 1956. including Christopher and Banks. For all of its stores. It generated $575M in revenue in fiscal year 2008. and continues to experiment with sales models in an attempt to attract new customers. Christopher and Banks seeks to provide distinctive products in line with the current year’s fashion trends. It only recently opened a Web storefront in February 2008. which are easily combined into complete outfits. 2007 Annual Report  26 Christopher 39    . Like the rest of the chain costs by cutting out middlemen. CJ Banks (which focuses on plus-sized clothing). Christopher and Banks uses a combination of externally branded and private label products. It has grown from a direct marketing company to a primarily retail company. with stagnant same-store sales and decreasing                                                          and Banks. Coldwater Creek used intermediaries to source its products. but it has recently made a strategic decision to begin dealing directly with upstream suppliers.

This led to a recent announcement to close all Acorn stores by the end of 2008. and increase conservatism in store expansion. The initiatives to improve the supply chain may experience unexpected difficulties. The company is in the unenviable position of sourcing 47% of its products through a single agent. and is the major reason why Limited Brands. is discussed. with programs in place to improve supply chain efficiencies. Over the years. Limited Brands has developed.28 Limited Brands. Christopher and Banks is working to prepare for this eventuality but should expect problems resulting from this event. Management additionally recognizes that it must improve same-store sales performance.. Inc.  28 The 27 Limited 40    . resulting in increased sales.margins across its brands. was originally founded as The Limited in 1963. Inc. Christopher and Banks sources the majority of its products overseas through third-party agents. Victoria’s Secret represents a special issue for Chico’s FAS with respect to the Soma Intimates line. petites) in response to proven customer demand.g. acquired. It is hoped that this increase in marketing will drive additional traffic to existing stores and to Christopher and Banks’s new websites. Additionally. Inc.27. who has recently informed Christopher and Banks that it intends to cease operations. Inc. and                                                          Brands. Management primarily hopes to address the issue through improvements to operating efficiencies.6 Limited Brands. 3. In addition to its efforts to realize increased efficiencies. 2007 Annual Report  discussion of Limited Brands. specializing in young women’s apparel. which comprises over 50% of Limited Brands’ net sales. improve direct marketing initiatives. Christopher and Banks intends to increase its marketing expenditures from 1% to 1. Inc. Christopher and Banks will expand select product lines (e. has been primarily restricted to the Victoria’s Secret segment.5% of sales.

Victoria’s Secret dominates the women’s intimate apparel market in North America. Despite Victoria’s Secret’s strong position. As currently constituted. and beauty products. It recently implemented new supply chain systems at Bath & Body Works and had to build up inventory as a hedge against supply chain disruptions during the conversion from the old system. Abercrombie & Fitch. personal care. The company has prominent advertising campaigns featuring fashion supermodels. The Victoria’s Secret segment sells women’s intimate apparel.300 store-fronts. In 2007. but the increase is primarily attributable to the acquisition of La Senza. the company divested itself of the underperforming Express and The Limited segments and acquired La Senza.occasionally divested itself of multiple specialty retailers. In 2007. Victoria’s Secret Direct has had issues 41    . prime-time fashion show. direct catalog marketing (Victoria’s Secret Direct). The Victoria’s Secret brand has tremendous mindshare in North America and is one of the strongest brands in women’s intimate apparel. Victoria’s Secret and Bath & Body Works collectively constitute over 80% of Limited Brand’s total net sales. the segment had net sales of $5. Limited Brands does not escape the macroeconomic downturn that is plaguing the fashion industry. Bath & Body Works. In fiscal year 2007. Limited Brands has been plagued by serious supply chain management issues. Victoria’s Secret. Additionally. Same-store sales declined by 2% compared to 2006.6B across 1. Express. and a nationally televised. including The Limited. Limited Brands generated $10B in net sales. Net income increased for fiscal year 2007. Additionally. Limited Brands primarily operates Victoria’s Secret and Bath & Body Works. Recently-acquired La Senza is organized under the Victoria’s Secret segment. and La Senza.

This.with a new distribution center. over $1B in principal is due in 2012).9B outstanding. where they attempt to attract customers of all kinds.                                                          29 Abercrombie & Fitch. Co. while WH|BM targets customers older than 25 years of age. This reliance on debt exposes Limited Brands to interest rate risk and the need to redirect some of its operating income to both servicing debt and potentially having to repay principal (e.7 Other Competitors There are many other competitors within the industry that might serve Chico’s target demographic. however.” Their business models are fundamentally different. Inc. is a remote risk for the company. there are targeted retailers that have some overlap with Chico’s. Limited Brands makes considerable use of debt to finance its activities.. Additionally. but the primary focus is different. with the companies operating under a “big tent” philosophy. Most of these department stores are roughly comparable to Dillard’s in terms of strategy and the threat they pose to Chico’s. and $300M of debt that can be issued from an outstanding shelf registration. Almost all major department stores will have floor space dedicated to serving adult females of all ages. It currently has $2.  2007 Annual Report   42    . 3.5B revolving credit line. Abercrombie & Fitch and American Eagle Outfitters might best be described as “overlap” competitors. department stores do not consider Chico’s target market to be their “mission.30 There is necessarily some overlap in customer taste and some competition for customers at these edges. a $1. However. resulting in significant shipping delays and additional costs to address the issue. Both target customers younger than 25 years of age. 2007 Annual Report   30 American Eagle Outfitters.29.g.

31 These new competitors are always lurking. Abercrombie & Fitch has established two new brands – RUEHL and Gilly Hicks – specifically targeting women in WH|BM’s 25-40 range. To this end. For example. Co. Conclusion Due to constant competition and ease of entry. when they want it. eager to steal market share at the smallest misstep.                                                          31 Abercrombie & Fitch. companies seek to build a strong brand identity and a consistent process for identifying and delivering what the customer wants.There is constant threat of entry from new competitors or established brands seeking entry into Chico’s target market. 2007 Annual Report   43    . Success is dependent primarily on two factors: the ability to create the perception of a qualitative difference in the customer’s mind and simple execution. companies in the fashion industry are always a season away from disaster.

Coldwater Creek Inc.. we will discuss the strategic. activity.4. Analyzing the aforementioned ratio families will help to understand Chico’s overall strengths and weaknesses and will allow one to speculate on the company’s future financial condition. target customer demographics. for each year of the analysis. Talbots Inc. These companies were selected based on similarities in industry. we will explain the general trend for Chico’s over the five-year period. our group selected five companies to comprise a comparables/competitor basket for Chico’s. Second. and/or tactical implications of the firm’s position relative to the family of ratios. For each family of ratios. we will compare Chico’s ratios to that of the industry and discuss whether family or individual ratios are materially different than the industry standard. The five companies selected were: Christopher & Banks Corporation. one must consider Chico’s financial health. In other words. The selected ratios cover the major financial areas of liquidity. isolating any individual ratios by year that vary from this trend. The following will analyze financial ratios for the years 2003 through 2007 for Chico’s and for its industry. Finally. profitability. We will also discuss the reasons for the overall company trend. leverage. For the purposes of this analysis. pricing points. and stock market. and AnnTaylor Stores. and identification in 44    . operational.. Financial Ratio Analysis Overview After analyzing Chico’s competition.. Dillard’s Inc. market capitalization. To obtain a good representation of each family of ratios. we will use a materiality of at least two times (2X). Chico’s ratios will be considered materially different if they are at least 2X above or below the industry average.

respectively. Chico’s 2007 10K. respectively. these increases in working capital accounts were a result of Chico’s growth-through-acquisition strategy and its ability to increase sales and operations over the five-year period as it continued to grow in the industry. The data for the ratio families for Chico’s and the industry averages can be found in Appendix A. from 2003 through 2007. The industry average for each ratio within each family was calculated as a simple average of all five companies. Cash flow per share followed the family trajectory but at a slower (or flatter) pace. with outlier data excluded from the calculations. Generally. Likewise. and Google Finance  45    . These ratios ended at a higher level than 2003. Likely. Working capital per share followed the family trajectory from 2003 through 2005 but declined at a slower pace from 2005 through 2007. With the exception of 2003 and 2005. operating cash flows remained in the $210 .1 Liquidity Ratios From 2003 through 2007. the trend of the liquidity ratios increased with a peak in 2005 and a subsequent decline through 2007. five-year change in liquidity with the exception of the working capital per share and cash flow per share ratios. Chico’s cash and short-term investments remained stable in the $265 . 4. grew with average five-year growth rates of 27% and 21%.                                                          32 Resources used: Bloomberg. Accounts payable and accrued expenses grew 25% and 24%. Hoover’s Pro.275M range.Chico’s annual report. this resulted in a relatively flat. Accounts receivable and inventory. the remaining ratios were found using Research Insight Web and Wharton’s Research Data Services.32 The stock market ratios for each company were found using the Bloomberg terminal. however.$290M range for most of the period.

receivables and inventories grew because of increased demand and sales in stores and through the internet. Chico’s acquired WH|BM in 2003 and launched Soma Intimates in 2004.5X that of the industry. Additionally. rising inventories could be an indication of obsolescence. From 2004 through 2007. Chico’s working capital declined. Chico’s quick ratio ranged from 2X to 2. a difference of 1. a key risk factor in the fashion industry. working capital per share. The five-year quick ratio average for Chico’s was 2. Increasing receivables is good if it means increased sales.3 versus 1. 2007 Annual Report. With the exception of higher values in 2003.3X. Chico’s quick ratio.6 for the industry. too-relaxed credit policies. the five-year average for the Chico’s current ratio was 3. all of which reduce access to cash.33 This growth also contributed to increased accounts payable over the period. Inc. Increasing inventories is likewise good if it means increased demand and sales. Also.3 for the industry. Over the five-year period. Chico’s liquidity position depends on its working capital management. Since 2005. 36  33 Chico’s 46    . From working capital per share and cash flow per share perspectives. increasing accounts payable is good                                                          FAS. However. Related. which ultimately leads to cash. Chico’s five-year average was almost 2X that of the industry. pg. but it could be negative if attributed to slowing turnover or conversion to sales. Finally.4 versus 2. and cash flow per share statistics were materially different. and ineffective monitoring of overdue client accounts. The company also opened 592 new stores and acquired 15 stores from franchisees over the five-year period. both the industry working capital per share and cash flow per share ratios were 2X those of Chico’s. it could be negative if attributed to lower turnover of sales into cash.Compared to the industry.

Additionally. a dividend-paying stock is more attractive to the market because it indicates the company’s ability to generate cash flows to pay dividends. Chico’s liquidity position coupled with stronger-than-industry price multiples (discussed later in the analysis) gives Chico’s advantageous payment alternatives (cash and/or stock) for potential acquisitions. Chico’s current and quick ratios were strong. Also. in addition to stock appreciation. In addition to affecting the working capital per share and cash flow per share ratios. the analysis in the activity ratios section below will show that Chico’s overall activity management was better than that of the industry. Given that analysis. Abundant liquidity allows the company the option of implementing a dividend-paying policy. This liquidity position allows the company. Strategically. Strategically. to pursue positive NPV projects and to take on additional projects or investments if attractive opportunities should arise. going forward. we have confidence in concluding that Chico’s liquidity position overall is strong.from a cash management perspective of delaying cash out the door. a favorable movement from an investor’s or analyst’s viewpoint. inventory and receivables levels factor into the current and quick ratios. These same payment alternatives allow the company to incentivize existing employees and to attract key outside personnel to the company. Chico’s better liquidity position gives it several advantages over its competitors. For example. dividends are another form of 47    . From both an absolute and relative perspective. Chico’s can more aggressively pursue the strategy of remodeling its existing stores as stated in its 2007 annual report and even add more creative changes to its original plans. if the company ensures that it is not incurring late fees on invoices or harming vendor relationships.

average collection period. Chico’s. relative to the industry as will be discussed later.2 Activity Ratios From 2003 through 2007. Given that the average collection period remained relatively flat for most of this same time period indicates that Chico’s credit policies. days to sell inventory. When compared to the industry. Although rising from about 179 in 2003 to 186 in 2004. receivables turnover declined every year thereafter through 2007 to end at a ratio of about 68. Chico’s ratios were materially different over the five-year period for the following ratios: receivables turnover. which showed a material. is in a better operational position than competitors to get through the current economic crisis. remained effective for the company and. A potential downside of a strong liquidity position is that a company may not be as critical when evaluating projects and investments or may not be as cost-effective operationally. The largest outlier was the receivables turnover ratio.return on investment. Chico’s activity ratios. and operating cycle in days. with access to liquidity. The trend of the receivables turnover ratio implies that Chico’s credit policies were tighter in 2003 and became more relaxed over the time period 2004 through 2007. in fact. remained relatively flat with one major exception. for the most part. and the operating cycle ratios ended with a slight increase in 2007. The average collection period. 4. although changing. the days to sell inventory. while the inventory turnover and total assets turnover ratios ended with a slight decrease. Finally. overall decrease over the five-year period. Regarding the receivables turnover 48    . Chico’s should be aware of these potential risks and mitigate by effective internal controls on the capital review and allocation process and on cost management.

Chico’s was more than double the industry standard for years 2003 through 2005. the industry’s average was approximately 11X that of Chico’s and decreased year-by-year ultimately to 2X in 2007. and in line with the industry in 2007. Operationally.ratio. The 49    . In 2003. the industry’s average collection period was materially over that of Chico’s. Chico’s payment terms for its customers may have been more effective than that of the industry and that Chico’s credit policies were tighter. historically. greater than 1X the industry in 2006. The fact that Chico’s receivables collection period was shorter further supports the fact that Chico’s may have been more effective in its receivables policies. Days to sell inventory was about 2X Chico’s in all five years.6X in 2003 to 2. while the operating cycle steadily declined from 2. Chico’s tighter credit terms. resulting in a higher turnover and a shorter collection period. in effect. an interest-free loan to customers. Additionally. As a smaller company relative to its comparables basket. a higher receivables turnover ratio for Chico’s relative to the industry indicates that. accounts receivable accrues no interest and is. Chico’s may have enforced tighter credit policies to manage collection of sales (cash management). As expected from the previous analysis. as Chico’s credit policies relaxed over the five-year period.4X in 2005 to almost 2X in 2007. Related to the receivables turnover ratio is the average collection period in days. may have been a disadvantage relative to other competitors who may have been able to offer more attractive credit terms and generate more sales as a result. On the other hand. historically. The industry averages for both days to sell inventory and operating cycle in days were higher than that of Chico’s.

25%. Again. the slow-down in receivables turnover could have resulted in lost investment opportunities for the company with cash “tied up” in receivables. while sales. From 2005 to 2007. 4. Chico’s net income decreased 47%. this means that Chico’s credit and collection policies are more effective than the industry. All company profitability ratios closely exhibited this behavior. and this contributed to longer operating cycles. 18%. However. and equity of 5%. assets. the overall trend of Chico’s profitability ratios was a decline.3 Profitability Ratios From 2003 through 2007. collection of cash. the industry took longer than Chico’s to convert inventory to sales.decline in receivables turnover over the five-year period through a relaxation of credit terms could mean that Chico’s was less effective at managing client accounts and. this is an operational advantage for Chico’s in that it is more effective at managing the conversion of inventory to sales and ultimately cash through a shorter operating cycle. with relatively little movement between 2003 and 2005 but a more rapid decrease afterwards. Strategically. Specifically for 2006 to 2007. the company is in line with the industry receivables turnover ratio as of 2007 but has a faster collection period than the industry. with corresponding increases in sales. Chico’s experienced declines in profitability due to a product offering that did not keep up with fashion demands. From 2005 to 2006. Within this five-year period. and 50    . therefore. relaxed credit terms could have contributed to increased sales. Chico’s net income decreased 54% over the two-year period. and 14%. respectively. and equity increased 22%. assets. Going forward. Given both historical points of view. contributing to better cash management with respect to receivables. and 13%. inadequate marketing. respectively.

Although Chico’s net profit margin. Over the five-year period. Talbots and Dillard’s.7X in 2007.1X the industry average. specifically Coldwater Creek. Chico’s ROA showed a four-year average of 2. while the remaining                                                          34 Chico’s 35 FAS. the industry showed declines in some cases. Chico’s profitability ratios were materially over industry averages for all ratios and all years. on average. Regarding sales. When compared to the competitor basket. 2006 Annual Report. Letter to Shareholders  Chico’s FAS. with the more rapid decline occurring after 2006 versus 2005. Inc. In the cases of Coldwater Creek and Talbots.5X that of the industry from 2003 through 2006. assets. Dillard’s. inadequate marketing. 2007 Annual Report. Likewise. the ratio spiked to 46. Letter to Shareholders  36 Analysis using Google Finance financial statement data  51    . and consumer reaction to a slowing economy.5X the industry in 2003 to a peak of 3X the industry in 2004 and 2005 and to a subsequent decline to 2.1X the industry before spiking to 74. Inc. Chico’s ROE was generally 2.34 Reasons cited for profitability declines from 2006 to 2007 were similar: clothing that was not compelling enough to the consumer. the industry had much larger declines between 2006 and 2007 in net income. However. a net income position in 2006 swung to a net loss position in 2007. was 2.36 Generally.inconsistency in applying its “most amazing personal service” strategy. Comparing Chico’s 2006 to 2007 percent changes in net income. sales.4X the industry in 2007. the industry’s decrease was slower.7X the industry in 2007. and Talbots. and equity noted above to the industry explains the behavior of the 2007 spikes in net profit margin and ROA and why ROE was not as materially impacted.35 The industry’s trend over the same time period had the same overall result as that of Chico’s – a decline. Chico’s operating margin after depreciation ratio moved from 2.

as was the case for both Talbots and AnnTaylor Stores.comparables and Chico’s showed an average increase of 5%. The industry utilized both debt and equity as components of capital structure. All comparables had declines in equity versus Chico’s increase in equity over the same period. The industry comparables also had smaller increases in total assets and.4 Leverage Ratios For the five-year period analyzed. With profitability and liquidity. the company could take the opportunity to implement a dividend-paying policy. in some cases. Additionally. A slowing economy was cited as the main reason for the decline in profitability among the comparables’ various annual reports. Profitable firms gain favor with Wall Street analysts and potential investors. Dividend-paying stocks are attractive to shareholders and analysts. it is in a better position relative to its comparables. Chico’s did not have debt in its capital structure. The industry pattern over the five-year period showed a dip in leverage from 2003 through 2005 with a 52    . Strategically. the company is in a better position to invest resources necessary to manage operations effectively. Higher profitability increases the likelihood of positive operating cash flows and the liquidity to be able to invest in positive NPV projects – both planned and unexpected. declines in assets. although Chico’s experienced declines in profitability for macroeconomic reasons affecting the entire retail apparel industry. This is supported by Chico’s better-than-industry stock market ratios discussed later. which is significantly different than that of the industry average. higher profitability gives Chico’s the advantage of being able to withstand price wars or significant variation of input costs. Finally. 4.

for example. Generally. it will likely be able to meet interest payments. This ratio was slightly below. Chico’s total assets-to-common equity ratio remained stable over the five-year period 2003 through 2007. the industry relied more heavily on an equity capital structure. Because of its ability to generate positive net income and strong cash flows. Industry debt levels as a percent of equity were below 25% over the five-year period.subsequent rise through 2007. positive NPV projects. A potential downside of maintaining a purely equity structure is a tradeoff between using cash for certain projects when debt obtained cheaply may have proven to be more beneficial. as supported by Chico’s strong liquidity position discussed above. instead. Chico’s is in a better leverage position relative to its industry. the company has the option to utilize its lines of credit and/or take on additional forms of debt for unexpected. this trend produced relatively little change in leverage levels in 2007 versus 2003. Going forward. Chico’s has been able to finance projects internally without reliance on debt capital markets or cash flows dedicated to interest payment requirements. were projects materially accretive to earnings foregone to maintain a no debt policy and. In other words. If Chico’s chooses this option. Strategically. Chico’s strong liquidity and financial position will likely allow it to obtain debt at better rates than its competitors. but in line. giving it yet another strategic advantage in minimizing financing costs. with both the trend and level of the industry. other projects undertaken that were less accretive? 53    .

sales. and 3X and 2. price/sales. declines or remaining flat between 2004 and 2005. the market recognizes value and rewards accordingly through a higher demand. per the 2X criteria. Chico’s was almost 4X the industry in 2003. with larger differences in 2003. Chico’s has a competitive advantage over its industry . and 2006.all stock market ratios for Chico’s exceeded the industry averages. Price/sales differences were larger with over 4X during years 2003. Strategically. and 2006. price/cash flow. about 3X from 2004 through 2006. but the market penalizes or undervalues the stock for other reasons. 2004. price/EBITDA remained in the 2X to 2. with the pattern repeated in 2006 and 2007. Finally. This shows that investors placed a higher value on Chico’s stock relative to its competitors on the variables of earnings. Regarding the price/book ratio. and price/EBITDA.5X range from 2003 through 2006 and declined to 1.4X in 2007. a low price/earnings or price/EBITDA ratio may mean higher earnings per share.5 Stock Market Ratios For the time period 2003 through 2007.4. On the other hand. Price/cash flow followed the same trajectory as price/sales. Chico’s stock market ratios followed the same overall trend. at roughly equal or even lower earnings. For example.4X differences in 2005 and 2007. a high price/earnings or price/EBITDA ratio (as in Chico’s case) relative to the industry means that. low confidence 54    . This trend exhibited a peak-and-valley movement with increases from 2003 to 2004. EBITDA. and a little over 2X in 2007. resulting in a higher stock price. book value. Ratios in 2007 were not materially different. and cash flow. for example. Chico’s stock market ratios were materially over the industry for price/book. than those in 2003. 2004. respectively.

Chico’s stock can be an attractive tool for compensation. relative to its competitors. Chico’s higher price/book ratio indicates that the market believed management was making productive use of the company’s assets as compared to competitors. if necessary. inventories. for both existing employees and as an incentive to attract key personnel from outside the company. Chico’s favorable stock market ratio position may allow the company to obtain external capital. the higher price/cash flow ratio was a signal of the market’s confidence in the company’s ability to generate cash flows. The higher price/sales ratio indicates that the market believed Chico’s was better able than competitors to obtain a profitable return on sales. Finally. Going forward. However. at lower costs than its competitors. Additionally. Finally. Chico’s needs to ensure effective management of working capital accounts to mitigate inefficiencies in collection of cash and obsolescence of inventory. From a liquidity standpoint. The review of the 55    .in the company’s ability to generate future operating cash flows. 4. Chico’s working capital had an overall decline over the five-year period due to increasing accounts receivable. working capital per share and cash flow per share are lower than the industry. Chico’s has strong current and quick ratios in both an absolute and relative sense. Going forward.6 Overall Strengths/Weaknesses and Future Financial Condition The financial analysis above indicates that Chico’s has several competitive advantages over its industry but still has room for improvement from an absolute perspective. and accounts payable. Chico’s strong stock market ratios give the company more edge in being able to use its stock for potential acquisitions. The growth in these accounts was attributable to Chico’s growth through acquisition and new store expansions during this same time period.

and the overall positive position regarding activity ratios. Chico’s has repeatedly cited an incorrect product offering and inadequate marketing as contributors to its declining performance. Given the strong current and quick ratios. and shorter operating cycles than the industry. Most notably. Chico’s profitability measures are materially over the industry’s average. Going forward. Chico’s has been able to rely on itself to finance its growth-by-acquisition strategy. receivables collection periods. The fact that Chico’s has no debt and has been able to outperform its competitors is its strongest point. In one case. degradation in customer service was also cited. This gives the company the flexibility over its industry to take on strategic initiatives in addition to meeting operational requirements. and the fact that Chico’s is a “repeat offender” is disturbing and could be detrimental if not addressed going forward. the company’s declining performance in an absolute sense is a concern. However. with better turnover ratios. These variables are key competitive points in the fashion industry. we believe Chico’s liquidity position is strong. the company’s strong liquidity and price multiples will allow the company to obtain debt more cheaply than similar actions by competitors. the company is in a good position should the need for debt arise for attractive projects or for operational purposes. Chico’s ROE and ROA are very strong relative to the 56    . Likely. the explanation of growth in the working capital accounts over the five-year period. The entire industry has been and will continue to be affected by a degrading economy. With its liquidity position.activity ratios shows that Chico’s appears to be very capable at managing both receivables and inventory. As discussed earlier. Although Chico’s profitability measurements exceed those of the industry.

If Chico’s is not able to offer the “right” product mix or service to the fashion consumer or if marketing continues to be inadequate. With the strengths and weaknesses noted above. cash flows. and the consumer’s reaction is decreased demand. Chico’s will lose critical sales and its strategic/operational advantages. The economy is hitting the retail apparel industry very hard. ROE is a highly-valued statistic reviewed by investors and Wall Street and. along with its ability to generate highly-positive returns. it must pay attention to the profitability issues cited in the last two years’ annual reports. Furthermore. Although Chico’s has strategic and operational advantages relative to its industry. with a resulting decline in Chico’s stock market value and confidence levels. Chico’s has more strengths than weaknesses and. is a key driver of stock price and the company’s price multiples.industry. For each family of ratios. and stock market. going forward. profitability. Failure to do so will erode the company’s income. appears to be in a better financial position overall as compared to its industry. Economic forecasts predict that the economy will get worse before it begins its rebound. isolating any individual ratios by year that varied from 57    . Chico’s ability to generate high operating cash flows. gives investors the expectation that the company will continue to be profitable relative to competitors in the future. In the current state of the economy. activity. leverage. we explained the general trend for Chico’s over the five-year period. the company must be able to control costs and to figure out how to cut prices to try to boost demand. Conclusion The above analysis reviewed the financial ratios for the years 2003 through 2007 for Chico’s and its industry for the ratio families of liquidity. and liquidity position. as a result.

weaknesses. Post-acquisition strategic initiatives derived from the SWOT analysis will be discussed later in the strategy section. after analyzing the aforementioned ratio families. we conducted a comprehensive analysis in order to assess Chico’s strengths. Second.  58    . Finally. operational. and/or tactical implications of the firm’s position relative to the family of ratios. we discussed the strategic. The specific points within each section and their strategic impacts are discussed in more detail in the subsections that follow. we compared Chico’s ratios to that of the industry and discussed whether family or individual ratios were materially different than the industry standard. Next. we also discussed the reasons for the overall company trend.37 This analysis helped us to identify the challenges Chico’s faces going forward and to determine specific strategic recommendations. for each year of the analysis. threats. The SWOT matrix is shown in Table 1. using a materiality level of 2X over/under the industry average. 5.this trend. and opportunities. we indentified Chico’s overall strengths and weaknesses and speculated on the company’s future financial condition.                                                          37 We changed the order because we felt the information flowed better to lead up to opportunities. Chico’s SWOT Analysis Overview Based on the retail apparel industry and Chico’s-specific analyses thus far.

Table 1. SWOT Matrix STRENGTHS • Customer interaction process o Loyalty programs o Customer service training program o Customer tracking database • Strong financial position o Debt free o High liquidity o Effective inventory and receivables management o Strong stock market ratios • • • • • Brand equity Experienced leaders Strategic outsourcing (foreign suppliers) Outlet stores Efficient supply chain distribution OPPORTUNITIES • Increased focus on core strategy of personalized attention o Strengthen customer service o Realign merchandise and marketing • • • • • Halt expansion and focus on existing stores Integrate Soma into Chico’s stores Overseas offices in Asia to oversee manufacturing and quality control Build strategic relationships More actively manage exchange rate risk WEAKNESSES • • • • • • Inappropriate or mismatched product mix (last 2 years) Marketing ineffectiveness (last 2 years) Declining profitability Dependence on foreign suppliers Dependence on single distribution location Low value-added acquisitions THREATS • • • • • • Consumer reaction to current economic crisis Changing consumer tastes/fashion trends Competition Dependence on foreign suppliers and third-party manufacturers Internet Significant increases in costs 59    .

2007 Annual Report. etc. increase traffic into the store.38 The goal for the company’s employees is to customize a person’s shopping experience by establishing a relationship with the customer through understanding her fashion needs and preferences. formalized customer interaction process. pg. these programs provide perks. The database is a tool to further allow Chico’s to enhance an existing customer’s shopping experience through offering suggested items.39 The loyalty programs. discounts. the focus on personalized attention. a key motivator given the current declining trends in consumer spending. Inc. 2007 Annual Report. and the benefits from maintaining a customer database incentivize existing customers to return to the store. Chico’s and WH|BM loyalty programs include the Passport Club and Black Book. The use of a customer-tracking database helps Chico’s to better understand customer preferences and the popularity of various inventory items. Chico’s seeks to make the customer happy by making her feel unique! This approach will increase the likelihood of customers returning to the store and sharing their positive experiences through “word of mouth.1 Strengths Chico’s has a strong. 7  60    .                                                          38 39 Chico’s FAS. Inc. such as periodic discounts.• • Exchange rate risk Changes in government regulation 5. pg. respectively. Operating as in-store credit cards. free shipping. 6  Chico’s FAS. in turn. advanced sales. to encourage demand from new customers and to retain existing ones. Chico’s formalized customer service training program emphasizes personalized attention through its “Most Amazing Personal Service” standard.” which will.

with high access to liquidity. price/sales. However. further supporting Chico’s strong liquidity position and the advantages mentioned above that this allows. Through the efforts of its customer service. Chico’s is managing inventory and receivables activities more efficiently than competitors. Chico’s is very strong financially. and price/cash flow. The market is placing a higher value on Chico’s with regards to price/earnings. Having no debt is a strategic advantage to Chico’s relative to its industry in that Chico’s does not need to forego operating cash flows to service debt. relative to its competitors. Additionally. This contributes to a faster conversion of inventory and receivables to cash. The company has been able to attract and maintain a loyal customer base within its target market. positive NPV projects. for both existing employees and as an incentive to attract key personnel from outside the company. Additionally. Chico’s could obtain debt at a lower cost. As discussed previously.Based on the ratio analysis discussed earlier. the company’s stock can be an attractive tool for compensation. Also detailed in the financial ratio analysis earlier in the paper. Chico’s strong financial position in the aforementioned areas contributes to higher stock market ratios relative to competitors. price/EBITDA. Chico’s has been able to 61    . if needed. Chico’s has been able to fully fund growth and operations with operating cash flow. price/book value. In turn. these reputation effects allow Chico’s stock to be more easily used for potential acquisitions. brand equity has become one of Chico’s main strengths. Chico’s strong liquidity position allows the company to remain debt-free and to access cash for attractive. the company is in a better operational position than competitors to get through the current economic crisis. This position improves the company’s visibility and reputation on Wall Street and to potential investors.

The resulting reputation effects increase the chances of new customers visiting the store and existing customers continuing to return – both of which are very favorable actions. CEO Scott Edmonds started with the company as an operations manager in 1993. Before coming to Chico’s. and Macy’s. pg. Chico’s leadership base is solid. have held various positions within the retail apparel industry.41 With combined years at the company and through retail industry experience. Inc. pg. Inc – a plumbing and electrical wholesale company.” They are well positioned to see the company through the current economic crisis. Appointing high-level executives to brand management shows the company’s emphasis on investing in its reputation and building brand equity. especially as customers become more price sensitive in the current economic crisis. this structure allows brand value and equity to be managed more holistically rather than being a by-product of operations management. Inc. he was President of Ferguson Enterprises. The top leaders have years of experience with the company. 2007 Annual Report. Chico’s leaders are familiar with the industry and its historical “ebbs and flows.                                                          40 41 Chico’s FAS.consistently post higher profits than its competitors. In addition. The Gap. 30-31  Chico’s FAS. or have leadership experience at other companies. brand equity gives Chico’s more visibility in the marketplace. such as AnnTaylor Stores.40 For example. and its stock market ratios have shown the market’s tendency to place a higher value on Chico’s relative to the industry. The company has a brand president for both Chico’s and WH|BM with prior experience holding high-level positions at the aforementioned retail apparel companies. 2007 Annual Report. Strategically. 30-31  62    .

2007 Annual Report. Chico’s has one distribution center in Winder. approximately 5% of net sales are generated from the outlet stores. Georgia. Strategically. Florida.Strategic outsourcing is a strength of the company. Finally. 2007 Annual Report. pg. contributing to faster inventory turnover relative to the industry.42 The use of outlets reduces the potentially negative perception for certain upscale customers of markdowns in the main stores. Chico’s supply chain distribution is efficient with quick turnaround43 times. The use of outlet stores is a strategic strength. Currently. other states across the Western. and Turkey for its clothing in order to take advantage of lower manufacturing cost structures in these localities relative to the United States. and Northeastern states). especially given the current state of the economy.44 This is impressive given that only one distribution center meets the needs of stores across the United States (California.12-13  45 Chico’s FAS. pg. Guatemala.  44 Chico’s FAS. 2007 Annual Report. 11  Turnaround means the time from products leaving the distribution center to arriving at Chico’s and WH|BM stores. pg. including the U. Inc.S. Virgin Islands and Puerto Rico. Inc.45                                                          42 43 Chico’s FAS. India. Peru. Outlet stores allow for the disposal of slower-moving merchandise from main stores and provide the opportunity to generate revenues from this merchandise. this number may increase as consumers are more thrifty and looking for deals in the current economy. Chico’s uses foreign suppliers and third-party manufacturers in China. 9  63    . Midwestern. Texas. this allows Chico’s to maintain high gross margins and effectively manage its pricing strategy. and turnaround averages approximately 24 to 48 hours for nearby stores and two days to one week for stores further away. Inc.

and deterioration of the financial strategic advantages (mentioned in the financial ratios analysis) over the competitor basket. The results could be detrimental to Chico’s – reduced flexibility. Although Chico’s profitability has been better than that of the industry as a whole. Chico’s has experienced declining profitability over the past five years. Any disruption to the single location will be highly 64    . The latter two are more directly controllable by the company and have detrimental strategic impacts if not corrected. potential degradation of brand value. Chico’s dependence on foreign suppliers and third-party manufacturers was mentioned as a strength from a cost-savings perspective. Chico’s single distribution center concept is a weakness for the company. However.2 Weaknesses Chico’s has areas in which improvement is possible. improve marketing. Political or economic instability could lead to major disruptions in the supply chain. and ineffective marketing. and market share. this dependence is also a weakness and a threat for the company. Due to geographic distance from Europe and Asia. The declines in the last two years have been due to a slowing economy. Ineffective product mixes and marketing strategies have yielded negative same-store sales growth.5. Recommendations on how to correct inappropriate product mix. pricing power. Although currently efficient. the company has difficulty exercising control over the quality of the inputs to the products. reduced cash flow. and reverse declining profitability are discussed in the opportunities section below and further detailed in the strategy section. One such area is profitability. a product mix mismatched with customer demand and fashion trends.

Chico’s purchased the Fitigues brand in January 2006. and diminished brand equity. 2  65    . Chico’s recently engaged in a low-value added acquisition.3 Threats Chico’s is faced with many threats and challenges as it attempts to move forward in the current economic crisis.                                                          46 Chico’s FAS. Inc.”46 Significant company time and resources were invested in acquiring Fitigues and integrating it into existing operations. 2007 Annual Report. Thorough due diligence and analysis is more critical now than ever – failure to do so will mean deterioration in Chico’s strategic advantages discussed in the financial ratios analysis. but it can be fatal during a declining economy. pg. This situation further stresses the importance of Chico’s being able to differentiate itself in order to attract new customers and. As discussed in the external analysis. and the Internet. The brand operated through 12 free-standing retail stores. especially in a time when the economy was in decline. By March 2007. misallocation of resources is harmful. In a normal economy. Such a disruption could yield lost sales. Consumer reaction to the current crisis is a threat to the entire retail apparel industry. especially within the upscale fashion market. The Fitigues failure was due to an incorrectly-defined target market and to poor due diligence. economists are not predicting a rebound in the current economic crisis until mid to late 2009. retain existing customers. catalog. negativelyimpacted customer relationships due to stock-outs. Chico’s decided to no longer support this brand because it did not meet “internal expectations. 5. The consumer’s disposable income has decreased and has translated into decreased demand and sales. more importantly.detrimental to the supply chain.

Foreign suppliers. Our strategy recommendations. it is critical that Chico’s be able to differentiate itself along one or more of the competitive points.S. the retail apparel industry operates in a highly-competitive environment. Related to this dependence is exchange rate risk. As discussed earlier in the Five Forces analysis. Dollar appreciates against their respective currencies. Chico’s dependence on foreign suppliers and third-party manufacturers also qualifies as a threat.S. high levels of inventory. which is the case in most of the company’s business. costs could increase unexpectedly and significantly through lost sales. This may result in supply chain disruptions or quality assurance issues for Chico’s with an additional impact of customer dissatisfaction. 66    . and other third-party vendors may resort to cheaper materials and other attempts to reduce their own costs because of exchange rate impacts on them if the U. As mentioned earlier.As a high likelihood in the retail apparel industry. For the company to maintain its strategic advantages and to improve its profitability. discussed later. Dollars. Exchange rate risk can affect Chico’s even if transactions are conducted in U. If a company is not wellpositioned to understand or forecast fashion demand. an inappropriately-designed product mix has been a recent concern for Chico’s and must be addressed going forward to mitigate the aforementioned detrimental impacts. and degradation of brand equity. There are relatively low barriers to entry and the products are easily replicable. unsatisfied customers. As explained in the weaknesses section. will explore this point in greater detail. changing consumer tastes and fashion trends can have significant impacts on a company. manufacturers. such as customer service.

will be led by a new presidential administration starting in January 2009.The Internet is another threat to Chico’s. 5. Although more details will be provided in the strategy recommendation section. the U. the following will briefly explain the opportunities in these areas and the overall strategic implications. increased logistics and fuel costs could have a material. This threat may challenge Chico’s strategy of personalized attention and opportunities to cross-sell items within the store. Finally.S. Changes in government regulations regarding import/exports and trade relations could potentially impact Chico’s costs associated with those activities. Significant increases in input costs or logistics costs. and improving marketing effectiveness. weaknesses in these areas led to a decline in Chico’s profitability since 2005. Today’s economy serves as a catalyst for companies to become even more costconscious than they have been before. weaknesses. As stated earlier in the financial ratio analysis. strengthening customer service. for example. Given Chico’s dependence on one distribution center. This increased focus can be accomplished through aligning the product mix with customer demand. First. negative effect on profitability. could interfere with Chico’s ability to effectively maintain appropriate pricing levels.4 Opportunities Several opportunities arise from the various analyses on Chico’s and the summary of the company’s strengths. 67    . Chico’s has the opportunity to increase focus on its personalized attention strategy. The Internet provides ease in comparing costs across companies and generally competitive products. and threats.

The strategic advantage of this is the ability to provide a more “holistic” product offering to its customers without incurring the full spectrum of operating costs (design. This will help to ensure excellent customer service. From a marketing perspective. Chico’s could call customers who stopped or decreased shopping at Chico’s since 2005. print. Feedback from sales associates who work directly with the consumer could provide additional insight on customer product and service needs. To additionally address customer needs. For example. given that the winter product line is designed in the spring and produced in the summer.). and broadcast advertising. color. fabric. which is part of Chico’s differentiation strategy. Chico’s should better utilize email. Focus groups of current and past customers could be formed to obtain feedback on product offering and customer service. Specific details are explained in the strategy section. Excellent customer service should be emphasized as a continuous process and tied to management compensation. manufacturing. and jewelry to its existing product mix.To align the product mix and understand customer service issues. As Chico’s implements a deep internal review and if unprofitable stores are closed. 68    . Chico’s needs to study the reasons for the mismatch between product mix and customer demand. Using loyalty club member lists and expansion in the aforementioned mediums. mail. Chico’s can broaden exposure to existing and potential customers. handbags. Chico’s should contact customers from those stores and help them find a nearby location. Chico’s can develop relationships with other companies to add or enhance complementary products such as shoes. were designs based on faulty data? Were fit/size. etc. and/or availability a problem? To help answer these and other questions.

and improving marketing effectiveness will result in several benefits to Chico’s. Chico’s can improve profitability by halting any expansion and conducting a deep internal review on many levels to essentially “clean house.Strategically. Inc. Per Chico’s 2007 Annual Report. pg. Our team believes that it would be an inefficient use of resources for Soma to attempt to directly compete with market-leader Victoria’s Secret as a stand-alone brand given Victoria’s Secret’s dominant mindshare and branding position within the industry.” This point will specifically be explained in further detail in our strategy recommendations later in the report. Additionally. Chico’s has the opportunity to integrate the Soma brand into the Chico’s stores. This will require eliminating certain Soma products to be more in line with Chico’s current target market of women ages 35 and over. The benefit of bringing the Soma brand back into the Chico’s stores will be opportunities to cross-sell and better address the clothing needs and personalized attention of Chico’s target demographic. strengthening customer service.47 Currently. aligning the product mix with customer demand. Another opportunity for Chico’s is to test out and eventually establish an overseas office in Asia to help in monitoring manufacturing and quality control. Chico’s products and customer service will gain more visibility in the More satisfied marketplace. 2  69    . This does not                                                          47 Chico’s FAS. which will build up brand equity and create demand. 2007 Annual Report. As will be detailed further in the strategy section. the Soma brand was initially positioned towards Chico’s target consumer but was repositioned in 2007 to target a broader customer base. These increased sales will improve Chico’s profitability. customers will increase loyalty and the probability of repeat same-store sales. the Soma brand is sold in stand-alone stores. Soma was launched in 2004.

perfectly hedged. consistency of fabric. and/or third-party channels to sell slow-moving merchandise. Finally. In addition. etc. This would help mitigate risks from potential issues such as quality. Also further detailed in the strategy recommendation section is an opportunity Chico’s has to more actively manage exchange rate risk. fit. These relationships would serve as a hedge against rising costs and quality concerns in China and potential American protectionism policies with a new upcoming presidential administration. offices could be extended to Europe and/or other geographic regions depending on Chico’s expansion efforts in the long-term. the company should take advantage of closeout merchandise stores like Tuesday Morning. More details on building strategic relationships are discussed later in the strategy recommendation section. the company should investigate implementing a more active currency risk management strategy. since we are recommending that Chico’s halt store expansion including outlets. The advantages of using third-party channels are that they reduce the potentially negative perception for certain upscale customers of markdowns in the main stores and reduce inventory storage costs. Dollars and is. with foreign suppliers and third-party manufacturers.S. As mentioned earlier. However. this office could work to establish relationships with various suppliers to create a network which currently does not exist. color. Chico’s should consider expanding relationships with suppliers in Mexico. Based on the success of this concept in Asia. Chico’s should evaluate the opportunity to build strategic relationships. For example. the company pays all overseas manufacturing expenses in U. The strategic advantage of this is a better position in 70    .mean a significant capital investment but rather a lease of office space and the hiring of one or two employees. Nordstrom Rack. therefore.

optimal. With numerous strengths.1 Discounted Cash Flow Analysis To value Chico’s using the discounted cash flow valuation (DCF) method. its financial position. 6. Valuation Overview Having evaluated Chico’s strategic position and having confirmed it is a strong competitor in the retail apparel market. we determined the free cash flow (FCF) growth rate and the weighted average cost of capital (WACC). 6. maximum acquisition premiums. and IRR. threats. Conclusion As demonstrated in the SWOT analysis above and weighing the probabilities of each point. we feel the strengths and opportunities outweigh the weaknesses and threats. The following analysis describes three valuation methods and provides a calculation of minimum. The investment must generate an internal rate of return (IRR) greater than Chico’s cost of capital. With an understanding of Chico’s industry. Chico’s is in an advantageous position to capitalize successfully on its opportunities and to address weaknesses and threats. weaknesses. Using Chico’s annual reports. the next section will show that Chico’s is a strong candidate for purchase. we must verify that the purchase of Chico’s will provide an acceptable return on investment over the next five years. we obtained operating cash flows and capital 71    . and its strengths.handling exchange rate risk from potential overseas expansion and indirect cost savings by not paying suppliers to manage the risk. and opportunities.

In addition. When we increased the FCF growth rate to 5%. total shareholder’s equity. we calculated a book value per share (BV/S) of $5.the risk-free rate. the BV/S decreased to $5.32%. the cost of equity was calculated at 17.78% by taking the average of 10-year Treasury note yields in October 2008.S. By decreasing the FCF growth rate to 0%. If the risk-free rate was decreased to 3%. These changes are the result of the WACC formula. and the total shares outstanding. the WACC is equal to Chico’s cost of equity.expenditures for the period 2002 through Using the Capital Asset Pricing Model (CAPM). both the risk premium and the WACC decrease. Treasury Department. when the WACC decreases. See Appendix B for a detailed DCF analysis. Then. we obtained a beta of 1. Therefore. When the risk-free rate increases. When the risk-free rate was increased by 1. the market return rate. from Google Finance. From Bloomberg.shtml  72    . the FCF growth rate.41. we conducted a sensitivity analysis on the four drivers of the DCF valuation . and the beta. the BV/S increased to $5. the WACC decreased to 16. the present value of the discounted future cash flows increases. We calculated a riskfree rate of 3. We determined an average FCF growth rate of 2. The same trends were seen when we increased the market return rate to 15% and decreased it to 7%.39. Historically.39 (see Appendix C). but the BV/S did not change from $5. Chico’s has had zero debt in its capital structure.38. and. we obtained a market return of 11.42.81%. Daily Treasury Yield Curve Rates.30%.98%. We then projected Chico’s FCF for the next five years and the terminal value. Using the sum of the discounted cash flows.22% to 5%. the WACC increased to 17.51% and the BV/S increased to $5.65. Increasing the rate                                                          48 U.ustreas. http://www. while all other parameters remained the same.

caused the WACC to increase to 22. Sensitivity analysis was done by varying selected parameters to estimate the impact of errors in the original parameter estimates. The Free Press. when we decreased beta from 1.34.. As stated above.29% and produced a BV/S of $5. Last.00.36. Macmillan. while a WACC value of 7.00% produced a BV/S of $5. the lower the sum of the DCF and BV/S.2 Value Creation Model Value creation models attempt to quantify the contribution of management to returns.65 to 1.17%. cash flows were generated and discounted. See Appendix D for a detailed sensitivity analysis. while the reverse was seen when we increased beta to 2.                                                          49 Rappaport.  73    . and the BV/S was $5. and incremental fixed and working capital investment were estimated from sources. Based on these parameters. as well as estimating the value of changes in management performance. In this case. and the BV/S value dropped to $5. The model used in our analysis was derived from Rappaport’s Creating Shareholder Value. risk-free rate. expected return. sales growth.98%. Creating Shareholder Value. the WACC decreased to 11. Since the beta. Therefore. BV/S is more sensitive to the WACC than to the FCF growth rate because the higher the WACC. or the market return either cause an increase or decrease in the WACC.00.51. Alfred. BV/S was lower. operating margin. the WACC increased to 20. the BV/S is sensitive to a high beta or market return and a low risk-free rate. 6. when all other parameters remain the same. such as the company’s 10-K SEC filing.49 Various parameters.68. including inflation. by discounting the FCF at a higher WACC value. New York. and the contribution of management was estimated. Inc. real return rate.

Value Created Value Created 74    .000  $60. Figure 1. thereby creating value along these lines. Operating Margin v. Value was increased at approximately the following rate ( increase over 1%): is percentage point The sales growth rate represents the single parameter which results in the strongest potential for value creation. Figure 2.000  $40. Value Created  (millions) $70. which result in increased sales.000  $50. In addition. Management can invest in marketing and other initiatives. Sales Growth v. Using the above mathematical model. Value Created Sales Growth v. management can compare the cost of creating sales growth to the value created and make decisions regarding the appropriateness of the investment.Our initial parameters (see Appendix E) resulted in an estimated value created of $22M.000  $20.000  $30. Varying parameters resulted in the following dominant drivers (sales growth and operating margins) of value created (see Figures 1 and 2).000  $‐ 1% 2% 3% Sales Growth 4% 5% Sales growth rate was found to be the dominant driver of increased value for Chico’s. it is a variable over which management has significant influence.000  $10.

Because the direct consumer retailers. management can estimate the gains from an initiative to improve operating margin and thereby determine whether the return on the initiative is sufficient to make it worth pursuing. and direct consumer retailers.000  $‐ 5% 10% 15% 20% 25% 30% Value Created Operating Margin Operating margin was the next largest factor in driving Chico’s performance. Value Created  (millions) $140. specialty stores. 6. Good management decisions can result in lowered costs or better capital investments. yielding increased operating margins. Google Finance.000  $100. operating margin represents a variable that makes a considerable contribution to the company’s results and can be influenced by management actions. we gathered data from the company’s 2007 annual report.000  $80. the Hoover’s Pro database.Operating Margin v.000  $60. Value was increased at approximately the following rate ( over 1%): is percentage point increase Like sales growth. 75    .000  $120. Chico’s competes with three types of companies – department stores.000  $40. See Appendix F for a detailed sensitivity analysis.000  $20.3 Comparables Valuation To construct a basket of Chico’s competitors. and Bloomberg. Using the above mathematical model.

and Internet databases (e. target companies were acquired at a lower price than their market value.g. However. Using Bloomberg. price/EBITDA and calculated average values for the comparables basket. we focused on the first two types. we used common current market multiples. such as price/earnings. which is lower than the current market price.. Coldwater Creek. Our selection of direct competitors in the United States was based on target demographic markets. we completed a historical M&A premium analysis for the apparel industry. The multiples valuation method yields an intrinsic value of $2. A general price/product search on the competitors’ websites yielded an average price point of around $100 to $120. were private companies. See Appendix H for a detailed multiples valuation. price/cash flow. product price points.44. On average. 6. To find Chico’s intrinsic value. and low debt-to-equity structures (Chico’s has no debt). Chico’s 2007 10K. 76    .4 Mergers and Acquisitions (M&A) Premium To decide the appropriate premium to use in Chico’s acquisition upscale women’s retailers. this trend changed in the last two years. The companies are all mid. Dillard’s. we identified five direct competitors – Christopher & Banks. current market capitalization. Google Finance and Wall Street Journal).12% in 2008. Talbots. SIC codes (5621: Retail Women’s Clothing Stores).suggested by the data sources. and Ann Taylor Stores (see Appendix G). The average premium was negative in 2005 and increased to 11. price/sales. we calculated an average premium for the entire period from 2005 to 2008 and for each of these years. which is in line with the prices Chico’s charges on its apparel products. price/book value. Based on deals with available premium data. which primarily target professional and fashion conscious women over the age of 35.

The maximum premium was 54.39% in 2007, and the lowest one was negative 94.81% in 2005 (see Appendix I). This data provided us with a broad picture of global M&A markets. However, because we primarily intend a 100% cash transaction, we looked for more specific M&A deals in retail apparel in the last five years. We found there were many deals without premium details. The average premium for the period was 19.10%, while the highest and the lowest ones were 62.08% and negative 8.83%, respectively. Average acquisition premiums declined sharply from 31.38% in 2005 to 10.79% in 2007 (see Appendix J). We faced limitations on the cash-only set of data. It lacked details on deal premiums in addition to the fact that the average values may not have been representative of the whole population. We do not have premium details for 2008. Therefore, for the purposes of our analysis, we used the broad set of data to determine Chico’s acquisition premium.

6.5 Acquisition Price
As discussed previously, M&A premiums varied in the last five years. Therefore, we took a conservative approach and decided that the 11.12% average M&A premium in 2008 be used as the optimal premium we would pay to acquire 100% of Chico’s outstanding shares. Because of the huge decline in the current stock market, many stocks are very cheap. If we apply a negative premium to the transaction, we may face

resistance from shareholders, causing a delay or a halt in the acquisition process. Thus, we determined a minimum premium of zero percent (buy Chico’s at its current market value). Based on the M&A premiums data in 2008, we also determined a maximum acquisition premium of 41.55% (see Table 2).


Table 2: Chico’s Acquisition Premium – Sensitivity Analysis
Premium Suggested purchase price Current stock price Minimum 0% $2.93 $2.93 Optimal 11.12% $3.26 As of Oct 24th 2008. Maximum 41.55% $4.15

6.6 Adjusted DCF Analysis and IRR
We believe that Chico’s rapid expansion and its associated expenses resulted in FCF that did not fairly represent the value of the company. In recent years (2006 and 2007), Chico’s spent as much as $150M per year on expansion projects. If desired, Chico’s could slow down expansion and redirect these funds and start paying dividends. We also believe that valuing Chico’s on the basis of an adjusted FCF statement excluding expansion costs is both sufficiently conservative and appropriate. We created a pro forma FCF model for Chico’s. It is based on adjusted cash flows, an average same-store sales growth rate of 8.47% that the company experienced prior to the recent market downturn, and capital investments pegged to the average historical proportion of operating income (20%). We chose to use the historical same-store sales growth rate, excluding the last two years, because we believe that the recent same-store sales growth rate for the past two years is an issue created by correctable mismanagement. Additionally, we chose to peg capital investments to the historical proportion of operating income because we believe that it is representative of ongoing capital investment requirements to maintain the company at the current size. See Appendix K for a detailed pro forma DCF analysis. Under the base assumptions in the pro forma model, we found that the IRR is higher than the WACC at the minimum premium (61.86%), optimal premium (57.27%), and maximum premium cases (47.81%). At the optimal premium, we set a target value


of $18.85 per share. Appendix L for results.

See Appendix K for IRR calculations and highlighted cells in

We did two sensitivity analyses under each of the determined acquisition premiums: 1) we changed the sales growth rate and maintained a 20% growth in capital expenditures; 2) we maintained a sales growth rate of 8.47% and changed the capital expenditures growth rate because it is the dominant factor in operating margin other than sales growth. In addition, operating margin is the dominant factor in value creation. By changing the sales growth rate at the minimum premium case to 0%, the IRR decreased to 49.22%, but, when we increased the sales growth rate to 10%, the IRR increased to 64.14%. The same trend was seen in both the optimal and maximum premium cases. In the optimal premium case, when the sales growth rate was 0%, the IRR was 44.99%, and, when the sales growth rate was 10%, the IRR increased to 59.49%. With the maximum premium case, the IRR was 36.27% and 49.89% for 0% and 10% sales growth rates, respectively. However, the opposite trend was seen when the sales growth rate was held at 8.47% and the capital expenditures growth was changed to 10% and 30%. With the minimum premium of 0%, the IRR was 67.30% and 56.13% for respective 10% and 30% capital expenditure sales growth rate changes. For the optimal premium, the IRR was 62.37% and 51.88% for respective 10% and 30% capital expenditure growth rate changes. Finally, for the maximum premium, the IRR was 52.28% and 43.06% for respective 10% and 30% capital expenditure growth rate changes. Therefore, IRR is more sensitive to the sales growth rate and less sensitive to the percentage change in capital expenditures. An analysis of the model’s IRR sensitivity to sales growth rates and capital expenditure requirements may be found in Appendix L.


We recommend purchasing 100% of Chico’s outstanding shares at a price of $3. and maximum acquisition premiums and prices. Chico’s can be expected to produce an IRR as high as 57. assumptions and results. slowing down growth will give Chico’s the opportunity to realize returns on investments in new stores and approach market saturation points slowly. and calculated the IRR on the investment.2M. In addition to a strong balance sheet. 80    . optimal. Chico’s creates value and can significantly increase FCF by slowing down its current expansion strategy. we provided a brief overview of Chico’s. thereby reducing the risk of over-expansion.27% (optimal premium case). the company generates high gross and operating margins and positive FCF. Chico’s has a zero-debt capital structure and a strong liquidity position as discussed in the financial ratio analysis section.30%. calculated minimum.Conclusion In our analysis. and we believe the company will successfully withstand the economic recession. This IRR greatly exceeds Chico’s cost of capital of 17.26/share for a total acquisition value of $575. described three valuation methods. without considering the effects of any sales growth due to additional stores. In addition. Depending on the magnitude of the slowdown. From the valuation analyses.

The following section describes in detail the implementation of the friendly acquisition of Chico’s. Chico’s has historically had very positive financial and operational results and performed above many of its direct competitors in the upscale apparel industry.7. Under the umbrella of conglomerate Berkshire Hathaway. we believe that the acquisition of Chico’s is a good opportunity for AWWI to create value and to achieve an IRR well above Chico’s current cost of capital. In the current economic recession. 7. We have formed an M&A team of young professionals with diverse backgrounds and expertise that increase the likelihood of a successful outcome.1 AWWI’s Merger and Acquisition (M&A) Team An essential element in any acquisition project is the people involved in the negotiation. the company is able to generate substantial cash from operations and to fund its growth strategy without financial leverage. Through the acquisition. including SEC regulations and filings. we will not make any major changes to the current business operations and will keep the executives on board. These 81    . Chico’s FAS Acquisition Strategy Overview Based on the internal and external analysis in the previous sections of this document. We believe we can provide Chico’s with a sound strategic turn-around plan. discussed later. can be found in Appendix M. that will increase the market capitalization levels seen in 2006 and generate an optimal 57% IRR for AWWI. and the proposed post-acquisition strategy. Chico’s can continue to operate with a zero-debt capital structure and absorb major economic shocks due to its strong financial position as discussed in the financial ratios analysis section. Details of a company’s acquisition process.

which can be both a positive and negative issue in regards to convincing shareholders to tender their shares and the speed at which the transaction can occur. AWWI will either use 100% cash in the proposed transaction. and IT. Currently. we will maintain the current management and will mutually revise the existing strategy to take advantage of Chico’s competitive advantage in the retail apparel market. the company’s vast majority of shares are institutional ownership (95%). 7. The people in the team have worked together on many corporate projects and have proven they can be extremely critical and disciplined to avoid overexcitement in Chico’s due diligence and pricing. This will prevent the dilution of existing holdings of shareholders by not issuing new stock to use as a currency in the transaction.diverse backgrounds include finance. based on the long-standing tradition of Berkshire Hathaway acquisitions. and management synergies from the proposed acquisition. We will also send a strong message to the investor community that AWWI is confident in achieving financial. the proposed transaction is a friendly acquisition in which AWWI will acquire 100% of Chico’s outstanding shares. or implement a stock buyback and swap between Berkshire Hathaway’s Class B shares and Chico’s common shares.50 Third. and this discussion is not part of the current project.2 Acquisition Objectives Our M&A team has developed Chico’s acquisition strategy based on several fundamental principles. First. The main                                                          50 Note: the expected synergies with existing companies in the portfolio are subject to thorough due diligence. operational. Second. accounting.  82    . marketing.

having a staggered board can have both positive and negative implications.S. 2008 Proxy Statement  83    . Inc. Although.reason for this strategy is to avoid any operational disruptions and to use the expertise and knowledge of Chico’s executive directors and regional managers. Chico’s has two anti-takeover mechanisms in place. Based on Chico’s latest proxy statement. in our case. staggered boards have the effect of making hostile takeover attempts more difficult. respectively. More importantly. the acquiring company must pay an extra $15M in total executive severance packages. Chico’s Board consists of eight directors elected for three-year terms. The Class I directors (two) serve until 2009. Chico’s executive directors have golden parachutes in their labor contracts if they lose their jobs in the event of a change in corporate control. a staggered board that cannot be dismantled or evaded is one of the most potent takeover defenses available to U. as of April 30.3 Chico’s Takeover Prevention Mechanisms To prevent a hostile takeover attempt. Chico’s has a staggered three-year Board of Directors. and Class III directors (three) serve until 2011. in combination with a poison pill. Class II directors (three) serve until 2010. 2008. This preventive anti-takeover practice aims to protect the interests of the target company’s shareholders and will lead to significant                                                          51 Chico’s FAS. When a board is staggered. hostile bidders must win more than one proxy fight at successive shareholder meetings in order to exercise control of the target firm. First. Second. ousting the Board would be very difficult. from a corporate governance perspective. 7.51 In publicly-held companies. in the event of a change in control with executive employment termination. companies.

It is expected that we will face strong resistance from institutional investors.51M outstanding common shares. We feel confident that the acquisition will be successful. It is likely that investors see Chico’s stock trading at a discount and feel its market price does not fairly capture the intrinsic value of the company. and we must convince them that the acquisition will be successful. Please refer to Appendix N for detailed information about Chico’s major shareholders. Rather than approaching institutional investors individually. 2008.4 Approach to Chico’s Shareholders The cornerstone of the proposed acquisition of Chico’s is the negotiation with current shareholders. We believe we have a strong postacquisition strategy that. otherwise.increases in the initial offer. supported by the industry experience of current executives. of which 95% were held by institutional investors. Chico’s had 176.and post-transaction risk of failure. we expect that there would not be 95% institutional ownership of the company. Our M&A team’s friendly acquisition approach avoids the anti-takeover provisions of the company structure in order to capture all expected value of the transaction and achieve our high IRR. we will meet and negotiate with Chico’s Board of Directors. 7. Paying for the outstanding stock with 100% cash means that AWWI assumes the whole pre. and potential synergies with existing portfolio companies and operational efficiency will be achieved. who have decided to retain their Chico’s stock despite the fact that Chico’s stock has slumped by 96% in the last two years. As of August 30. They represent the interests of shareholders. These are very sophisticated investors. will help Chico’s increase same-store sales growth and emerge from the economic recession as a key player in the upscale apparel industry. 84    .

93 to $1. and mismatched product mix in the last two years. It is expected that the proposed premium is reasonably high to induce shareholders to sell. To increase the probability of a successful negotiation. However.5 Plan A . 2008. It is also high enough to compensate Chico’s shareholders for the capital gain taxes they have to pay if they decide to tender their shares. we have prepared two acquisition plans. since the initial company valuation. In order to convince the Board of Directors and Chico’s shareholders. The offered premium is still conservative and does not incorporate the full potential of Chico’s intrinsic value. Chico’s stock price declined from $2.89 on November 20. representing a control premium of 11.52 Applying the same initially-offered purchase price gives shareholders an acquisition premium of 55% over the current market price. ineffective marketing. However. At the time of the initial valuation. In the current situation. Chico’s shareholders cannot expect to enhance the market value of their holdings and achieve return on investment above the level Chico’s currently provides. our team recommends offering a premium above the current stock market price.12% over the market price.The company’s strong balance sheet and the effective asset and supply chain management are not appropriately leveraged to address the declining profitability.26. the offered purchase price was $3. 7.12% optimal control acquisition premium is based on the analysis of the historical M&A transactions in the retail apparel industry. we are prepared to increase the bid up to a                                                          52 Google Finance  85    .100% Cash Transaction Our first bid in the negotiation is 100% cash for all outstanding shares of Chico’s. The 11.

Effectively. Please.B) shares with 100% of Chico’s shares. The potential risk of this bid comes from the fact that stock swap transactions usually generate negative market reaction.6 Plan B . we will use 100% cash to buy back shares. we will not dilute existing Berkshire Hathaway shareholders’ equity. and there are multiple benefits to this transaction structure. 7.55% control premium above the market price in the initial valuation. refer to Appendix O for details on BRK.41.B shares. Chico’s shareholders will be able to defer paying capital gain taxes until the time they decide to sell their newly-owned BRK. We will repurchase a number of BRK. First.B shares for use in the transaction instead of issuing new  86    . by repurchasing BRK. we present the option of a stock swap in Plan B. in                                                          53 Portfolio. http://www.B stock. The market’s perception is that acquiring companies will only choose this type of transaction when the stock is Berkshire Hathaway’s Class A and B stock have outperformed the S&P 500 index and have delivered an annualized return of 25% since 1976. Historically. Berkshire Hathaway.A and BRK.B shares with a value equal to the acquisition transaction value and use these shares in the exchange deal.B stock.53 Last. Incorporated Class A (BRKA). which slumped 96% during the same period. which in the last two years dropped only 26% in comparison with Chico’s stock.100% Stock Buyback and Swap The stock buyback and swap bid entails exchanging Berkshire Hathaway Class B (BRK. we offer Chico’s shareholders the opportunity to acquire the more stable BRK. Second. Berkshire Hathaway is a greatly-diversified company that is less vulnerable to economic shocks. As an additional negotiating point.

(2) To shareholders who own less than 2. which are intended to align their wealth more closely with shareholders’ interests. are likely to oppose AWWI’s bid. collectively. Therefore. even though this bid would increase shareholder wealth.B shares.12% as already discussed in Plan A. we will offer to purchase the stock with cash for a control premium of 11. the proposed transaction will have two elements – (1) We will exchange 219. they are a significant stakeholder in the proposed transaction and an integral part of implementing the post-acquisition strategy. 87    . we will approach them in a friendly manner offering them several key opportunities. As already mentioned. We are not diluting current equity stakes by issuing new shares to be used in lieu of cash.which case. we expect that the market reaction will be favorable because this transaction is structurally different from other stock swaps.B stock to acquire the majority of Chico’s outstanding stock (exchange ratio of 0. Because of the large difference in the market price of both Chico’s and BRK. We face a situation where Chico’s executives. they use the cheapest source of capital to finance the acquisition. The fact that Chico’s has 95% institutional ownership makes it easier to conduct the swap transaction. once faced with an acquisition attempt that might lead to a loss of their jobs. We are instead repurchasing existing shares to be used as a tax-advantaged means of transferring value.001244). However. executive directors have golden parachutes.000 shares of Chico’s stock. 7.627 BRK.7 Approach to Chico’s Executive Managers Despite the fact that executive directors own a small percentage of Chico’s outstanding shares.

already discussed in the first part of this document.12% control premium. we will take a conservative approach and recommend purchasing 100% of Chico’s outstanding shares for $3. Current executives have underperformed in the past two years. and allowing a product mix that has resulted in negative same-store sales for two consecutive years. In particular.First. the executives will be able to reap great benefits under the new company ownership.8 Offer Price and Expected Return on Investment Based on our initial valuation. According to our reasonably- conservative financial projections. we will offer Chico’s executive managers the opportunity to stay with the company and take part in implementing the proposed post-acquisition strategy. our bid to executives includes access to abundant capital resources under the umbrella of Berkshire Hathaway.” Last. Fitigues). we should also give them credit because Chico’s has historically outperformed its direct competitors.26 per share. we will perform a thorough due diligence along with the compensation committee and tie executive compensations more closely to Chico’s performance. Second. However. Chico’s managers will not have to worry about how to finance new projects because they will have easy access to capital. 7. Because of recent declines in the stock market. they will also have the chance to communicate closely with executives from other companies in the conglomerate and gain “know-how. we will increase the proportion of their above-base compensation and reevaluate the stock option and restricted stock plans. following an overly aggressive expansion plan. making inappropriate acquisition decisions (e.g. 88    . which represents an 11. We would like to take advantage of the directors’ experience and expertise and work together to increase the value for shareholders. In the future.

first.15.12% control premium for all Chico’s outstanding shares based on the market price as of October 24.15 Based on our initial valuation model of Chico’s. Chico’s has a three-year staggered Board of Directors and.93 $2. If we apply a negative premium to the transaction.26 As of Oct 24th 2008. assuming we offer Chico’s shareholders a maximum premium of 41. causing a delay or halt in the acquisition process. AWWI will achieve an IRR considerably higher than Chico’s cost of capital. we offer an 11. the IRR is 57% over the next five years. will provide returns above Chico’s cost of capital.55% over Chico’s current market price (see Table 3).93 Optimal 11.55% $4. 2008.many stocks are trading at a discount relative to their recent prices. Thus.12% control premium.55% over the current share price. second. we will face strong resistance from shareholders. In particular. we determined a minimum premium of zero percent (buy Chico’s at its current market value). which based on the initial valuation analysis. This premium can be achieved through (1) purchasing Chico’s 89    . which represents a control premium of 41. Table 3. Conclusion Our main goal is to pursue a friendly acquisition of Chico’s. executives have golden parachutes in their employment contracts. To better position ourselves in the negotiation process. A sensitivity analysis of the IRR and Chico’s purchase price yields a minimum rate of return of 48%. Based on the M&A premiums data in 2008. Chico’s Acquisition Premium – Sensitivity Analysis Premium Suggested purchase price Current stock price Minimum 0% $2. Maximum 41. our team has prepared two major deal propositions. we also determined our walk-away price of $4. A hostile takeover would be very expensive and extremely hard to accomplish because.12% $3. In our optimal offer of 11.

55% over Chico’s stock price as of October 24. but also to avoid overpaying for Chico’s.outstanding shares with 100% cash. Please refer to the alternative acquisition candidate section for a detailed analysis of AnnTaylor. or (2) repurchasing BRK. Should the negotiation with Chico’s Board fail. Both approaches have advantages and disadvantages. Even if we pay this high price for Chico’s. To achieve this goal. we will offer Chico’s executive directors the opportunity to stay with the company and help execute our proposed post-acquisition strategy (see post-acquisition strategy section below). would be a strong motivation for these executives to agree to the proposed merger. our M&A team will be ready to approach the Board of Directors of our back-up acquisition candidate AnnTaylor. and we will use them to convince Chico’s shareholders to sell.B shares and exchanging them for 100% of Chico’s outstanding shares. we expect that we would still achieve a high return on investment of 48% over the next five years. In addition to the acquisition premium.15. we have set a maximum per-share acquisition price of $4. 2008. We not only strive to avoid any disruption in operations. which can be used for future strategic initiatives. 90    . The abundant resources under the Berkshire Hathaway conglomerate. representing a premium of 41. The fact that many acquisitions fail to create the expected value for the acquiring company gives us strong motivation to walk away from a potentially unfavorable deal. Our goal is to ensure an acquisition price that provides optimal return to Berkshire Hathaway.

All elements of the strategy are based on the SWOT analysis and include marketing. Also. which will help us identify the reasons for the decline in same-store sales and.1 Align Product Mix and Strengthen Customer Service Chico’s must be very careful about what messages it sends to clients. While total sales revenue increased due to expansion of store fronts. A possible reason is incorrect product design that was not in line with industry trends. and its worsened financial position led the decline in the apparel retail industry. we have to find out what Chico’s did well until 2005 and what went wrong after that time. Chico’s will not be able to respond if its merchandise is not in line with customer demand. whether its product lines correspond to market trends. based on this. one of the major points in our post-acquisition strategy is aligning Chico’s product mix with customer demand and strengthening customer service. This is particularly important. In this respect. We have identified several lines of due diligence. our team has developed a set of postacquisition business strategy initiatives. we will analyze the ERP 91    . Given the fact that the fashion industry has quick-paced business cycles. Post-Acquisition Strategy Overview Based on the previous analyses thus far. 8. Chico’s same-store sales growth declined. financial and business development initiatives. to develop a turnaround strategy. existing same-store sales decreased as customers were switching to competitive brands. The big question is what changed from 2005 to 2007. First.8. given the fact that between 2005 and 2007. and how it handles client requests. These initiatives require full commitment from current senior management and are intended to create value for Berkshire Hathaway’s shareholders.

and lack of product availability. and tying their compensation to sales results will not only empower them to deliver outstanding customer service. fit/size. Next. and how they think we can improve so that we win back their business. Chico’s sales associates are the people who have constant contact with our clients. the measurement and application of this data in developing new products.system of the company. they not only look for a 92    . we will create focus groups with our target customers and provide rewards for participating in the discussion. in particular sales associates. In addition. but they fail to implement a process that will ensure it. we have to focus on excellent customer service and continuously train our staff. who purchased less product between 2005 and 2007 to determine what they liked or disliked about Chico’s products. We must take care to ensure that our post-acquisition strategy is implemented. We will call Chico’s pre-2005 repeat customers. in delivering this service. but also that of our employees. the process of capturing data from customers. Getting Chico’s employees involved in the marketing research process. We will not only seek our clients’ opinion. Second. Usually. leaders and managers express that they want continuous improvement. the mismatched product mix has led to negative same-store sales growth in the last two years. Potential problems that could be identified in the marketing research are: design choices. fabric. in many organizations. when people visit a fashion retailer. In this respect. color. why they stopped buying. why they switched to a competitive brand. as mentioned above. but it will also be reflected on Chico’s income statement. organizing regular workshops at successful stores. and they can give us valuable feedback on product mix/design preferences at the store level and help us bring lost clients back. and most importantly.

we believe that Chico’s should improve its product lines by adding more complementary products to the existing mix. and bags to Chico’s existing collection. jewelry. To avoid a sales disruption. Finally. notify them about the location of the nearest Chico’s store. we will contact all loyal clients by email. we plan to improve marketing effectiveness by restructuring the current marketing strategy to better utilize email. and broadcast advertising. and offer coupons or other promotional incentives. print.single item. mail. we will have to reach out to displaced customers from closing Chico’s stores. ideally matching the customers with their traditional salespeople. We will also reach out to customers. hats. 8. mail. It should hire style experts to find the matching combinations of apparel and accessories to help sales associates guide customers. or telephone. shoes. but also for a collection of apparel and other accessories like jewelry. Customers can choose any combination of existing clothes and accessories that fit their fashion tastes. Rather than being part of a one-time marketing research initiative. who have relationships with specific store employees and offer a transition plan to nearby stores. and bags. hats. Therefore. the company should collaborate with other apparel accessory producers in a strategic relationship to add suitable styles of shoes. the activities discussed above will be integrated in a continuous process that will align Chico’s product mix with clients’ needs and will help the company build long-term relationships with its clients.2 Improve Marketing Effectiveness Following the acquisition of Chico’s. Our overall goal is to significantly improve same-store sales 93    . More importantly. The availability of an appropriate product mix will increase the opportunity to cross-sell and improve the company’s sales and brand equity.

and Vogue magazines. Before mailing out catalogs. 2007 Annual Report. 18  94    .8% of net sales.7M or 4. In Style. Once acquired. Chico’s will explore placing full page. We will also explore the purchase of                                                          54 Chico’s FAS.which have been declining over the past two fiscal years despite the use of these previously-mentioned media channels. we will explore placing half page.54 We plan to increase marketing expenses in an attempt to address negative same-store sales growth. We make the distinction between full page and half page advertisements in these magazines due to advertising cost and the expected effectiveness of the individual magazines in reaching our target customers. In addition. color Chico’s ads in O. Chico’s will conduct an analysis to determine the appropriate amount of the increase. color ads for Chico’s and half page. Inc. while the weekly newsletter will be specific to the customer and provide promotional information for the nearest store locations. The Oprah Magazine and Good Housekeeping and full page. black and white ads for WH|BM in Elle. pg. we plan to send out monthly store catalogs and weekly email newsletters. This will keep our print costs down and save money on excess postage fees. We plan to implement a print campaign in popular women’s magazines that service Chico’s target demographic. the two lists will be cross-checked to make sure the same person does not receive more than one catalog. The catalog for WH|BM will contain the newest merchandise and accessories as well as contain inserts with promotional information and discount cards. Using loyalty club member lists for both Chico’s and WH|BM and catalog sign-up lists from individual stores. The catalog for Chico’s will contain the newest merchandise and accessories. As of fiscal year 2007. black and white WH|BM ads in Cosmopolitan magazine. the advertising budget was $82.

Chico’s has pursued an ill-advised rapid expansion of its retail locations. and therefore cannot be wholly attributed to the downturn in the macroeconomic environment. The Oprah Magazine websites to display a WH|BM and Chico’s promotion. As part of this process. 8. In these last two years. Two Chico’s commercials will be produced to highlight the unique. Oprah Winfrey. and Live with Regis and Kelly. These benchmarks will include a 95    . we will establish a store benchmarking system to evaluate the performance of stores over the past two years.3 Halt Expansion and Refocus on Existing Stores It is our opinion that over the last two years. We believe that such an effort will result in a return to positive samestore sales growth and allow the company to resume reasonable expansion activities in the future. we will explore a broadcast commercial campaign targeting our intended demographic. quality products and accessories found in multiple colors and sizes. Rachel Ray. Part of our post-acquisition strategy is to halt expansion and refocus the company’s attention on its historical strengths of customer service and delivering the right product mix. We considered the demographics of the viewers of certain daytime programs and compared those to our target demographic to come up with a list of programs during which we will run Chico’s commercials. the company has invested $300M to open additional retail locations while losing focus on its core mission. These commercials will be approximately 30 seconds long and run in conjunction with the following programs: The View.advertising space on the Cosmopolitan and O. respectively. Last. This loss of focus has led to negative same-store sales growth.

However. overperformers should be studied to determine if the keys to their success are replicable elsewhere. If a store consistently does better than its local economic environment would suggest. A store which underperforms in terms of efficiency may still be worth keeping if it nonetheless provides significant operating income. if a store consistently underperforms the local economic environment. and expected future capital investments in the store as discussed below. Overall operating income must also be considered. Stores that vary significantly from the benchmark should be given special attention. the store’s staff should be restructured even if the store is retained. Each store must be evaluated in the context of its local economic environment. a low-performing store 96    . Chico’s should attempt to retain the staff irrespective of whether or not the store is retained.comparison of the individual store’s growth rate to the local economic environment. it is possible to evaluate the performance of management and personnel at the location. overall operating income. Similarly. a store which overperforms in terms of efficiency may not be worth keeping if its operating income is negligible. Per square footage results would indicate whether a store is efficiently using its floor space compared to its peers. A high-performing store may not be able to meet hurdle rates in the future if large capital improvements are necessary for its continued success. the store’s overall efficiency must be evaluated. Expected capital expenditures in the near future should also be considered. measures of store efficiency based on per square foot results.or overperforming its local economic environment. Similarly. Additionally. By evaluating whether the store is under. and underperformers should be studied to see if the problems can be remedied.

may be worth retaining if it is providing positive operating income and will require few capital investments in the foreseeable future. among those stores targeted for shutdown. Chico’s should determine a set of stores that are overall underperformers and consider them as candidates for closure. Using these metrics. Stores with appropriate shutdown costs with little prospect of sufficient performance improvement should be closed with all reasonable haste. Utilizing local talent is the best way to address these issues. Regional managers will then evaluate each plan and allocate resources to implement these plans as appropriate. Chico’s should make an attempt to relocate overperformers to nearby stores wherever possible. Both store-level and regional manager performance will be evaluated based on the success (or lack thereof) of each store’s plan. management and staff should be evaluated for individual performance capability. These candidates should be further evaluated for shutdown costs and the potential for each store’s underperformance to be corrected. 97    . managers of the remaining stores will be required to develop and submit a plan for improving store sales in their local market. Additionally. Negative same-store sales growth is a major problem for Chico’s company-wide. It is believed that each store has localized problems and opportunities that a centralized plan may not be able to remedy or exploit. In an effort to address this issue. Examples of such overperformers would be managers who outperform the local market but whose local market is so bad that the store must be shut down and salespeople who have unusually high customer ratings or sales figures.

Of Soma’s current apparel line. This reduction in product line and the fact that Chico’s was already renovating stores will facilitate integrating the Soma brand into 98    . To plan for this possibility. We do not believe Soma can effectively compete with Victoria’s Secret as a stand-alone store. we will have Chico’s explore possible partnerships with third-party closeout retailers.4 Integrate Soma into Chico’s Stores Based on the company’s own questioning of the long-term sustainability of Soma and our team’s assessment. halting expansion presents a potential problem in terms of outlet stores. athletic one. shapewear and sleepwear and discontinue activewear and swimwear. we recommend that Chico’s integrate the Soma brand into Chico’s stores over the next two years. such as Tuesday Morning and Nordstrom Rack. These third-party stores provide essentially the same function as Chico’s outlet stores but will allow Chico’s to dispose of excess inventory without having to make large capital investments in outlet stores. Chico’s should focus on undergarments.Finally. 8. the benefits of cross-selling Soma products through personalized attention at the Chico’s stores can help boost sales and increase brand equity for Soma/Chico’s. However. Victoria’s Secret operates on a significantly larger scale than Soma and has the advantage of dominant brand equity and market share in the intimate apparel sector. This re-defining of the Soma portfolio will help Chico’s focus on its classy. we preclude the possibility of opening additional outlet stores which might be beneficial if Chico’s has the need to dispose of more inventory than existing outlet stores can support. By having a general expansion freeze. more formal-to-business-casual image versus a casual. Chico’s will experience operational savings from shutting down Soma’s separate storefronts. Additionally.

Additional benefits include exploration of new suppliers in the region as a contingency plan. Chico’s should terminate Soma leases. Additionally. color. 99    . 8. the primary purpose is to enable continuous evaluation and local enforcement of Chico’s quality standards with regards to cost. etc. The company should also evaluate if the one/two-employee office is sufficient or if there is a need for additional employees and infrastructure. the company should look for opportunities to shut down Soma stand-alone stores as leases expire. Given recent concerns in manufacturing quality in China. From a reduction in force standpoint. As most retail space is leased. fabric.4 Establish an Overseas Office in Asia As discussed in the SWOT analysis section. the company should perform a cost-benefit analysis on lease breakage fees versus costs of operating standalone stores. The company should consult with individuals experienced in the intimate apparel industry to make these decisions. fit. This does not need to be a significant investment – leasing a small office and hiring or assigning one or two employees should suffice to determine the acceptability of the concept. as necessary. style.existing retail store space and the Chico’s outlets as necessary. A variety of colors and styles should be offered to the Chico’s customer. this concept can be expanded to Turkey and other geographic regions. If fees are less than operating costs. Based on the lessons learned from the office in China. Chico’s should establish an office in Asia. Chico’s should retain top-performing Soma management and sales associates. to create a process to oversee manufacturing and quality control.

8. Chico’s should take advantage of closeout merchandise stores. the better it will be able to address this threat. As discussed in the financial ratio analysis section.5 Evaluate Opportunities to Build Strategic Relationships One of the threats to Chico’s we have indentified is the change in trade regulations as the new presidential administration takes office in Jan 2009. however. Chico’s financial position is better than the industry basket’s. such as Tuesday Morning. it would negatively affect Chico’s overall business. agree on merchandise pricing. as Chico’s operates in the fashion industry with high inventory turnover. 100    . Nordstrom Rack. However. In the meanwhile.S. In order to improve profitability in this recessionary period. Chico’s profitability has declined in recent years. Given the current economic recession and the U. the new government may apply quotas. It takes time to identify reliable suppliers. or other trade restrictions to Asian countries. so it is highly unlikely that the U. the United States has a free trade agreement with Canada and Mexico under NAFTA. so the earlier Chico’s starts looking for new suppliers. Chico’s will not open any new outlet stores. government will apply any trade restrictions to those countries. in order to deal with this contingent threat. Chico’s also needs to liquidate excess inventories. and methods of disposing excess inventory. and/or other third-party channels to sell its obsolete merchandise. the company needs to establish relationships with these stores as soon as possible. Hence. we recommend Chico’s reduce capital expenditures in the short run. As part of the general freeze on expansion. trade deficit. Therefore. new tariffs. If this happens. frequency.S. in particular China. Chico’s should start building strategic relationships with apparel suppliers in Mexico. make agreements and integrate into the supply chain.

but Chico’s also permits the supplier to reap all of the benefits of good risk management practices. Additionally. All of its revenues are matched with its expenses in terms of currencies. Because of our near. This provides Chico’s with a perfect understanding of its expenses going forward. this presents a lost opportunity for Chico’s – not only exchange rate risks.6 Explore Active Management of Exchange Rate Risk Chico’s currently structures all of its overseas manufacturing contracts so that Chico’s pays all expenses in dollars. we believe that Chico’s should begin developing expertise in currency exchange risk management. By developing this expertise. Chico’s simply agrees to the contracts and lets its suppliers manage all However. These choices will increase Chico’s exposure to exchange rate risk in the intermediate term. does Chico’s have the supplier manage all exchange rate risks.and intermediate-term recommendations and our long-term expectations.S. we will recommend that Chico’s explore minor international expansion by opening stores in select locations in Canada and have recommended establishing an office in Asia. dollar position. In terms of a passive hedging strategy. In the short-term. we foresee a future in which Chico’s may wish to engage in more aggressive international expansion in Canada and possibly Europe. In essence. Chico’s will be well positioned to handle exchange rate risk from international expansion. Additionally. development of this expertise will permit Chico’s to take more nuanced exchange rate 101    . Chico’s current implementation is very effective. we believe that this is appropriate as it permits Chico’s to focus on its core business activities.8. Chico’s has created a perfect hedge with an all-short U. However.

when Chico’s does resume growth. we suggest that Chico’s start a small risk management division consisting of two or three risk management professionals.7 Other Possible Long-Term Opportunities We will not address Chico’s single distribution location issue at this time because we are suggesting a no-growth strategy. similar culture and demographic to the United States. 8. Chico’s should maintain the proposed nogrowth strategy for at least two years. the company must evaluate the risks associated with a single distribution point and determine if additional locations would better serve stores and customers. we believe Chico’s product offering and focus on personalized attention will transfer 102    . To this end. It is possible that Chico’s will be able to develop more efficient risk management in-house and save money by not paying suppliers to manage the risk and by making better risk management decisions. the metropolitan cities of Toronto and Vancouver. this team should look into the possibility of expanding into Canada. Suppliers do not take on the risk of exchange rate fluctuations for free. If the results of the evaluation are favorable.positions with respect to its suppliers. Chico’s should develop a plan to implement a risk management division that takes into account its increasing exposure to currency risks. These professionals should evaluate the potential contributions that a full-blown risk management division could contribute to the company in terms of cost savings and superior management capability. With geographic proximity. in particular. However. In addition to domestic U. expansion. A cross-functional team should be formed now to begin evaluating the opportunity for the company to resume expansion after two years. Given the current state of the economy.S.

Strategically-placed distribution centers could help mitigate international logistics costs. 103    . We believe our aforementioned strategy will permit Chico’s to address the managerial missteps.successfully. Additionally. we believe our strategy will allow Chico’s to take advantage of opportunities going forward by improving customer service. Chico’s has considerable opportunities going forward to improve and solidify its position. Conclusion Chico’s is a strong company experiencing difficulties due to the recent market downturn and managerial missteps. specifically the aggressive expansion and incorrect product mix that led to over-expansion in a declining economy and declining same-store sales growth. and laying plans for a larger international presence in the future. reintegrating Soma to take advantage of cross-selling opportunities. Additionally.

however. pg. and accessories under the Ann Taylor.55 AnnTaylor targets affluent women and provides them with “updated classics products that are feminine. Corp. The following sections will present our analysis of AnnTaylor’s financial position. should that acquisition fail. and polished.58 Like other companies in the industry. LOFT.57 The company has a “total wardrobing strategy” that helps its clients choose the appropriate merchandise mix and wardrobe coordination based on their personal styles. shoes. and valuation. our alternative acquisition candidate is AnnTaylor Stores Corporation. Alternative Acquisition Candidate – AnnTaylor Stores.anntaylorstorescorp. Started as a primarily East Coast brand. SWOT. We have decided to acquire Chico’s. the company has grown into a national brand with 929 retail stores nationwide and annual sales revenues of $2.9. stylish. AnnTaylor does not manufacture its apparel merchandise but develops designs in-house and then outsources the production process to independent manufacturers. 2007 Annual Report. pg. and Ann Taylor Factory brands. primarily in  57 AnnTaylor Stores. The company experienced declines in profitability due to the economic downturn that started in 2007. The LOFT brand contributes the most significant part of the company’s sales revenue. The program is expected to include reviewing company’s                                                          55 56 AnnTaylor Stores. 2  AnnTaylor website: http://www. In an effort to enhance profitability and improve overall operating effectiveness.”56 AnnTaylor’s product line is comprised of women’s apparel. the company initiated a multiyear restructuring program. 2  58 AnnTaylor Stores. 9. 2007 Annual Report. Corp. Corp.4B in 2007. 2007 Annual Report. 2  104    . pg. Corp.1 Company Overview AnnTaylor is a women’s career and casual wear retailer established in Connecticut in 1945. versatile.

We added Chico’s into the basket and removed AnnTaylor so that AnnTaylor could be compared to the basket. and distribution center. the company expects to spend about $60M on new store openings and construction. and streamlining corporate organization structure. We followed the same procedures as in the Chico’s financial ratio analysis section in order to understand AnnTaylor’s financial strengths and weaknesses and their strategic implications. 24  105    . store expansion or relocation. AnnTaylor pays special attention to strengthening its brands through effective marketing and top-tier client services. Furthermore. Since AnnTaylor is one of the companies within the industry comparables basket used to assess Chico’s. store renovation. it is expected that AnnTaylor will generate enough cash from operations to finance its capital needs. the only change made was a switch in position between Chico’s and AnnTaylor in the basket. Corp.2 Financial Analysis In order to assess AnnTaylor’s financial health. Besides closing underperforming stores. 2007 Annual Report.cost structure. corporate office. pg. Therefore. This is a strategic advantage in that a strong brand name can command a higher price than a weaker brand name. 9. With AnnTaylor’s current financial situation. and refurbishment programs. See Appendix P for the                                                          59 AnnTaylor Stores. we examined its performance over the past five years and compared it with that of the industry basket average.59 Management hopes that these actions will help increase corporate efficiency and attract new customers. the company plans to invest in its information technology systems. closing underperforming stores over three years. One of AnnTaylor’s strengths is its brand equity.

AnnTaylor is able to meet its current liabilities and generate enough cash from operations to self-finance. AnnTaylor is in a better position compared to its competitors to get through the current difficult economy. AnnTaylor has consistently had a stable inventory turnover ratio. which is 2/3 faster than the industry basket. eroding AnnTaylor’s advantage in this area. this position allows AnnTaylor to pursue positive NPV projects and/or expand production should an attractive investment opportunity arise. Therefore. While the industry has experienced a declining trend over the past five years. Compared to the basket’s average. the industry basket has narrowed the gap by nearly 50% in the past 5 years. The trend of these two ratios is similar to that of the industry. however. which results in a relatively flat trend in the days to sell inventory ratio. The company has consistently maintained collection periods of approximately 3 days. AnnTaylor has maintained a consistent advantage in these areas. Strategically. This results in a faster cash conversion cycle for AnnTaylor than the industry basket. they fluctuated noticeably from 2003 to 2007 and declined last year. However. However. there is a material difference in the receivable turnover ratio and the average collection period. these ratios are materially higher. 106    . This trend is not present in the working capital and cash flow per share ratios. Activity Ratios In the past five years. Liquidity Ratios AnnTaylor’s current ratio and quick ratio are slightly lower than those of the industry average. Furthermore. The following analysis uses a materiality of 2X above or below the industry basket average. with respect to ratios.

Strategically speaking. while the industry’s average ROE movement decreased by 66%. this suggests AnnTaylor has an advantage over its competitors. While the industry has experienced a declining trend in profitability. Its operating margin was in line with the industry between 2003 and 2006. it was materially higher in 2007. it could also lead to losing customers in the economic recession period. the company’s sales growth rate declined and caused a drop in profitability. Last year. Strategically speaking. however. The tight credit policy has helped AnnTaylor to decrease its operating cycle with a faster conversion from sales to cash and enjoy higher profitability. AnnTaylor’s activity ratios are strong. However. The company’s profit margin is stable and also outperformed the basket average in the last two years. In 2007. AnnTaylor’s ROE has almost doubled in the last four years. AnnTaylor’s high receivables turnover ratio implies that the company has tight credit policies. it has a real advantage in other areas. which will be discussed later. Operationally. Other ratios in the profitability family have the same trend. it can be inferred that AnnTaylor’s credit terms applied to its customers may be more effective than those of AnnTaylor’s competitors. supporting AnnTaylor’s solid position in liquidity and management of and access to cash. Profitability Ratios AnnTaylor’s profitability is very strong. However. possibly due to better operational strategies. For example. AnnTaylor has managed to avoid this trend and was materially higher than the industry last year.The similar inventory turnover ratio of both AnnTaylor and the basket shows that AnnTaylor has no comparative advantage in this respect. Its recent high profitability results from its 107    . AnnTaylor had a relatively stable ROA whereas the industry basket dropped almost 100%.

All other debt ratios in this family show this position. Because of this. on average. meaning that the company has operated with no debt in the last four years. Almost all of the companies in the basket have a low level of debt. Talbot’s is at a relative disadvantage compared to all other competitors within the basket. AnnTaylor’s debt-free position affords the company considerable flexibility in the current recession. Another advantage arising from its strong liquidity and leverage position is that AnnTaylor can obtain debt at a better rate than other levered companies and thereby minimize the interest expense. the company has the option to utilize its credit facility to take advantage of attractive investment opportunities. AnnTaylor has a zero debt to equity ratio. Talbot’s is the only competitor in the basket with a material difference in debt level and skews the data set. Leverage Ratios From a financial leverage perspective. 108    . Low financial leverage is also a common characteristic of other companies in the women’s retail apparel industry. However. long-term debt to equity is approximately 20%. which allows AnnTaylor to engage in strategic initiatives and increase the value to shareholders by buying back outstanding shares. Even if demand for capital exceeds its capacity. Jill acquisition. Talbot’s position is the result of the unsuccessful J.positive free cash flow. This debt-free position and AnnTaylor’s ability to generate positive net income and strong free cash flow will help AnnTaylor to finance strategic projects without debt or other external sources of capital. It has a strong balance sheet with shareholder’s equity and internally-generated cash as a main source of financing.

and dropped in 2007. and EBITDA. The industry average ratios are 2X higher than AnnTaylor’s between 2003 and 2006. AnnTaylor has several advantages over its competitors. creates opportunities for improvement. These three ratios followed the same trend . It has a strong liquidity position and generates enough cash to finance its operations. AnnTaylor’s price/earnings. The company could start paying dividends and continue repurchasing shares to increase the value to its shareholders. the market would have better expectations for AnnTaylor’s performance. peaked in 2006.they were low in 2003. Conclusion Overall. the company has good credit policies. This trend shows that investors placed equal value on AnnTaylor’s stock and its competitors’ on variables. Strategically speaking. AnnTaylor does not have any competitive advantages over the industry basket regarding stock market ratios. in terms of book value and sales. except the price/book and price/sales ratios. From an operational perspective.Stock Market Ratios From 2003 to 2007. there was a significant difference in the price/book and price/sales ratios. and price/EBITDA were not materially different from that of the industry. This trend changed in fiscal year 2007 as AnnTaylor’s price/book and price/sales ratios were in line with those of AnnTaylor’s competitors. cash flow. The positive market reaction to AnnTaylor’s stock last year. However. such as earnings. If this is successful. Almost all of AnnTaylor’s price multiples. which allow it to collect receivables from customers quickly. AnnTaylor maintained high profitability in difficult 109    . are similar to the basket averages. price/cash flow.

All these strengths provide AnnTaylor with flexibility to take advantage of positive NPV investment opportunities that might arise in the future. while the industry experienced losses. we conducted a comprehensive analysis in order to assess AnnTaylor’s strengths. weaknesses. The company also has a strong balance sheet with no current debt but a reserved credit facility. opportunities. STRENGTHS • • • • Product mix Trained sale associates Brand equity Financial position o Debt free o Effective inventory and receivables management WEAKNESSES • • • • Declining profitability Underperforming stores Dependence on a single distribution facility Dependence on foreign 110    THREATS • • • Economic downturn Licensing its brand name from thirdparties Changing client preference/fashion trend OPPORTUNITIES • • • • Restructuring program Increase in sales through Internet Debt financing Opening LOFT outlet stores . such as inventory management and profitability. Its credit policies should also be reviewed to increase sales during these difficult economic times.times. 9. AnnTaylor has areas for improvement. On the other hand. and threats.3 AnnTaylor’s SWOT Analysis Based on the retail apparel industry and AnnTaylor’s specific analyses thus far.

a strong brand can provide more visibility for AnnTaylor in the marketplace. AnnTaylor has a strong and nationally-recognized brand name. fabrics. This is a strategic advantage because a stronger brand can help a company command a higher price and gross margin than a weaker brand. and customer service to strengthen the AnnTaylor and LOFT brands. In addition. This helps the company provide an updated classic look aligned with the consumer’s personal preference. The company’s “total wardrobing strategy” has proven effective and helped increase client satisfaction and loyalty. footwear. design. As it targets affluent women. These associates give advice and help customers in selecting merchandise in order to reflect personal styles. and style. Its brand name is an asset and helps it stay strong in a competitive market with quick changes in demand. Third. 111    . AnnTaylor has a good product mix consisting of apparel and accessories. which could lead to repeat sales and additional demand from new customers. and accessories. AnnTaylor has trained sales associates. separates. AnnTaylor’s customers find it easy to assemble coordinated outfits. who understand customers’ fashion tastes and preferences in respect to color. With the availability of products that are complementary by design.manufacturers • • Competition Change in government regulations Strengths First. Second. AnnTaylor has invested money in marketing. the company focuses its attention on developing the right merchandise mix among suits. tops.

however. Additionally. which cost over $32M. 117 stores have failed to yield acceptable long-term results. The company enjoys high inventory and receivables turnover. The company has a single distribution facility in Louisville. the company will close those stores. and renovate existing ones. AnnTaylor maintains a strong financial position. which means the company has shorter operating cycles compared to its competitors. This means that the company is in a better position to generate positive cash flows and maintain a debt-free capital structure. Last. In fiscal year 2007. As stated in the company’s restructuring program. In a recession. If there is a disruption at the facility. the company experienced negative same-store sales growth. KY. company profits will be negatively affected due to stock outs 112    . This also contributes to a faster cash conversion cycle.Fourth. AnnTaylor manages its inventory and receivables effectively. allowing the company to maintain a strong financial position. declines in profitability present a weakness that must be addressed. the company should focus on stabilizing same-store sales revenue and decreasing costs where possible. because the company has no debt it is likely to obtain better debt ratings and thereby have access to relatively inexpensive debt. which have underperformed over the past three years. AnnTaylor’s profitability is superior to the industry basket. In response. AnnTaylor has identified a number of stores. As discussed in AnnTaylor’s financial analysis section. invest in opening new stores. in the last year. It also initiated a restructuring program. Weaknesses AnnTaylor’s financial position is a strength when compared to the industry.

Furthermore.and increased customer dissatisfaction. Outsourcing production processes to foreign manufacturers can provide the company with low-cost merchandise. AnnTaylor has limited control over the quality of the raw materials and the resulting final product. Additionally. identifying and eliminating underperformers. This channel has global reach and is available to consumers at any time. In turn. The program will also review and streamline AnnTaylor’s cost organizational structures. AnnTaylor’s “total wardrobing strategy” ensures that each of its products can be easily combined with other 113    . Opportunities AnnTaylor’s restructuring program provides an opportunity for the company to improve profitability and overall corporate performance. where there is network access. heavy dependence on foreign suppliers is a potential weakness and threat to the company. If successful. The Internet is constantly increasing the number of consumers to whom AnnTaylor can market. ultimately leading to improved profitability. This program will examine AnnTaylor’s current retail stores. AnnTaylor’s design process is uniquely positioned to take advantage of Internet automation in order to cross-sell products. and open new ones in attractive locations. this could damage the company image and ultimately decrease sales. the company will renovate and expand existing stores. This could lead to disruptions in the supply chain with results similar to those from a disruption to the single distribution facility described above. However. in any place. AnnTaylor will drive sales and reduce overhead. The Internet provides AnnTaylor with an additional low-cost sales channel.

and manage inventory levels even more effectively. Therefore. people 114    . the company has no debt and maintains a strong financial position.AnnTaylor products to create a complete outfit. this is an area for improvement. as shown in the AnnTaylor’s financial ratios analysis. Another opportunity presented to AnnTaylor is debt financing. Yet. AnnTaylor will be able to serve more customers. the current economic slowdown is the primary threat to the company’s performance. LOFT. the women’s retail apparel industry is characterized by high inventory turnover. Because consumer spending depends heavily on disposable income. increase sales. as discussed earlier in the financial ratios analysis section. As we discussed in the industry and competitor analysis section. all AnnTaylor merchandise is sold through Ann Taylor. This will enable AnnTaylor to transition its “total wardrobing strategy” to its Internet presence and provide a similar experience to its in-store and on-line customers. Threats First. Opening new LOFT Outlets provides AnnTaylor with a good opportunity. and AnnTaylor Factory stores. Currently. Currently. This gives AnnTaylor an advantage over its competitors allowing it to obtain low-cost debt to finance potential investment opportunities. by opening LOFT outlets. Because of this deliberate product matching. AnnTaylor has already internally identified which products fit together for maximum effect when presenting products to the customer. AnnTaylor can enable its Internet presence to take advantage of this information and present total wardrobing solutions to customers by immediately showing complementary products.

The license agreement was signed in August 2005 and expires in June 2015. Hence. Third. economy declines. the company will experience a disastrous loss in sales. negatively impacting the profitability and the brand name. AnnTaylor does not own the AnnTaylor brand in China. it licenses the brand from Guangzhou Pan Yu San Yuet Fashion Manufactory Ltd. Competition and low barriers to entry present a constant threat to AnnTaylor. for the right to use the AnnTaylor brand for manufacturing and exporting purposes in China. specialty stores. AnnTaylor is forced to defend its market share against a wide variety of competitors. and direct marketing businesses that offer similar products. Additionally. 115    . Therefore.S. Finally. Because strategic advantages erode rapidly in the industry due to rapid business cycles. Changes in government regulations regarding imports/exports and trade relations could potentially affect AnnTaylor’s costs associated with those activities. national and regional department stores. if there are any disruptions in the agreement or the Chinese party stops licensing to AnnTaylor. including international. the frequent change in fashion trends may bring both opportunities and threats for the company. the company’s sales are expected to be negatively affected as the U. the United States will be led by a new presidential administration starting in January 2009. the company will lose its ability to manufacture and export under the AnnTaylor brand name in China. AnnTaylor must consistently execute at a high level in order to maintain its competitive position. Second.tend to spend less on apparel in an economic recession. Should AnnTaylor fail to keep up with current fashion trends.

we feel AnnTaylor can capitalize successfully on its opportunities and work towards addressing its weaknesses and threats. First.Conclusion As demonstrated in the SWOT analysis above and weighing the probabilities of each point. With numerous strengths. Google Finance. going forward. The investment must generate an IRR greater than AnnTaylor’s cost of capital. such as Bloomberg. We used two methods to calculate AnnTaylor’s stock intrinsic value: We used financial price/earnings (P/E) and discounted cash flow (DCF) model. databases. Hopefully. This method provided us with a value per share of $30. where Expected EPS = EPSFY2007*(1+EPS Growth rate)  116    . we performed a P/E valuation to determine the company’s stock price.29.60 We conducted a sensitivity analysis to see how the share price fluctuates as the two input                                                          60 P/E valuation model formula: Stock price = P/E multiple*Expected EPS.4 Valuation Having evaluated AnnTaylor’s strategic and competitive position. we feel the strengths and the threats outweigh the weaknesses and the opportunities. especially in its financial position.53 to estimate the current year’s EPS along with the EPS growth assumption of 2%. 9. the company's strengths can provide the foundation to identify and take advantage of additional opportunities. We also used AnnTaylor’s fiscal year 2007 earnings per share (EPS) of $1.41) from the data contained in our Chico’s financial ratio analysis. to obtain the input parameters for our models. This P/E model has only two input variables: the industry average P/E and AnnTaylor’s EPS growth rate. We obtained the industry average P/E multiple (19. and Research Insight Web. we must verify that the purchase of AnnTaylor will provide an acceptable return on investment over the next five years.

45. Second. which was still higher than AnnTaylor’s market price as of 11/19/2008.22%. The average FCF growth rate for the period was -0. Using information from AnnTaylor’s 2007 annual report and Research Insight Web. AnnTaylor has had no debt in the last four years. Please refer to Appendix R for more details on the DCF valuation. therefore.75.58/share as of 11/19/2008. we obtained operating cash flows and capital expenditures from 2003 to 2007 to calculate FCF. and the total shares outstanding.62 The lowest price calculated from the sensitivity analysis was $21. We then projected AnnTaylor's FCF for the next five years and terminal value. To be conservative. We used the same DCF method as Chico’s to value AnnTaylor’s stock. average growth rate.30. stock beta of 1.78%. we took into account a pessimistic scenario using a lower P/E and an EPS growth rate than those of the base model. we did a DCF valuation for AnnTaylor.ustreas. the lowest intrinsic value of AnnTaylor’s stock price was found to be $10. we obtained from the above-mentioned sources. the total shareholder's equity.                                                          61 62 http://www. Using the sum of the DCF. Please refer to Appendix Q for more details regarding the P/E valuation. we calculated an intrinsic value per share of $25.parameters Using the Capital Asset Pricing Model (CAPM).53. which is still higher than the market price of $5. the WACC is equal to its cost of equity. We calculated the company’s FCF.shtml  Note: for details regarding the rationale of the sensitivity analysis see Chico’s valuation section  117    . such as a market return of 11. Even with this pessimistic scenario.32%.98%. The input parameters. a risk-free rate of 3. We also did a sensitivity analysis to see AnnTaylor’s stock price variation by changing the FCF growth rate and the WACC. the cost of equity was calculated at 16. and WACC.

AnnTaylor’s acquisition will yield an IRR of 36. Overall Project Conclusion The preceding analyses discussed five aspects of the environment and the industry. optimal. in which Chico’s operates. opportunities.20/share for the friendly acquisition of AnnTaylor. Because AnnTaylor is in the same industry and market as Chico’s. a valuation of Chico’s as an acquisition candidate. respectively. and an evaluation of AnnTaylor as an alternative acquisition candidate.9. a financial analysis evaluating the five ratio family trends. at the optimal premium (see Appendix S). the same acquisition premiums apply to both companies. AnnTaylor’s strong financial position. 118    .12%.5 Potential Acquisition of AnnTaylor Stores AnnTaylor has been profitable over the last five years. AnnTaylor’s market value and P/E have become attractively low. coupled with the similar market capitalization as that of Chico’s. makes it our top choice for a back-up acquisition. with a stock price of $5. and threats (SWOT). It performed relatively well in comparison with the industry basket. weaknesses. The minimum.55%. we recommend an optimal price of $6. compared to an IRR of 57% for Chico’s. If successful. AWWI’s acquisition strategy and postacquisition recommendations. stable performance. Therefore. If the attempt to acquire Chico’s should fail. 11. an evaluation of Chico’s strengths. and strong balance sheet make it a strong competitor in the retail apparel industry. and 41.58 (as of 11/19/2008).90%. an analysis of Chico’s closest competitors on the basis of product lines. AWWI should focus on AnnTaylor as a suitable alternative. Due to stock market declines. and maximum premiums would be 0%. The company’s solid strategy.

119    .

0 7.2 1.1 24.4 1.0 12.8 0.3 3.7 20.7 11.4 178.0 0.6 8.8 1.0 16.0 0.0 13.8 2.4 32.3 1.8 24.4 12.0 0.4 68.7 0.0 1.4 1.1 24.4 28.3 2004 3.1 21.4 21.3 16.3 26.0 24.0 0.4 7.9 31.0 13.9 10.0 22.0 1.3 7.3 21.8 15.7 26.6 1.0 66.1 Liquidity Ratios Current Ratio Quick Ratio Working Capital Per Share Cash Flow Per Share Activity Ratios Inventory Turnover Receivables Turnover Total Assets Turnover Average Collection Period (Days) Days to Sell Inventory Operating Cycle (Days) Profitability Ratios Operating Margin Before Depreciation (%) Operating Margin After Depreciation (%) Pretax Profit Margin (%) Net Profit Margin (%) Return on Assets (%) Return on Equity (%) Return on Investments (%) Leverage Ratios Long-Term Debt/Common Equity (%) Long-Term Debt/Shareholder Equity (%) Total Debt/Invested Capital (%) Total Debt/Total Assets (%) Total Assets/Common Equity Market Ratios Price Earnings Ratio (P/E) Price to Book Ratio Price/Sales Price/Cashflow Price/EBITDA 2.4 2.0 24.0 24.2 46.6 4.7 2.5 21.2 24.1 8.7 0.3 9.0 7.4 19.0 3.0 9.4 10.7 2004 2.6 2.3 13.8 1.3 10.0 7.3 21.1 1.2 9.7 8.9 2.5 7.6 1.5 8.0 1.8 21.8 10.8 16.5 5.0 26.4 2003 3.0 0.4 44.3 21.0 22.7 25.3 0.0 1.9 72.0 0.1 2.8 13.7 24.2 14.2 25.2 21.8 2.6 8.8 20.0 12.7 24.3 12.1 11.4 7.4 24.3 19.2 2.7 22.6 1.4 7.1 1.0 0.8 2006 2.4 11.9 11.0 22.2 8.0 60.9 15.4 21.0 32.8 58.0 0.2 5.9 77.7 10.Appendix A Chico’s Financial Ratios Chico's FAS 2007 2006 3.0 10.1 4.7 9.6 7.3 2005 4.3 1.3 5.3 2.4 3.3 6.0 16.9 1.4 0.0 1.1 11.3 11.6 12.3 2.8 1.0 1.5 1.66 161.8 19.3 4.0 11.2 Industry 2005 2.6 5.8 9.7 39.4 1.1 15.1 9.6 45.0 3.4 22.6 2.6 62.9 14.2 0.0 1.8 2.9 71.0 4.0 16.5 22.1 4.8 0.3 12.7 1.3 64.0 0.9 12.1 11.4 50.1 21.0 1.9 1.9 1.9 16.0 27.0 1.1 5.7 1.1 -4.7 16.0 26.0 0.5 5.4 4.6 8.7 1.7 1.0 46.0 0.4 2.0 0.0 23.5 4.3 8.5 2.4 13.3 2.4 2.1 6.3 3.0 19.2 20.0 7.3 7.0 0.0 2.0 0.8 2.6 0.7 21.2 11.1 0.2 120    .0 11.7 2007 1.2 17.8 10.7 7.9 10.1 1.9 13.3 22.0 10.1 8.8 1.0 124.7 1.4 -0.8 2.9 17.6 0.0 15.6 1.2 19.4 11.8 17.3 8.8 12.0 0.0 22.3 86.0 2003 2.65 186.3 11.4 13.6 3.3 23.0 8.6 56.2 12.0 2.8 4.3 0.3 7.0 21.

683 -41% Year Ended February 2006 2005 $268.080 111% 2003 $108.477 $4.191 912.065 $120.601 $3.771 $130.762 $4.39 121    .Appendix B (in thousands) Operating Cash Flow* Capital Expenditure* Free Cash Flow Growth Rate Average Growth Rate *CHS 10-K Chico’s DCF Valuation 2008 $208.311 $70.32% 2007 $288.424 $6.994 218.065 Year 1 2 3 4 5 Terminal Value Sum DCF (000) Total Liabilities/Equity (000)* Sum DCF +Total Liabilities/Equity (000) Common Stock Outstanding (000)** BV Per Share *Chico's 10K 2007 **Yahoo! Finance Free Cash Flow (000) $6.807 64.954 Discounted Free Cash Flow (000) $5.647 202.916 952.540 5.107 176.620 147.742 $44.131 $18.300 $93.552 $6.817 $6.380 52.406 $223.424 -91% 2.141 $3.555 -7% 40% 2004 $145.223 $6.635 93.684 $6.079 $ $ 39.

2008 ***Bloomberg Data ^CHS has no debt --> WACC=Re (Bloomberg Value 15.30% *Google Finance **Average of 10-year Treasury Yields in October.Appendix C Chico’s Weighted Average Cost of Capital WACC Calculation Beta* 1.98% Risk Premium 8.S. Market Return (10/25/08)*** 11.08%) 122    .65 Rf** 3.19% Cost of Equity^ 17.78% U.

38 5.58 9 12.65 5.56 5.43 1.41 5.36 5.36 5.57 5.35 15 22.14 5.39 5.51 5.34 5.98 5.57 5.36 5.47 5.44 5.43 5.29 5.49 1.53 5.43 8 14.37 5.48 5.42 *All other parameters remain the same Sensitivity Analysis of Beta Beta WACC BV/Share 1.34 *All other parameters remain the same Sensitivity Analysis of FCF Growth FCF Growth Rate* (%) BV/Share ($) 0 5.54 5.45 5.64 5.40 5.41 5.34 4% 5.09 5.41 1.37 2.53 5.4 13 18.51 10 14.04 5.35 5.51 5.40 5 16.61 5.49 5.38 2 5.67 5.5 16.81 5.39 4 17.6 16.07 5.62 5.39 5.36 *All other parameters remain the same 123    .89 5.54 5.8 18.43 5.2 13.45 5.26 5.50 5.76 5.9 19.39 3 5.46 5.48 5.4 15.47 5.55 5.46 5.42 12 17.39 5.71 5.44 5.42 5.37 14 20.36 W A C C 9% 10% 11% 12% 13% 14% 15% 16% 17% 18% 19% 20% 21% 0% 5.38 5.53 5.17 5.35 5.43 5.68 5.47 1.38 5.38 1.37 5.36 5% 5.42 5.70 5.25 5.61 5.51 5.50 5.91 5.35 5.46 10 13.1 12.0 20.7 17.34 1% 5.40 5.39 5.38 5.47 5.45 5.40 5.40 1.35 5.41 6 15.16 5.37 6% 6.41 5.73 5.39 5.49 5.Appendix D Chico’s DCF Valuation: Sensitivity Analysis Sensitivity Analysis FCF Growth Rate 2% 3% 5.4 4 5.42 5.40 5.38 Sensitivity Analysis of Risk-Free Rate Risk-Free Rate* BV/Share (%) WACC (%) ($) 3 17.38 1 5.50 5.0 11.51 1.59 5.38 5.99 5.44 5.41 5 5.78 5.37 5.93 5.81 5.68 8 10.60 5.59 5.69 5.41 5.74 5.45 1.42 7 15.58 5.46 5.37 5.21 5.79 5.40 5.42 5.86 5.53 5.66 5.48 *All other parameters remain the same Sensitivity Analysis of Market Return Market Return* BV/Share (%) WACC (%) ($) 7 9.39 1.90 5.45 9 13.63 5.39 5.46 11 15.54 5.3 14.43 5.

Inc.30% 17.00% 12.65 11.021 $ 75.00% 3.negative or flat growth in same store sales. 125 million in fixed capital investment in 2009 (3) From 10K.878) Business with the following Forecasts Number of periods in forecast Sales (last historical period) Sales growth rate Operating profit margin Incremental fixed capital invest. and has been decreasing since 2006.30% 13.818 $ 209.063.679 $ 233.469 703.18% 17.29% (2) 2% (3) 40% 60% 17% 260469 1063596 71146.754 $ 34. Macmillan.297 $ 426.709 $ 52.92% 7% All currency numbers in thousands (currency numbers are in 1.80% 8.985 $ 3.80% 8.846 $ 439.881 $ 199. Appendix F Chico’s Value Creation Model: Sensitivity Analysis 124    . I estimate 2% growth from this (2) From 10K.501 $ 77.80% 1. New York (1) From management predictions in 10K -.147 $ 72.915 $ 4.566 Present value Cumulative Present Cumulative of Residual PV+ Residual Increase in Value Present Value Value Value Value $ 60. Cash income tax rate Residual value income tax rate Cost of capital = WACC Marketable secutities and investments Market value of debt and other obligations Cash flow in year 1 Year 1 2 3 4 5 Cash Flow $ 71.519 $ 431.951 $ 5.432 $ 443. Incremental working capital invest.317 $ 39.011 Marketable Securities and Investments Corporate Value less: Market value of debt Shareholder Value The material and methods of this spreadsheet are according to the "Creating Shareholder Value" by Alfred Rappaport.232 $ 4.Appendix E Cost of capital Chico’s Value Creation Model Weight Debt Equity Cost of capital Cost of Equity Expected inflation rate Real interest rate Risk-free rate Beta Expected return on Market Risk-free rate Risk Premium Risk free rate Equity Risk Premium Cost of Equity Cost Weighted Cost 0. -30 million in working capital investment in 2009. The Free Press.139 $ 240.249 $ 3.863 $ 159.00% 17.654 $ 366.00% 100.654 $ 60.98% 3.30% 2.30% 17.742 $ 113.18% 3.000's) 5 1714326 2. 4-7% increase in total stores.008 $ $ $ $ 260.258 $ 276.718 1.396 $ 318.596 (359.964 $ 45.973 $ 436.80% 1.264 Total value Created => $ 22.00% 0.00% (1) 7% 7.569 $ 74.

661 $ 17.574 $ 45.812 Sales Growth 1% 2% 3% 4% 5% Value Created (000) $ 10.448 $ 15.371 $ 58.820 $ 22.451 $ 35.530 $ 57.591 $ 19.212 $ 104.791 $ 21.895 $ 12.101 $ 13.Risk Free Rate 3% 4% 5% 6% 7% 8% 9% 10% Value Created (000) $ 23.008 $ 33.885 Operating Margin 5% 10% 15% 20% 25% 30% Value Created (000) $ 12.052 Appendix G Chico’s Direct Competitors 125    .959 $ 16.132 $ 127.291 $ 81.

firm's annual reports.*** DDS The Talbots. TLB Ann Taylor Stores Corp. Forbes.7 9. ANN Chico's CHS Market Cap (in millions) Debt/Equity SIC Code* 10.38 0.7 n/a 92.6 n/a 48. CWTR Dillard's. Inc.Comparable Ticker Christopher & Banks CorpCBK Coldwater Creek.64 0 22.38 0 n/a 4.31 5621 5621 5311 5621 5621 5621 Demographic market (age)** Professional women (40-60) Professional women (45-65) Professional women (35-55) Professional women (25-55) Professional women (over 35) *Source: Hoover Pro ** Sources: Bloomberg. Inc. Google Finance *** Listed as a direct competitor in Chico's 2007 annual report Appendix H Chico’s Comparables Valuation 126    . Inc.

03 32.77 0.44 3.90 0.77 $ 5.86 2.45 $ 2.54 P/CF 4.25 $ 2.35 $ 2.35 4.35 0.06 0.24 0.35 *For the purposes of our analysis we excluded the P/CF and P/EBITDA multiples of Talbot’s and Coldwater Creek.90 2. **As of Oct 24.06 2.26 4.29 0.Comparable Ticker Christopher & Banks CorpCBK Coldwater Creek. TLB Ann Taylor Stores Corp.58 2.38 4. Inc.67 0.3 0.01 22.90 0.01 $ 0.61 $ 0.90 Average Intrinsic Value $ 2. ANN Average Basket Chico's CHS Multiples P/E P/S P/B P/CF P/EBITDA P/E 10.37 $ 4. Inc. because they skewed the results.90 3.45* 1.38 P/S 0. 2008 Source: Bloomberg Appendix I M&A Premium Analysis: General Search 127    .61 $ 1.24 $ 9.73 $ 2.15 1.14 $ 2.83 Basket Avg Chico's Intrinsic Value Current Price* 10.64 10.63 $ 2.38 n/a n/a n/a 9. DDS The Talbots.6 13.98 0.99 P/Ebitda 3.38 $ 0. Inc.02 0.2 0.03 1.61 3.13 $ 1. CWTR Dillard's.30 $ 2.91* 3.31 P/B 0.

37% 32.19% 54. Deal Status (Pending.55% -27. Stock).021. D: Deal value. M: Company's Market value D = M*(1+x) => x = D/M -1 Pros: Cons: Large scale M&A activities.397.00% 2007 7. There is no information about: Payment method (Cash.62% 54.67% -94.00% 2006 11.31% -3.39% -94. We calculate Average premium based on available data only Total Deal Value: Total Companies' Market Value 65.Apparel Industry M&A average premium General Statistics Source: Bloomberg Terminal Industry Apparel Period 45 months from Jan 05 to Sep 08 In which 6 months: no premium data available. Completed or terminated) Appendix J M&A Premium Analysis: Detailed Search 128    .39% -27. more representative information General information about M&A premium in Apparel Industry.43% 2005 -69.81% Average M&A Premium * Maximum Premium Minimum Premium * suppose x is premium.81% 2008 11.12% 41.07 US$ million Overall -34.00 US$ million 100.34% 20.

383.10% 62.60 US$ mil.34% Avg Premium * High Low * suppose x is premium.08% 22.72% 2006 16. The available data (deal with premium data) may be not representative for whole population Appendix K Chico’s Pro Forma Adjusted DCF Valuation 129    .Apparel .83% 2004 17. 12.03% 2005 31. M: Company's Market value D = M*(1+x) => x = D/M -1 Pros: Cons: More matched with Chico's deal There are so many deals without premium information.26% 2003 34.79% 55.60% 62.21% 30.52% 10.83% 14.Retail Apparal Industry M&A Premium Detail Search Source: Bloomberg Terminal Period Criteria Search Jan 2003 to Sep 2008 Current Deal Status: Payment Method: Industry: Extend: Completed Cash Apparel & Retail (apparel) Global Results: Total Deal value: Total Companies' market value: Overall 19.97% -8.38% 37. D: Deal value.10% -4.34% 35.77 US$ mil.08% -8.076. 2007 10.22% -0.

669 8.465 8.81 Initial Stock Price* Shares Outstanding (000) Market Cap (000) Premium 0.600 $185.428.198 257.323 50.428.86% 57.000 $232.198 $257.081 279.964 $135.067 *This is the same-store growth rate value if the company had forgone the 152.1% $239.600 201.47% $218.288 218.600 Values in Thousands 2 3 4 $218.47% Year Ended February 2010 2009 $252.198 8.21% 41.288 218.8M and 150M in capital expenditures on planning and opening of new.262 Year 0 ($517.299 8. remodeled and expanded stores in FY2006 and FY 2007 respectively ^FY2008 same-store growth rate from CHS 10-Q filed August 26.400 46.345 54.288 $279.247) (732. relocated.47% 2011 $273.684 -5% 2007 $304.299 3.299 3.600 201.858 8.975 Sum DCF (000) Total Liabilities/Equity (000) Sum DCF +Total Liabilities/Equity (000) Common Stock Outstanding (000)* Pro forma Value Per Share *Yahoo Finance $2.(000) Operating Cash Flow^^ Capital Expenditure** Same-Store Growth Rate*^ FCF Growth Rate 2012 $296.676 237.47% -18% 2008 $279.669 $1.900 $125.185) Pro Forma Adjusted Free Cash Flow Model 1 $201.93 176.540 $517.968.262) (575. 2008 and the FY2009-FY2011 same-store growth rate is an average of the same-store growth rates from FY2002-FY2006 found in CHS Annual Reports **Average of the proportion of capital expenditures to operating cash flows from FY2006-FY2007 multiplied to current year operating cash flow value ^^Previous years operating cash flow adjusted by the estimated same-store growth rate Year 1 2 3 4 5 Terminal Value Free Cash Flow (000) $201. 2008 $2.081 $302.578 65.055.198 257.676 $237.47% $237.081 279.218 176.428.55% *As of Oct 24.916 2.540 $16.907 52.511 2.081 Terminal $3.497 59.1% $227.299 IRR 61.198 $257.81% 130    .47% -17% $201.676 237.223 -8.00% 11.600 $218.315.676 8.302 912.27% 47.288 5 $279.866 $158.928 $146.719 Discounted Cash Flow (000) $171.676 $237.

00% FCF 7.41% 62.30% 64.94% 62.81% 69.00% Rate 8.47% 9.00% 25.34% 0.47% 47.11% 50.93% 64.27% 63.61% 57.00% 30.00% 49.03% 62.38% 59.62% 65.88% 66.00% 20.47% 9.94% 54.14% 52.35% 61.02% 55.00% 25.54% 60.16% 60.00% 40.22% 46.59% 53.66% 66.12% 65.99% 42.66% 56.11% 59.46% 56.00% 15.00% 15.50% 51.00% 40.44% 43.85% 54.61% 49.84% 52.16% 56.00% 25.03% 68.89% 61.17% 44.00% 20.47% 9.35% 36.79% Maximum Premium IRR Sensitivity Analysis Capital Expenditures Growth Rate 10.Appendix L Chico’s IRR Calculation and Sensitivity Analysis Minimum Premium IRR Sensitivity Analysis Capital Expenditures Growth Rate 10.00% 10.00% 43.65% 59.00% 54.00% 15.00% 20.12% 42.86% 67.37% 59.90% 58.15% 58.02% 49.80% 43.13% 56.07% 131    .88% 52.76% 45.63% 58.68% 55.81% 53.00% 10.22% 51.80% 48.89% 41.00% 30.00% Growth 8.57% 63.00% Growth 8.49% 56.52% 61.00% Rate 8.00% 30.38% 38.52% 0.27% 50.62% 54.42% 47.61% 59.00% Growth 8.37% 44.17% 57.00% Rate 8.00% FCF 7.06% 43.07% 45.00% 10.02% 50.28% Optimal Premium IRR Sensitivity Analysis Capital Expenditures Growth Rate 10.69% 47.89% 47.67% 59.82% 51.19% 49.42% 52.53% 46.66% 62.00% FCF 7.00% 31.27% 34.37% 64.04% 45.21% 48.75% 49.14% 61.02% 0.23% 51.18% 54.04% 55.

Given the legal nature of these rules and regulations. (6) closing phase. the acquirer and the target. are required to file various documents with the SEC at every step of the acquisition. This letter is often used in complex transactions. Securities and Exchange Commission. or merger proxy) is simply a document signed by all parties to a proposed transaction that states the general agreement to one or more key terms. Overview of the Acquisition Process and Filings: All acquisitions usually follow a standard structure – (1) initial valuation.. These key terms comprise of both binding and non-binding agreements. Initial Offer63 After a company has identified a potential acquisition target and has done the initial valuation. The Company Sale Process. Harvard Business School. 2007  132    . The following is a brief description of necessary filings. a term sheet. most of the text is directly from the following sources: SEC websites. Case 9-206-108. (4) due diligence. (3) structuring the deal. Both parties. when the parties want to tie down the principal terms of the deal early in the negotiation. (2) initial offer.S. (5) definitive agreement negotiation. Wikipedia articles on mergers and acquisitions. Regulations and Rules The following section includes rules and regulations stipulated by the U.Appendix M Firm’s Acquisition Process. Jr. Binding provisions: • 63 Confidentiality. April 10. it has to file a letter of intent with the SEC. and other related sources as noted below. Harvard Business School cases. Fruhan.                                                          Professor William E. A letter of intent (sometimes referred to as a memorandum of intent.

• • • • • • Purchase price.e. when the closing will occur. Definite Merger Agreement64 Once the due diligence process is completed by both parties.. The ‘fiduciary out’ clause. Break-Up Fee. Harvard Business School. There are some key negotiation points. Steps to closing. and includes the following sections: the purchase price. Case 9-206-108. transfer of assets. Additional due diligence. such as: • • The ‘material adverse change’ clause. how the price will be paid. Fruhan. or cash. or stock. The Company Sale Process. Jr. Warrants/indemnities. Non-compete agreements.• • • • Deal Termination i. Non-binding provisions: • Structure of transaction – payment by stock. “Drop Dead”.                                                          64 Professor William E. The definite merger agreement is usually 50 to 100 pages (excluding exhibits). covenants including how the business will be conducted pre-closing. Non-Solicitation. or both. closing conditions. or both. Exclusivity. 2007  133    . April 10. a definite merger agreement should be filed. Employment contracts. and what happens if the deal is terminated.

contingent considerations. Escrows. the regulators may request additional time to review additional information and the filing parties may request that the waiting period for a particular transaction be                                                          65 Wikipedia. Consummation of debt financing to be used in the acquisition.wikipedia. The Hart-Scott-Rodino Antitrust Improvements Act provides that before certain  134    . they have to arrange for certain U. Although the waiting period is generally 30 days. The filing describes the proposed transaction and the parties to it. Hart-Scott-Rodino Antitrust Improvements Act. ‘Tail directors’ and officers’ liability insurance covering these individuals until the period of continued legal liability following the sale expires (approximately six years). Upon the filing. tender offers or other acquisition transactions can close. Voting agreement and irrevocable proxy for management and directors. both parties must file a “Notification and Report Form” with the Federal Trade Commission and the Assistant Attorney General in charge of the Antitrust Division of the Department of Justice. a 30-day waiting period then ensues during which time those regulatory agencies may request further information in order to help them assess whether the proposed transaction violates the antitrust laws of the United States. http://en. Pre-Merger Notification65 Before both parties close the deal. It is unlawful to close the transaction during the waiting period. Expense reimbursement caps.• • • • • • • The ‘breakup fee’.S. The ‘antitrust out’. Government antitrust provisions.

Rule 10b-5 of the Securities and Exchange Commission66 One of the most important regulations promulgated by the SEC is the antifraud provision known as Rule 10b-5. Bagley. or artifice to defraud. or of the mails or of any facility of any national securities exchange. James W. For the purpose of determining the "size of the parties" one assesses the size of the party to the transaction. the size of the parties. scheme. The filing requirement is triggered only if the value of the transaction. 2004  135    . Early terminations are made public in the Federal Register and posted on the Federal Trade Commission website. not misleading. directly or indirectly.terminated early. and all subsidiaries of that ultimate parent entity. in connection with the purchase or sale of any security. The formal title is "Rule 10b-5: Employment of Manipulative and Deceptive Practices". The rule itself is relatively short.                                                          66 Carliss Y. practice. and in certain cases. (b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made. Additionally. or (c) To engage in any act.S. Baldwin. HBC 9-904-004. Quinn: M&A Legal Context: Standards Related to the Sale or Purchase of a Company. It also applies to the issuance of equity by the bidder in connection with a merger or acquisition. (a) To employ any device. by the use of any means or instrumentality of interstate commerce. Constance E. in the light of the circumstances under which they were made. and the complete text is the following: It shall be unlawful for any person. This rule is always invoked in insider trading cases and in fraudulent accounting practices. Dollar thresholds. its ultimate parent entity. or course of business. which operates or would operate as a fraud or deceit upon any person. exceeds certain U. some types of transactions are afforded the special treatment of shorter waiting periods. Feb 23.

damages typically consist of out-of-pocket loss.11  67 136    .0. 3.11. not opinions Material misrepresentation or omission Belief and reliance Scienter (or ‘knowingly or willfully’) Causation Interstate commerce Under the SEC rule. There are several required documents:                                                          U.’ Alternatively.S.1.gpoaccess. Regulation M-A is the main framework for conducting mergers and acquisitions in the United States. 2.’ Generally. or ‘the difference between what the investor paid (or received) and the fair market value of the stock on the date of the transaction.11&idno= 17#17:2. 5. 7. Securities and Exchange each of the following seven elements/conditions should be met: 1. 6. Regulation M-A67 Under the Code of Federal Regulations Title 17: Commodity and Securities Exchanges.1. it is difficult for plaintiffs to prove all conditions needed to obtain a finding of liability in Rule 10b-5. http://ecfr.The SEC or any damaged investor can sue a company and its officers for violation of the rule. returning what they received and getting back what they gave. In order for a defendant to be found liable in a civil case under Rule 10b-5. 4.1. Connection with the sale or purchase of securities Facts. Title 17: Commodity and Securities Exchanges.0. ‘investors can elect to rescind the transaction.

The summary term sheet must briefly describe in bullet point format the most material terms of the proposed transaction. the reasons for engaging in the transaction. trading price. if material. the vote required for approval of the transaction. an explanation of any material differences in the rights of security holders as a result of the transaction. The bullet points must crossreference a more detailed discussion contained in the disclosure document that is disseminated to security holders. current principal occupation or employment. Provides security holders with a summary term sheet that is written in plain English. Name and address. material occupations. 137    . Identity and background of filing person. if material. Terms of the transaction. dividends information. business and background of entities. The summary term sheet must provide security holders with sufficient information to understand the essential features and significance of the proposed transaction. and country of citizenship. and the federal income tax consequences of the transaction. a brief statement as to the accounting treatment of the transaction. the consideration offered to security holders. and prior stock purchases. if material. business and background of natural persons.Summary term sheet. A brief description of the transaction. title and number of securities. a statement whether or not the person was a party to any judicial or administrative proceeding during the past five years. Subject company information. a statement whether or not the person was convicted in a criminal proceeding during the past five years. This section includes the name and address of the subject company (or the issuer in the case of an issuer tender offer).

securities transactions during the past 60 days. proceedings. Companies engaged in M&A activities should also file documentation in compliance with the following SEC regulations: Agreements. use of securities acquired. intent to tender. retained. subject company negotiations. borrowed funds. The purposes of the transaction. Source of funds. Solicitations or recommendations.Past contacts. intent to tender or vote in a going-private transaction. significant corporate events in the past two years. Source and amount of funds or other consideration. potential conflicts of interest between the filing person and the subject company or its executives. employees and corporate assets. Purposes of the transaction and plans or proposals. negotiations. Persons/assets. recommendations of other interested parties. Solicitation or recommendation. regulatory requirements. and legal 138    . transactions. Financial information. negotiations or contacts. Additional information. itemized statement of all expenses incurred or estimated to be incurred in connection with the transaction. pro-forma information. The solicitation or recommendation. plans. compensated or used. A brief statement of the nature and approximate dollar amount of any transaction. Interest in securities of the subject company. summary information. Securities ownership. and agreements. Financial statements. reasons. employed. material conditions.

Securities and Exchange Commission.Regulation S-X . A tender offer is a proposal to buy shares of stock from the stockholders for cash or some type of corporate security of the acquiring company. Securities Exchange Act of 1934 and Energy Policy and Conservation Act of 1975.S. Williams Act68 The Williams Act of 1968 amended the Securities and Exchange Act of 1934 (15 U. Congress passed the Williams Act in 1968.S. Since the mid-1960s.C. or corporation seeks to acquire control of another corporation. it may make a tender offer. the proxy campaign.                                                          U. When an individual. Regulation C . § 78a et while at the same time providing the offering party and management equal opportunity to fairly present their cases.) to require mandatory disclosure of information regarding cash tender offers.governs the Form and content of and requirements for financial statements.governs the electronic submission of documents submitted to the Security and Exchange Commission together with EDGAR Filer Manual. which purpose is to require full and fair disclosure for the benefit of stockholders.html  68 139    . group. Regulation S-T . Because of abuses with cash tender offers. A proxy campaign is an attempt to obtain the votes of enough shareholders to gain control of the corporation's board of directors. cash tender offers for corporate takeovers have become favored over the traditional alternative.provides standard instructions for filing forms under Securities Act of 1933.provides registration and filing requirements. Regulation S-K . Williams Act. http://law.A.

When a person or group of persons acquires beneficial ownership of more than 5% of a voting class of a company’s equity securities registered under Section 12 of the Securities Exchange Act of 1934.htm  140    . Filing and public disclosures with the SEC are also required of anyone. The Williams Act gives the SEC the authority to institute enforcement lawsuits. Schedule 13D. Schedule 13-D69 Schedule 13D is commonly referred to as a “beneficial ownership report. they are required to file a Schedule 13D with the SEC.The act requires any person. Copies of these disclosure statements must also be sent to each national securities exchange where the securities are traded. The law also imposes miscellaneous substantive restrictions on the mechanics of a cash tender who makes a cash tender offer (which is usually 15% to 20% in excess of the current market price) for a corporation that is required to be registered under federal law to disclose to SEC the source of the funds used in the offer. misleading. Schedule 13D reports the acquisition and other information within ten days after the purchase. Securities and Exchange Commission. and includes any person who directly or indirectly shares voting power or investment power (the power to sell the security). http://www.S.” The term "beneficial owner" is defined under SEC rules. or incomplete statements in connection with a tender offer. and it imposes a broad prohibition against the use of false. making the information available to shareholders and investors. and any contracts or understandings concerning the target corporation.sec. The schedule is filed with the SEC and is provided to the company that issued                                                          69 U. who acquires more than 5% of the outstanding shares of any class of a corporation subject to federal registration requirements. the purpose for which the offer is made. the plans the purchaser might have if successful.

Nov 2003  141    . an increasing amount of attention is focused on the executive severance arrangements that are triggered upon a change in 280G.php/Internal_Revenue_Code:Sec. The important thing for potential acquirers._280G  71 Christian McBurney. and 20% excise tax is imposed on the executive. Internal Revenue Code:Sec. who receives the payment. the potential for disallowance of deductions and for the obligation of the target company to make substantial payments to executives. Golden Parachute Planning a Key in Acquisitions of Public Companies. Section 280 G of the IRS Code (Excess Golden Parachutes)70 In acquisitions of public companies.71                                                          70 Tax Almanac. The schedule is often filed in connection with a tender offer. This excise tax is in addition to normal payroll withholding tax and income tax and is also non-deductable. http://www. in pricing the deal.the securities and each exchange where the security is traded. From a acquisition target perspective. the target corporation may not deduct from its taxable income change in control payments made to an executive. is to understand several issues: the extent of the change in control payments.taxalmanac. and the opportunities for planning to reduce any potential adverse impacts. The change in control payments may result in the application of the IRS Section 280G ‘golden parachute’ provisions. Any material changes in the facts contained in the schedule require a prompt amendment. companies should plan for Section 280G ahead of time and to ensure that the executive severance packages accomplish their intended purposes in a tax efficient way. To the extent Section 280G applies.

302.458.7 5.Appendix N Chico’s Institutional Ownership Total Number of Shares Outstanding (Apr 30.183 3.0 6.663.578.6 4.8 6. Templeton Investment Counsel.005.000 5.8 9.P.697 2. LLC TOTAL: # Shares Held % Outstanding 10.8 4. Snow Capital Management.180 4.052 5. Schneider Capital Management Corporation Frontier Capital Management Company. L.197. Inc.956 283 95% Top 15 Institutional Shareholders as of Apr 30. Inc. Barclays Global Investors.927 3.103 3.4 9.564. N.630.512.289.919 3. 2008 Institution Name Columbia Wanger Asset Management. Deutsche Asset Management Americas UBS Global Asset Management (Americas).2 7.3 142    .900 2.2 7.3 7.706 2.424 4.510.690 4.1 5.644.A. Franklin Templeton Investments Corp. LLC State Street Global Advisors (US) Vanguard Group.0 5.509.811 5.P. UBS Global Asset Management (Switzerland) PRIMECAP Management Company Fidelity Management & Research Mazama Capital Management.412. 2008) Number of Institutional Holders % Institutional Ownership 176. L.256.6 99.083 56.485.093.177 3.314 2. Inc.6 4.2 5.

2008. On the other hand. The Class B can never sell for anything more than a tiny fraction above 1/30th of the price of Class This pushes the prices back into a 1:30 ratio. which is held the first Saturday in May. When there’s a lesser demand. has two classes of common stock designated as Class A and Class B. it will fall to a discount. Comparative Rights and Relative Prices of Berkshire Class A and Class B Stock. When there is more demand for the B (relative to supply) than for the A. http://www. BKR Class A share price was $77.                                                          72 Warren Buffet. When it rises above 1/30th. the B will sell at roughly 1/30th of the price of A. the B can sell for less than 1/30th the price of the A since conversion doesn’t go in the reverse direction.berkshirehathaway. at the holder’s option. As of November 20. written by Warren Buffett to Berkshire Hathaway’s shareholders: Berkshire Hathaway Inc. A share of Class B common stock has the rights of 1/30th of a share of Class A common stock. All of this was spelled out in the prospectus that accompanied the issuance of the Class B.html  143    . This conversion privilege does not extend in the opposite direction. That is.Appendix O Berkshire Hathaway Class A and Class B Stock72 The following section is a direct excerpt from a memo. Each share of a Class A common stock is convertible at any time. Both Class A & B shareholders are entitled to attend the Berkshire Hathaway Annual Meeting. into 30 shares of Class B common stock. except that a Class B share has 1/200th of the voting rights of a Class A share (rather than 1/30th of the vote). arbitrage takes place in which someone ¾ perhaps the NYSE specialist ¾ buys the A and converts it into B. holders of Class B shares are not able to convert their stock into Class A shares.500 and BKR Class B share price was $2.

3 76.1 13.6 62.0 0.4 5.0 40.4 1.9 139.4 30.6 10.7 139.7 16.9 1.1 45.8 6.9 16.6 12.0 0.4 0.8 4.0 39.2 18.6 1.3 16.0 0.4 1.8 2.1 0.8 3.0 41.2 10.1 9.0 2003 3.5 13.6 2005 2.0 88.2 1.4 -2.2 6.0 5.9 22.9 1.2 8.0 5.1 5.7 14.4 26.2 11.2 27.0 37.1 10.8 0.1 9.5 3.0 9.7 10.2 10.4 54.7 144    .6 7.6 1.2 148.0 0.5 2006 2.0 9.7 45.0 68.2 2.0 46.6 2.9 5.7 11.1 0.6 0.Appendix P AnnTaylor’s Financial Ratios AnnTaylor Stores 2007 Liquidity Ratios Current Ratio Quick Ratio Working Capital Per Share Cash Flow Per Share Activity Ratios Inventory Turnover Receivables Turnover Total Assets Turnover Average Collection Period (Days) Days to Sell Inventory Operating Cycle (Days) Profitability Ratios Operating Margin Before Depreciation (% Operating Margin After Depreciation (%) Pretax Profit Margin (%) Net Profit Margin (%) Return on Assets (%) Return on Equity (%) Return on Investments (%) Leverage Ratios Interest Coverage Before Tax Interest Coverage After Tax Long-Term Debt/Common Equity (%) Long-Term Debt/Shareholder Equity (%) Total Debt/Invested Capital (%) Total Debt/Total Assets (%) Total Assets/Common Equity 1.2 40.4 1.7 10.7 11.6 11.0 45.0 6.8 2.9 2.6 2.7 22.0 59.3 2006 2.0 2.5 14.2 14.4 4.5 1.8 48.5 2.0 0.1 7.4 40.8 14.8 2.7 108.3 0.6 95.7 Industry 2005 2.5 0.0 34.2 44.8 75.7 4.3 5.8 12.6 55.2 15.9 2.6 10.9 10.0 41.2 10.0 10.5 14.3 6.5 3.6 10.2 4.3 14.0 0.6 11.0 1.4 2.2 2.8 6.0 58.8 1.7 7.1 4.4 2004 2.3 10.2 2007 2.8 16.0 1.4 8.3 15.0 44.4 22.6 -1.0 0.1 15.2 10.4 19.4 11.0 37.9 77.4 8.5 5.1 10.7 38.2 18.0 1.7 4.7 3.4 1.9 7.8 9.6 14.0 0.1 15.7 14.7 5.6 13.4 1.8 10.2 10.0 0.9 4.5 14.8 6.3 1.5 67.9 1.3 21.3 21.4 87.1 6.6 3.3 24.4 10.1 2.2 2003 3.0 10.0 9.2 6.0 0.5 3.5 7.3 10.0 1.9 1.5 12.0 0.5 1.5 1.5 27.6 7.5 3.6 6.3 16.0 11.4 10.8 1.3 3.8 43.0 10.1 0.0 8.0 1.8 0.0 42.6 42.2 8.5 15.6 3.3 14.1 65.8 1.9 9.1 145.1 13.6 28.4 2004 2.2 6.8 12.0 0.3 1.0 2.2 10.8 1.0 38.6 139.0 1.9 143.2 3.

88 -48% 2003 1.8 33.2 11.5 31.7 29.5 28.4 33.7 20.2 31.7 $ $ $ $ $ $ $ $ $ $ $ $ 11 16.3 27.9% 2006 1.1 19.5 10.42 Expected 2008 EPS $ 1.8 17.0 26.0 22.13 25% 2004 0.4 11.29 Sensitivity Calculations Sensitivity to P/E and Growth rate Assumption P/E ratio -4% -3% -2% -1% 0% 1% 2% 3% 4% 5% 6% 7% $ $ $ $ $ $ $ $ $ $ $ $ 7 10.7 10.5 26.5 25.1 11.53 2% Share price = Expected EPS * P/E Multiple = $ 30.2 13.7 17.1 27.2 28.8 27.5 17.1 $ $ $ $ $ $ $ $ $ $ $ $ 21 30.2 25.6 14.0 17.1 32.0 $ $ $ $ $ $ $ $ $ $ $ $ 13 19.3 22.4 13.4 29.6 27.8 31.6 13.2 16.6 23.8 32.2 23.3 17.7 19.0 11.3 20.0 14.Appendix Q AnnTaylor’s Price/Earnings Valuation and Sensitivity Price/Earnings Model Valuation Calculation Industry Average P/E multiple as of Jan 08 FY2007 EPS EPS Growth rate 19.3 $ $ $ $ $ $ $ $ $ $ $ $ 15 22.5 13.7 16.4 23.8 31.9 11.5 32.0 25.53 -26% 1.7 34.98 56% 2005 1.41 $ 1.1 24.4 10.5 20.8 13.3 16.1 21.8 29.3 24.5 16.9 20.6 $ $ $ $ $ $ $ $ $ $ $ $ 17 25.5 30.9 14.5 $ $ $ $ $ $ $ $ $ $ $ $ 9 13.5 22.2 17.1 33.3 10.4 EPS Growth Rate AnnTaylor historical EPS EPS Growth rate Avg Growth 2007 1.9 28.8 10.1 20.3 14.9 24.5 19.9 21.1 29.5 14.2 14.6 10.7 23.3 26.2 30.9 30.56 145    .7 26.8 $ $ $ $ $ $ $ $ $ $ $ $ 19 27.0 23.1 34.3 19.8 18.

1 Terminal Value 700.63 32.3% 13.53 Rf** 3.429.84 26.02 33.50 26.3% 12.80 23.27 30.87 24.22% 2006 295.94 24.00 27.82 25.46 31.40 26.92 39.3% 18.41 22.2 3 116.710 5% 2004 169.0 5 116.99 25.78% 30.54 32.97 29.3% 17.17 36.78% U.29 29.3% 11.76 30.3% 20.22% 29.78% 1.23 23.776 200% 2003 189.88 26.01 36.11 29. Market Return (10/25/08)*** 11.886.3% 16.323 187.595.35 28.35 23.26 24.357 $ 803.15 33.04 25.67 24.74 25.24 24.199 100.18 27.197 139.83 25.389 57.08 21.25 27.78 26.032 803.98% Risk Premium 8.357 Debt**** Equity**** Total Liabilities and Stockholders' Equity Weighted Interest on all Liabilities WACC^ 0 803.998 117.89 28.12 28.618 71.86 30.0 $ 662.70 22.37 26.757.05 22.45 W A C C 10.936 86.032 0 16.20 27.78 31.45 26.32% *Google Finance **Average of 10yr Oct T-Bill Yields *** AnnTaylor 10-Q Report as of Aug 02 2008 ^ANN has no debt so WACC=Re (Bloomberg value 13%) Year Operating Cash Flow (Thousands) Capital Expenditure FCF Average Growth 2007 257.16 34.22% 0.38 22.9 2 116.96 27.138.3% Sum DCF* Total Liabilities/Equity* Sum DCF +Total Liabilities/Equity* Common Stock Outstanding* Instrinsic Value Per Share *Value in Thousands $ 662.55 24.3% 14.254 -195% Expected Future Free Cash Flow Year Free Cash Flow (thousands) Discounted Cash Flow Total 1 117.3% 21.20 28.60 22.931 165.674 74.364 118.259 152.613 123.57 3.20 23.3% 15.06 33.616 282.3% 22.04 29.43 22.78% 39.S.15 26.17 23.12 22.1 4 116.3% 19.08 23.465.89 27.74 23.06 27.152 54.71 24.96 27.19% Return on Equity^ 16.01 36.91 24.551.18 26.199 -0.79 25.62 24.583 $ 25.483 16.19 30.31 25.16 24.66 31.78% 42.13 2.74 23.20 24.04 146    .77 23.26 22.005 -10% 2005 311.Appendix R AnnTaylor’s DCF Valuation and Sensitivity Analysis Historical Free Cash Flow WACC CALCULATION Beta* 1.83 22.926 130.66 24.032 $ 1.22% -0.04 25.28 23.11 30.64 24.31 24.413 63.75 Share Price Sensitivity Analysis FCF Growth Rate -1.3% -2.28 28.09 23.

674 $ 116.616 IRR 41.9% 28.2% 36.21% 41.313 Expected Cash Flow (thousands) Premium/Year 0% 11.313) $ 117.58 (as of 11/19/2008) 57.413 $ 116.0% 147    .Appendix S AnnTaylor’s IRR Calculation IRR Calculation Initial Stock Price Common Stock Outstanding Market Cap (thousands) $5.199 $ (357.674 $ 116.674 4 $ 116.936 $ 116.936 3 $ 116.152 6 $ 700.152 $ 116.583 $321.819) $ 117.55% 0 1 $ (321.199 $ (454.616 $ 700.413 5 $ 116.199 2 $ 116.332) $ 117.152 $ 116.413 $ 116.616 $ 700.936 $ 116.

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