Complications and Legal Issues
The pending deal is not without controversy. In fact, it is the subject of at least two separate legal investigations that have been launched in an effort to determine whether Hot Topic, Inc. (NASDAQ:HOTT)’s board observed the proper “shopping” protocols before announcing the deal. Specifically, the Brower Piven investigation alleges that the company abdicated its fiduciary responsibility to its shareholders by accepting a deal that undervalued it by as much as 17 percent.
It should be noted that such investigations are common in the wake of buyout announcements. In addition, the means by which Brower Piven “values” Hot Topic, Inc. (NASDAQ:HOTT) is suspect: It simply notes that a stock analyst had issued a $16.40 price target for the company at some time in the past. Owing to this relatively flimsy rationale, it is unlikely that these legal actions will ultimately delay or scuttle the deal. However, they could lead the company’s board to entertain the prospect of higher rival bids that may provide shareholders with an additional arbitrage opportunity.
Competitors: Who Could Be Next?
Although the announcement of this buyout deal has fuelled talk that more teen apparel buyouts might be on the horizon, such speculation might be premature. For starters, this sub-industry is unique in several key ways, and it does not necessarily respond well to consolidation. Since fashion trends are subject to rapid change, it is often not in the best interest of a management team to accept a merger offer or buyout from an outside group.
While companies like Aeropostale, Inc. (NYSE:ARO) and Abercrombie & Fitch Co. (NYSE:ANF) have lately struggled to stay out in front of changing clothing tastes and posted underwhelming earnings results, this does not necessarily make them prime buyout targets. In the fashion world, it is often more effective for boards of directors to replace the key executives or managers in order to see change.
Aeropostale, Inc. (NYSE:ARO) has experienced flat sales for the past year, while Abercrombie has actually increased sales by 10%. With the PEG ratio much larger for Aeropostale, Inc. (NYSE:ARO), investors are apparently expecting more growth out of that retailer than Abercrombie in the next five years. Investors who hold positions in Hot Topic’s peer companies should not necessarily be crossing their fingers for a flurry of buyout activity.
In sum, investors should refrain from drawing broad conclusions from the specific circumstances of the Hot Topic, Inc. (NASDAQ:HOTT) buyout. Within those constraints, this transaction represents an excellent opportunity for arbitrage investors to realize short-term profit.
Those who believe that legal issues will ultimately delay the deal may wish to initiate a short position in Hot Topic or hold out for a higher buyout offer from a third party. Those who believe that this deal will go through as planned should stand ready to buy into Hot Topic, Inc. (NASDAQ:HOTT) on any news-related dips.
The article More Buyouts in the Teen Clothing Space? originally appeared on Fool.com and is written by Mike Thiessen.
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