Cherokee Inc. has acquired a European footwear company, only to turn around and sell all the hard assets in the deal. For consumers, Cherokee’s name is more synonymous with classic American sportswear than with sneakers and boots. But late last month the Sherman Oaks firm announced a $96 million deal to acquire Dutch shoemaker Hi-Tec Sports International Holdings B.V., taking the company back to its roots in the footwear business. “The acquisition of (Hi-Tec) … aligns with our strategic focus,” Cherokee Chief Executive Henry Stupp said in a press release on Nov. 28. “We are excited by the potential to further expand the brand into additional categories.” Cherokee’s management team, which was unavailable to speak with the Journal by press time, announced on Dec. 8 that the acquisition had closed. Scott Stanton, a partner at the San Diego office of Morrison Foerster and who has served as Cherokee’s outside corporate counsel since 2005, described the process behind the transaction as highly complex. “The challenge was that Hi-Tec was sort of a ‘soup-to-nuts’ footwear maker,” Stanton explained. “They designed and manufactured the product, had it sold in different places – they did everything.” Cherokee’s business model is essentially the opposite. Its operations have focused solely on apparel licensing since 1995, when former Chief Executive Robert Margolis liquidated $20 million in manufacturing assets to pay off the company’s debt. Reestablishing itself as a “brand marketing platform” may have been Cherokee’s salvation – the company had filed Chapter 11 bankruptcy twice in the two years before Margolis took the helm – but it proved a tricky test for brokers’ negotiating skills when it came to acquiring Hi-Tec 20 years later. “When we looked at the Hi-Tec brand next to the other brands (in Cherokee’s portfolio), we thought, ‘Wow, that would really go with what we do,’” Stanton said. “But Cherokee holds intellectual property, which it licenses out to retailers and wholesalers. It never holds inventory and doesn’t sell products directly at all.” To make the deal work, Cherokee needed to purchase the whole of Hi-Tec’s business before selling its product-centric assets to individual operating partners. The company then plans to re-establish licensing agreements with each supplier, thereby retaining the Hi-Tec brand but not its tangible assets. Corporate attorney and consumer products expert Andrew Apfelberg, a partner at Greenberg Glusker in Los Angeles, observed that the deal’s unorthodox structure was a testament to the finesse of Cherokee’s management. “They’re cutting out just the intellectual property assets they need to conduct their core business … and shedding the rest to companies who do value those assets,” Apfelberg said. “(The structure) is very unusual for the apparel industry generally, but in this case it’s quite bright given Cherokee’s business model.” Financing the deal Back in 1968, before Cherokee had evolved into a multi-million-dollar apparel brand licensing firm, the company consisted of little more than an immigrant cobbler fashioning footwear for hippies on Venice Beach. By 1980, James “Argy” Argyropoulos was producing more than 1.5 million pairs a year, his wares lining shelves at national department stores the likes of Bloomingdale’s Inc. and Macy’s Inc. The Hi-Tec deal, together with the acquisition of the Flip Flop Shop chain of beachwear stores last year, puts Cherokee back in the shoe business. But before the company can focus on moving Hi-Tec’s products, it has to come up with the money to fund the purchase. To that end, the company will use cash on hand, a $50 million credit facility with Cerberus Business Finance LLC and proceeds from a $35 million public equity offering priced at $9.50 a share, launched on Dec. 2 through an underwriting agreement with Roth Capital Partners. The company will sell 3.7 million new shares of its stock priced at $9.50 a share. In a press release announcing the offering, Cherokee noted the proceeds would be applied first to the Hi-Tec acquisition, then to “general corporate purposes.” Even with an end in sight, Cherokee wasn’t out of the storm just yet. An unexpected glitch in the financing framework could have brought the whole acquisition tumbling down. “In terms of closing, the more moving parts, the harder,” Apfelberg said. “If you’re relying on the sale of certain assets … to finance part of the purchase price and that doesn’t go through or is delayed, it can mess up other aspects of the deal.” At the operational level, the acquisition involves the task of melding the two companies’ disparate business models as well as geographical challenges. From its headquarters in the Netherlands, Hi-Tec oversees manufacturing facilities and distribution channels across multiple continents. “This transaction required us to find operating partners in the U.S., Europe, South Africa – all over the place,” Stanton said. At press time, Cherokee had signed licensing agreements with three operating partners, including Carolina Footwear Group for markets in the U.S. and Canada; Batra Group in Europe and the United Kingdom; and Hi-Tec’s founder Frank van Wezel in South Africa. Together they will assume $32.8 million of Hi-Tec’s working capital, including its employees – along with the responsibility of generating sufficient revenue growth to keep Cherokee’s business afloat. “A licensor has to think about whether the operator is going to make a quality product and whether it will be sold in stores that enhance the goodwill of the brand,” Apfelberg said. “You want the licensee … to get the product to the customer’s hands regularly and often so it becomes a valued brand in that territory.” Hi-Tec’s presence in global markets will make promoting its products easier for Cherokee’s international operating partners. But while Hi-Tec’s footwear is already distributed in the U.S. through Amazon.com and Wal-Mart Stores Inc., the brand lacks the same awareness it enjoys overseas. “One challenge ahead will be to take a brand that has been particularly strong in Europe and the U.K. and build it here in the U.S. and other parts of the world,” Stanton said. “It’s not a new brand in the U.S., but there’s a real opportunity to grow it tremendously and then take it elsewhere.” That task could become much more crucial after Jan. 31, the day Cherokee’s license with Target Corp. expires. Target customers represent 43 percent of the company’s revenue, according to a report published Dec. 5 by Roth Capital, and failing to replace them could constitute a significant blow to Cherokee’s financial health. Value creation Despite its convoluted nature, Cherokee was able to see the acquisition through. In Apfelberg’s experience, negotiating such a complex deal to this point calls for exceptional skill on the part of the buyer. “This requires a very sophisticated deal team made up of the management, the buyer, their attorneys and their accountants,” he said. “Each individual aspect of a deal is its own mini transaction, so hats off to them for the coordination.” Of course, closing the deal is just the beginning. Cherokee aims to widen Hi-Tec’s shoe brands to include apparel, accessories and other products, which will constitute a significant initial investment. The strategy could backfire if excessive expansion dilutes the company’s core brands, noted the Roth Capital report, and “lackluster” consumer confidence in general could make the problem worse. But Stanton believes that Cherokee’s management, particularly Stupp, has demonstrated that it’s more than capable of moving the company forward. “I think this acquisition proves Cherokee is able to execute even the most complicated deal when there’s value to be unlocked,” Stanton said. “It really validates Cherokee as a company that can conclude complex, value-creating transactions.” Apfelberg agreed. Companies that demonstrate discipline and consistency in their dealings tend to fare the best over time, he said. “When I look back five years after a closing, I find that the most successful deals are by acquirers who really know their core values and competencies,”Apfelberg said. “From the outside, this appears to be exactly that.”
