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2008

 

 

Ayesha Hafeez Erin Young Kyle Sparger Manh Vu Duc Nasko Chobanov 

Acquisition of Chico’s:                MBA Capstone Project 

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Table of Contents EXECUTIVE SUMMARY  5 INTRODUCTION  6 1.  INDUSTRY ANALYSIS  8 

OVERVIEW  8 1.1 ECONOMIC ENVIRONMENT  8 1.2 REGULATORY ENVIRONMENT  10 1.3 TECHNOLOGY ENVIRONMENT  11 1.4 SOCIO-CULTURAL ENVIRONMENT  16 1.5 GLOBAL ENVIRONMENT  17 

2.  PORTER’S FIVE FORCES FRAMEWORK  18 OVERVIEW  18 2.1 THREATS OF NEW ENTRANTS  19 2.2 EXISTING COMPETITION  26 2.3 RIVAL PRODUCTS  28 2.4 BARGAINING POWER OF THE END CONSUMER  29 2.5 BARGAINING POWER BETWEEN THE COMPANY AND THE SUPPLIER  30 2.6 BARGAINING POWER OF SUPPLIERS  31 CONCLUSION  33 

3.  COMPETITOR ANALYSIS  34 OVERVIEW  34 3.1 DILLARD’S  34 3.2 TALBOTS  36 3.3 ANN TAYLOR  37 3.4 COLDWATER CREEK  38 3.5 CHRISTOPHER AND BANKS  39 3.6 LIMITED BRANDS, INC.,  40 3.7 OTHER COMPETITORS  42 CONCLUSION  43 

4.  FINANCIAL RATIO ANALYSIS  44 OVERVIEW  44 4.1 LIQUIDITY RATIOS  45 4.2 ACTIVITY RATIOS  48 4.3 PROFITABILITY RATIOS  50 4.4 LEVERAGE RATIOS  52 4.5 STOCK MARKET RATIOS  54 4.6 OVERALL STRENGTHS/WEAKNESSES AND FUTURE FINANCIAL CONDITION  55 CONCLUSION  57 

5.  CHICO’S SWOT ANALYSIS  58 OVERVIEW  58 5.1 STRENGTHS  60 5.2 WEAKNESSES  64 5.3 THREATS  65 5.4 OPPORTUNITIES  67 CONCLUSION  71 

6.  VALUATION  71 OVERVIEW  71 

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6.1 DISCOUNTED CASH FLOW ANALYSIS  71 6.2 VALUE CREATION MODEL  73 6.3 COMPARABLES VALUATION  75 6.4 MERGERS AND ACQUISITIONS (M&A) PREMIUM  76 6.5 ACQUISITION PRICE  77 6.6 ADJUSTED DCF ANALYSIS AND IRR  78 CONCLUSION  80 

7.  CHICO’S FAS ACQUISITION STRATEGY  81 OVERVIEW  81 7.1 AWWI’S MERGER AND ACQUISITION (M&A) TEAM  81 7.2 ACQUISITION OBJECTIVES  82 7.3 CHICO’S TAKEOVER PREVENTION MECHANISMS  83 7.4 APPROACH TO CHICO’S SHAREHOLDERS  84 7.5 PLAN A - 100% CASH TRANSACTION  85 7.6 PLAN B - 100% STOCK BUYBACK AND SWAP  86 7.7 APPROACH TO CHICO’S EXECUTIVE MANAGERS  87 7.8 OFFER PRICE AND EXPECTED RETURN ON INVESTMENT  88 CONCLUSION  89 

8.  POST-ACQUISITION STRATEGY  91 OVERVIEW  91 8.1 ALIGN PRODUCT MIX AND STRENGTHEN CUSTOMER SERVICE  91 8.2 IMPROVE MARKETING EFFECTIVENESS  93 8.3 HALT EXPANSION AND REFOCUS ON EXISTING STORES  95 8.4 INTEGRATE SOMA INTO CHICO’S STORES  98 8.4 ESTABLISH AN OVERSEAS OFFICE IN ASIA  99 8.5 EVALUATE OPPORTUNITIES TO BUILD STRATEGIC RELATIONSHIPS  100 8.6 EXPLORE ACTIVE MANAGEMENT OF EXCHANGE RATE RISK  101 8.7 OTHER POSSIBLE LONG-TERM OPPORTUNITIES  102 

CONCLUSION  103 9. ALTERNATIVE ACQUISITION CANDIDATE – ANNTAYLOR STORES, CORP.  104 

9.1 COMPANY OVERVIEW  104 9.2 FINANCIAL ANALYSIS  105 9.3 ANNTAYLOR’S SWOT ANALYSIS  110 9.4 VALUATION  116 9.5 POTENTIAL ACQUISITION OF ANNTAYLOR STORES  118 

OVERALL PROJECT CONCLUSION  118 APPENDIX A  CHICO’S FINANCIAL RATIOS  120 APPENDIX B  CHICO’S DCF VALUATION  121 APPENDIX C  CHICO’S WEIGHTED AVERAGE COST OF CAPITAL  122 APPENDIX D  CHICO’S DCF VALUATION: SENSITIVITY ANALYSIS  123 APPENDIX E  CHICO’S VALUE CREATION MODEL  124 APPENDIX F  CHICO’S VALUE CREATION MODEL: SENSITIVITY ANALYSIS  124 APPENDIX G   CHICO’S DIRECT COMPETITORS  125 APPENDIX H   CHICO’S COMPARABLES VALUATION  126 APPENDIX I  M&A PREMIUM ANALYSIS: GENERAL SEARCH  127 APPENDIX J  M&A PREMIUM ANALYSIS: DETAILED SEARCH  128 

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APPENDIX K  CHICO’S PRO FORMA ADJUSTED DCF VALUATION  129 APPENDIX L  CHICO’S IRR CALCULATION AND SENSITIVITY ANALYSIS  131 APPENDIX M  FIRM’S ACQUISITION PROCESS, REGULATIONS AND RULES  132 APPENDIX N   CHICO’S INSTITUTIONAL OWNERSHIP  142 APPENDIX O  BERKSHIRE HATHAWAY CLASS A AND CLASS B STOCK  143 APPENDIX P  ANNTAYLOR’S FINANCIAL RATIOS  144 APPENDIX Q  ANNTAYLOR’S PRICE/EARNINGS VALUATION AND SENSITIVITY  145 APPENDIX R   ANNTAYLOR’S DCF VALUATION AND SENSITIVITY ANALYSIS  146 APPENDIX S   ANNTAYLOR’S IRR CALCULATION  147 

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Executive Summary As the consulting team for Ace Whippo Widgets, Inc. (AWWI), a wholly-owned

subsidiary of Berkshire Hathaway (BRK), we conducted a comprehensive analysis of Chico’s FAS, Inc. (Chico’s) and its industry to determine the financial health of the company and whether it represented a good acquisition candidate. In addition, we conducted an analysis of an alternative acquisition candidate, AnnTaylor Stores, Corp. (AnnTaylor), in the event that our attempt to acquire Chico’s should fail. The retail apparel industry is characterized by rapid business cycles, vigorous competition, and low barriers to entry. The industry’s product line changes every season as customer fashion preferences change quickly. Because of low barriers to entry, the industry is highly concentrated with many companies producing rival products. Companies are currently experiencing difficulties due to the declining economy, resulting in reduced revenue and same-store sales. 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. This exposes the industry to exchange rate risks, extended supply chains, and international trade regulations.

Chico’s sells women’s apparel and accessories through its brick-and-mortar stores and websites. The company operates multiple brands such as Chico’s, White House| Black Market (WH|BM), and Soma Intimates (Soma) to target different market segments with mid- to high-income levels. Chico’s has been performing well compared to its competitors. The company places special emphasis on customer service and building brand equity. Chico’s manages inventories and receivables effectively, resulting in a short operating cycle. Financially, the company has a zero-debt capital structure and a strong liquidity position. This provides Chico’s with the ability to take advantage of attractive investment opportunities that may arise. Chico’s has historically generated strong operating results and profitability. Given these competitive strengths, the stock market has historically placed a high premium on Chico’s. However, we have identified areas that need improvement, including a mismatched product mix, an ineffective marketing campaign, and declining same-store sales growth. We also found that Chico’s has recently pursued an overly-aggressive expansion strategy.

We found that Chico’s market value is currently attractive. Its current market capitalization is roughly twice its one-year pro forma adjusted free cash flow. We believe that if Chico’s were to halt its aggressive expansion strategy, it would save considerable capital investment which could then be redistributed to investors or other superior projects. We recommend that AWWI should acquire Chico’s with an optimal offer price of $3.26 per share, resulting in a projected internal rate of return of 57%. AWWI should use a combination of cash and an open-market buyback and stock swap of Berkshire Hathaway Class B stock. If successful, we expect to implement our post-acquisition strategy, which includes halting expansion, realigning product mix, improving marketing effectiveness, closing Soma Intimates as a separate store, and reintegrating the Soma product line into Chico’s other stores.

Should the acquisition of Chico’s fail, we recommend that AWWI pursue AnnTaylor as an alternate candidate. The company is a direct competitor of Chico’s and shares many common feature, such as similar market capitalization, a strong financial position, and strong performance indicators. These similarities make AnnTaylor an acceptable alternate candidate.

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Introduction Chico’s started in 1983 as a small store, selling sweaters in Florida before

adopting the Chico’s name in 1985.1 The company has grown into 642 company-owned

Chico’s locations targeting women 35 and older with mid- to high-income levels. It also

has 332 company-owned WH|BM locations targeting women 25 and older with mid- to

high-income levels. Last, the company has 70 Soma locations targeting similar “fashion

conscious” customers as Chico’s and WH|BM.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.3 Seasonality in the fashion industry refers to the fact that each year, there are

four distinct fashion seasons requiring markedly different product characteristics.

Chico’s has a “multi-faceted” growth strategy that encompasses internal

infrastructural adaptations and external expansion via acquisitions and new-store

development.4 In order to prepare itself for future growth, the company has increased the

number of direct-to-consumer and management employees. It has also developed

technology systems to obtain SKU-data, information pertaining to loyalty programs, and

point of sale data. Currently, the company does not plan to acquire any new subsidiaries

but plans to continue introducing product extensions that align with its current product

lines. 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 Chico’s FAS, Inc. Website: http://www.chicos.com/store/page.jsp?id=39 2 Chico’s FAS, Inc. 2007 Annual Report, pg. 2 3 Chico’s FAS, Inc. 2007 Annual Report, pg. 2-3 4 Chico’s FAS, Inc. 2007 Annual Report, pg. 4 

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complementary accessories.”5 This approach, coupled with the company’s customer

service and loyalty programs, is viewed as a major advantage for Chico’s. Sales

associates receive special training in order to create a pleasant experience for the

customer. Training includes fashion advice regarding outfits and jewelry, and learning

the preferences of repeat customers in order to serve them more efficiently. In addition,

Chico’s increases its repeat sales through customer rewards programs for Chico’s/Soma

and WH|BM, which had 2.4M and 2.1M members, respectively, in 2007.6

The following analysis discusses five aspects of the environment and the industry,

in which Chico’s operates; an analysis of Chico’s closest competitors on the basis of

product lines; a financial analysis evaluating the five ratio family trends; an evaluation of

Chico’s strengths, weaknesses, opportunities, and threats (SWOT); a valuation of Chico’s

as an acquisition candidate; AWWI’s acquisition strategy and post-acquisition

recommendations; and an evaluation of AnnTaylor as an alternative acquisition

candidate.

                                                        5 Chico’s FAS, Inc. 2007 Annual Report, pg. 4 6 Chico’s FAS, Inc. 2007 Annual Report, pg. 6-7 

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1. 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. In addition, companies have to find other ways to differentiate their product

from the competition, such as customer service. Business strategies revolve around the

customer’s wants, needs, and perception in this industry due to the potentially high

bargaining power of the end consumer. The industry has fast-paced business cycles that

make it difficult for companies with the wrong product mix to correct the problem. This

is due to the fact that when winter clothes are in the stores, spring lines are being

manufactured, summer lines have been designed and approved, and next year’s fall lines

are being conceptualized. Thus, the wrong product mix can be detrimental to a

company’s profitability during a particular season.

Currently, retail apparel companies are operating in an economic recession.

Consumer spending has decreased, which has caused decreased profitability for retail

companies, who depend on consumer sales. Companies must find a way to continue to

develop a coveted product while at the same time maintaining current expense levels.

1.1 Economic Environment

The state of the economy has a large impact on the retail apparel industry. When

the economy does well, consumers spend money and buy new products, but, when the

economy declines, consumers tend to spend less and save more. Based on 55

economists’ forecasts in The Wall Street Journal (WSJ), the Gross Domestic Product

(GDP) is predicted to decline through the first half of 2009, with a small recovery

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beginning in the second half of the year.7 The United States has a trade deficit, which

means that imports into the United States are greater than exports from the United States.

In fact, the deficit in the current account decreased to $56.5B in September 2008 from

$59.1B in August 2008. Exports decreased by 6.0% from August 2008 to September

2008, while imports decreased by 5.6% over the same period. The trade deficit in goods

slightly decreased by 2.1% over the same period. In addition, the trade surplus in

services increased 9.2% over the same period. 8

Currently, the United States is in a period of deflation. The Consumer Price Index

(CPI), which measures average price of consumer goods and services purchased by

households, can give a measure of inflation by taking the percent change in CPI.9 In

October 2008, the CPI decreased by 1%. However, WSJ economists expect inflation to

end the year at 2.8% and forecast 1.2% by June 2009 and 1.8% by December 2009.10

The immediate deflationary environment can force a decrease in gross operating margin

for companies. Companies have difficulty decreasing labor wages and other

contractually-defined costs, but they are forced by the market to decrease prices. In

addition, consumer spending has declined and is expected to continue to decline. Further,

projected increases in unemployment will continue to put pressure on the consumer’s

ability to spend, as will increasing consumer interest rates. However, 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. Additionally, lower energy                                                         7 The Wall Street Journal. Economic Forecasting Survey: November, 2008, http://online.wsj.com/public/resources/documents/info-flash08.html?project=EFORECAST07 8 U.S. Department of Commerce. U.S. Census Bureau U.S. Bureau of Economic Analysis, http://www.census.gov/foreign-trade/Press-Release/2008pr/09/ft900.pdf 9 The Wall Street Journal. Economic Forecasting Survey: November, 2008, http://online.wsj.com/public/resources/documents/info-flash08.html?project=EFORECAST07 10 The Wall Street Journal. Economic Forecasting Survey: November, 2008, http://online.wsj.com/public/resources/documents/info-flash08.html?project=EFORECAST07 

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costs directly benefit industry because decreases in energy prices reduce transportation

and other costs.11 Recently, the U.S. Dollar has been appreciating against other

currencies, potentially lowering the input costs for producers that outsource

manufacturing to, or import from, other countries.

Because Chico’s sells commodity items, the continuing decline in the economy is

likely to have a significant effect on Chico’s operating results. The decrease in consumer

spending is likely to translate to lower sales, and the deflationary environment is likely to

put pressure on Chico’s gross margins. A decrease in energy costs may buoy Chico’s

operating results but is unlikely to fully offset the aforementioned decrease in consumer

spending.

1.2 Regulatory Environment

There are several trade regulations that are important to consider as part of the

regulatory environment. The North American Free Trade Agreement (NAFTA) between

the United States, Canada, and Mexico, signed in 1994, will remove the majority of trade

barriers by the end of 2009.12 In 1995, the World Trade Organization’s “Agreement on

Textile and Clothing” phased in a reduction in import quotas. The Agreement fully

matured in 2005, resulting in the removal of all restrictions on the import of textiles and

clothing.13 Additionally, labor laws must be considered. The Fair Labor Standards Act

in the United States specifies an employee minimum wage and regulates overtime pay

                                                        11 The Wall Street Journal. Economic Forecasting Survey: November, 2008, http://online.wsj.com/public/resources/documents/info-flash08.html?project=EFORECAST07 12 U.S. Department of Agriculture. North American Free Trade Agreement (NAFTA), http://www.fas.usda.gov/itp/Policy/nafta/nafta.asp 13World Trade Organization. UNDERSTANDING THE WTO: THE AGREEMENTS, http://www.wto.org/english/thewto_e/whatis_e/tif_e/agrm5_e.htm 

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and youth employment requirements. These regulations, if violated, can result in

litigation and large penalties for companies.14

Because Chico’s exports the entirety of its manufacturing processes, free trade

without quotas is critical to the company’s global supply chain and operations. NAFTA

is also very important to Chico’s operations because the company maintains “cut and

sew” shops in Mexico, Guatemala, and the United States.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.

1.3 Technology Environment

Technology has become a critical infrastructural component of operations within

the industry. The ability of technology to automate record keeping, provide decision

support or automate decisions, 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. Other companies embrace technology and find ways to

use it to create strategic advantage or to level the playing field.

Because efficient supply chains are critical to companies operating within the

retail apparel industry, Enterprise Resource Planning (ERP) systems are critical to a

company’s ability to remain competitive. In the context of a supply chain, 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.

A well-designed ERP system can provide a company transparency into its supply

chain and speed up and improve decision making. Real-time data on the disposition of                                                         14U.S. Department of Labor. Compliance Assistance ­ Fair Labor Standards Act (FLSA), http://www.dol.gov/esa/whd/flsa/ 15 Chico’s FAS, Inc. 2007 Annual Report, pg. 22 

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inventory, orders, transportation, accounts payable and receivable, and just about any

metric the company has identified as relevant is made available with a simple database

query.

Modules can be implemented to provide “dashboard” style views of company

health, providing managers instant understanding of the status of various parts of the

company. Automated alerts can be generated when exceptions arise, increasing the speed

with which the company becomes aware of and responds to problems. Certain decision

processes can be automated, such as placing orders or making payments to suppliers,

reducing workload and the probability of errors in the process. Power users can develop

their own reports, providing real-time information to local managers in order to improve

decision making. Additionally, historical data can be used to make forecasts (e.g.,

demand) which can improve supply chain efficiency.

It should be noted that ERP systems are only as good as the processes with which

they interact. When implementing and maintaining an ERP system, 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. Without the appropriate data, an ERP system is

virtually useless.

Additionally, the company must ensure that there is a strong understanding of

business processes in order to use the ERP system appropriately. Without this

understanding, the automation and decision support capabilities of the system will not

function as expected. At best, this can lead to inefficiency. At worst, a poorly-designed

or implemented ERP system could lead to or execute poor decisions, resulting in lost

time and money for the company.

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There is danger that a company will assume that ERP systems are a “magic

bullet” which will solve all of their problems. Companies that implement ERP systems

often fail to recognize that such systems are only as good as the processes they support,

and in turn are supported by. 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 Internet poses a special problem and opportunity for retail apparel stores.

The Internet provides companies operating in the industry with a new, low-cost channel

to reach its customers. Because of this, companies can use the Internet to increase their

sales with relatively little incremental investment. 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.

Additionally, a clever company could use such a website as an automated method

for receiving customer feedback, recording customer interest in various products and

which product combinations customers tend to buy. This would allow the company to

learn which products are likely to cross-sell easily, which can increase sales.

However, the Internet also provides potential competitors with an easy way of

developing a new marketing channel. If one company can easily create an Internet

catalog, others can too. This makes entry into the market easier in an industry that is

already easy to enter, resulting in intensified competition. In the past, potential entrants

would have to either make large capital investments to develop a physical presence or

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develop a mail-order business. The Internet allows entrants to bypass these steps and

reach interested customers directly with relatively little investment.

Additionally, because consumers can easily cross-check competitor websites, the

Internet allows customers to drastically reduce their searching costs. Prior to the Internet,

a customer would have to visit multiple stores or check multiple physical catalogs to

compare prices and products. Now, the customer can easily browse multiple websites

simultaneously and rapidly find the best deals. 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.

Companies can also invest in infrastructure and processes that track customer

purchases and preferences. The system could be part of an ERP or stand-alone. Once in

place, the system can improve customer interaction or marketing campaigns or track and

forecast customer demand.

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. The associate can be made aware of past customer purchases, allowing the

associate to present the customer products that are more likely to appeal to the customer’s

taste. Knowledge of the customer’s past purchases increases the opportunity for cross-

selling, as the associate can provide recommendations that will complement or be

complemented by those past purchases. Additionally, the sales associate can be made

aware of special customer issues, such as past complaints, and react accordingly. All of

these capabilities improve the ability of the sales associate to create revenue and improve

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the ability of the company to create a strong relationship with the customer in order to

drive revenue in the future.

With specific customer information in hand, such a system can allow the

company to develop targeted marketing campaigns. Managers could mine the system for

customers with certain characteristics, such as geographic region, demographics, visit

frequency, purchase frequency, or specific products the customer has previously

purchased. These characteristics can then be used to elicit specific responses from the

targeted customer group.

Finally, such a system can be used to improve management of the supply chain.

While historical order information can be used as a good metric for forecasting future

demand, knowledge of specific customer habits can be used to make better forecasts. For

example, using simple historical order information can only tell the company which

stores have historically demanded a product or type of product. However, tracking this

information at the customer level can result in better decisions. For example, if a

customer moves, 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.

Technology has become a critical component of any retail company’s

infrastructure. It is no longer just a source of competitive advantage; technology has

become a cost of doing business. Retail companies with poor technology management

will suffer from inefficiencies compared to their competitors and experience lower

returns. As such, retail company management must pay special attention to their

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technology infrastructure, as well as industry and competitor trends, in order to remain

competitive.

1.4 Socio-cultural Environment

People are moving from urban to suburban areas and “micropolitans” for the

clean air, decrease in traffic, healthier environment, less noise, and less pollution.16 This

results in changing demographics which companies must consider when determining

marketing strategy and store placement.

More companies are outsourcing manufacturing to take advantage of low-cost

labor and raw materials. However, outsourcing occasionally creates public relations

issues. 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, increasing healthcare costs have become a major issue for the

United States. A WSJ-NBC Survey reported that healthcare was seen as the number one

concern for approximately 50% of the U.S. population.17 These increasing healthcare

costs directly translate into decreased disposable income for consumers, which may lead

to decreased profits for the companies that market to them. However, 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

increases.

                                                        16 Killion, Rick. “Micropolitans - Life keeps getting better on the Northern Great Plains.”Prairie Business Magazine. November 7, 2008.Online. Available: http://www.prairiebizmag.com/articles/index.cfm?id=9517&section=News 17 National Coalition on Health Care. Health Insurance Costs, http://www.nchc.org/facts/cost.shtml 

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Also, increasing health care costs result in larger employee benefit expenses due

to increasing health insurance premiums. Chico’s must either suffer these additional

increases in cost or decrease their employee coverage, which will either lead to decreased

operating margins or increased employee dissatisfaction.

1.5 Global Environment

The United States will experience significant changes at the federal government

level as it transitions from Republican President G.W. Bush to Democratic President-

Elect B.H. Obama. Additionally, the Democratic Party increased its hold on both houses

of Congress, and now holds a strong majority in both the House of Representatives and

the Senate. This change may result in the government taking a more hostile view of

business activities. The Democratic Party historically takes a more populist view than the

Republican Party and often implements laws that empower unions, increase consumer

and worker protections, increase taxes, and otherwise increase government regulation of

business activities.

The new administration faces many challenges. The current financial crisis,

which began in the United States in 2007, involves many different parties. It has led to a

decrease in consumer spending, lowered consumer confidence, a large number of

foreclosures in the subprime mortgage sector, and increased unemployment.

Additionally, many financial institutions have gone bankrupt or have had to be rescued

by the federal government. 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.

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2. 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.”18 This

allows companies to develop a competitive strategy based on their specific industry

environment. Thus, to continue the analysis of the external environment, Michael

Porter’s Five Forces Framework provides a more in depth look at the retail industry,

specifically apparel retail.

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. Companies compete on customer service, size, fit,

quality, and price. If a company tries to enter the market and wants to be competitive, it

must consider this criteria and work hard to differentiate its products from those of its

competitors. Companies experience difficulty competing in this market because it is

difficult to differentiate products, and the industry cycle turns multiple times per year,

rapidly eroding any advantage gained. These market characteristics make the

achievement of consistent abnormal returns difficult, while permitting competitors the

opportunity to steal market share at any time.

Since the majority of the companies import their products to take advantage of

lower input and labor costs, joining trade organizations such as Custom-Trade

Partnership Against Terrorism (C-TPAT) is one way to gain an advantage. C-TPAT is a

voluntary government-industry organization. Members are held accountable for the

                                                        18 Porter, Michael E. Competitive Strategy. New York: The Free Press, 1980. 

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integrity of their supply chain with regards to security and sound practices. Member

companies have a special relationship with customs agents and receive priority over non-

members when inspections are required. More importantly, member companies have

reduced inspections on imports.

The following analysis will discuss each component of Porter’s five forces

framework in detail. First, the analysis will look at the threat of new entrants and how

Chico’s is susceptible to companies entering its target market. Second, it will look at

existing competition and how Chico’s attempts to separate itself from the competition.

Third, 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.

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. Last, there

will be a discussion of the bargaining power of the supplier and how Chico’s is less

susceptible to it.

2.1 Threats of New Entrants

In the retail apparel industry, there is a constant threat of new entrants into

individual market segments. However, there are large economies of scale that give

established market participants a distinct advantage over new entrants. Entrants will have

to make large investments to bring merchandise to market, including design,

manufacturing, and the creation of a distribution channel. The type of distribution

channel selected will impact the magnitude of the capital investment necessary to make

sales to the customer. Direct channels necessarily require less investment while retail

store fronts will require considerable capital investment. As the channel matures, the

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company will experience increasing economies of scale as common infrastructure

supports multiple points of sale. Another key investment is brand equity, which can be

developed through advertising, high quality products, customer service, and other means.

Marketing campaigns and promotions to entice traffic into new stores have the potential

to be expensive and, if not conducted properly, ineffective.

Founded in 1983, Chico’s has developed a mature supply chain with its designers,

manufacturers, and distribution center in place. 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. Companies entering the market will have

to compete with not only Chico’s established supply chain, but also with Chico’s highly-

experienced executive management. Because Chico’s has over 1000 stores in the United

States and 25 years of experience, 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. Not only does Chico’s have a

marketing strategy in place, they also have established relationships with media

representatives. New companies will have to spend a large amount of money in finding

the right medium to reach customers and obtaining prime ad locations. A new company

with a small roll-out will have difficulty competing with the financial resources and

mature supply chain that Chico’s maintains.

A first mover advantage is not likely to be sustainable in the retail industry, which

revolves around constantly-changing fashion trends. Currently, the majority of retailers

use manufacturers in foreign countries to obtain lower-cost raw materials and labor.

However, if a company were to identify a new supplier market providing superior cost

21  

advantages, the move has the potential to be more sustainable, as competitors will take

longer than a fashion season to match the move. Another non-sustainable advantage is

membership in trade organizations that provide expedited customs processes for

members. Membership in organizations, such as C-TPAT, is available for most U.S.

importers, and provides an advantage only in so far as competitors do not join.

As a member of C-TPAT, Chico’s reaps the benefits that some of its rivals fail to

obtain. Based on the understanding that Chico’s will maintain integrity in its supply

chain, U.S. Custom’s regulatory processes are less rigid. Because of this membership,

Chico’s receives preferential treatment in the customs inspection process. Membership in

C-TPAT does not prevent companies from entering into Chico’s target market, but it does

allow Chico’s an advantage in the import process.

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.

When winter clothes are in the stores, spring lines are being manufactured, summer lines

have been designed and approved, and next year’s fall lines are being conceptualized.

Thus, if a company’s product is not in line with fashion trends, it is almost impossible to

correct the problem without a long lag and considerable cost. Despite this fact,

companies can differentiate their product on the basis of quality, fit, color, size, brand,

and customer service. Many consumers are loyal to certain brands, especially when

customers receive personalized service or they feel that a company’s brand is the “it”

brand, as Victoria’s Secret is the “it” brand for lingerie. However, there are low

switching costs for consumers if new entrants offer an equal or superior product in this

industry. As stated above, brand recognition and customer loyalty are important factors

22  

in this industry. 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.

Chico’s strives to differentiate its product through personalized customer service.

Its sales associates are trained to be able to determine and provide advice on the fashion

needs of customers. With this training, 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. In addition, point-of-sale registers collect data on

inventory, 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. Over its 25 years of

existence, 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, Chico’s must maintain and enhance its customer service and ensure that it has the

correct product mix to offer to customers.

New entrants face large capital requirements and non-capital investments, which

are important to consider. 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. Stores are

built or space is rented in prime locations, which can be an expensive investment. In

addition, remodeling existing rental property to meet specific needs can have high input

and labor costs as well as opportunity costs for new entrants. Once the property has been

developed, companies have to buy the materials that make up the infrastructure of the

23  

store, such as displays, manikins, and registers. Companies will also have to invest in

technology and security systems to track the product and monitor the store and its

occupants. The non-capital requirements include buying the merchandise to stock the

store, hiring new administrative staff to oversee the design and manufacturing of the

merchandise, setting up a distribution center to transport the merchandise, and launching

an advertising/promotions campaign to increase foot traffic into the store. These are non-

trivial tasks in a highly-competitive industry but are necessary to capture market share

from existing competitors. Therefore, the up-front capital requirements are very

expensive and necessary to compete in this industry.

As an alternative, a designer could sell their product to third-party department

stores. However, in order to sell product in a department store, a fashion designer must

make considerable investment in developing relationships with department store buyers,

which can be a difficult and lengthy process. 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. In addition, if the store is leased in a mall, the payment

structure might be linked to store revenue. This could prove to be very expensive for a

new entrant if, in fact, they have a variable rate attached to their lease. Entrants also have

to be aware of whether or not there are restrictions on remodeling the leased property.

Such restrictions can limit the entrant’s flexibility and require significant capital

investment to meet the mall’s regulations.

As stated above, when discussing economies of scale, there are large monetary

costs to opening a new apparel store to compete against Chico’s. New entrants must find

suppliers, buy or lease a distribution center for its merchandise once it arrives in the

24  

United States assuming they outsource their manufacturing, develop a logistics method,

and lease or build store fronts to sell the merchandise. Since Chico’s is already an

established brand with a liquid financial position, it will be expensive for a new entrant to

compete against the company in the short-term and, with brand loyalty in place for

Chico’s, continue to be expensive in the long run.

The industry has several cost advantages independent of scale, such as low input

costs due to the utilization of foreign suppliers, who purchase lower-cost raw materials

and manufacture the product with cheaper labor than if the product was manufactured

domestically. In addition, many companies have already acquired favorable locations to

build stores, but, with the population migrating from urban to suburban areas and

“micropolitans,” there are still locations that new entrants can capitalize on in the future.

The growth of Internet usage is another potential distribution mechanism for new

entrants. As more people become accustomed to shopping on the Web, the Internet will

reduce entry and selling costs. However, most people buy products on the Web from

companies with which they are familiar. Therefore, it is vital to have a recognized brand

which customers associate with quality and fashion.

Chico’s launched a website for Chico’s clothing in 2001, WH|BM in 2005, and

Soma in 2006. In addition, the company has evolved its website design to be easily

browsed by customers. With the Internet operations, Chico’s has established a call center

in which customers can directly talk to a company representative and place an order.

Any entrant can create a website to compete with Chico’s, but, without an established

brand name, it is less likely to gain considerable sales from the Internet.

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Any entrant can outsource their manufacturing to foreign suppliers like Chico’s;

however, establishing the relationships with the suppliers and making sure the product is

of sufficiently high quality is a more difficult task. As stated before, Chico’s has an

established and effective supply chain in operation. In order to receive the benefits of

low input and labor costs, new entrants would first have to establish a working and

efficient supply chain.

Government regulations do not present a barrier to entry into the industry. The

United States has laws regarding labor and compensation for hours worked. The Free

Labor Standards Act provides the guidelines for minimum wage, overtime pay, and youth

employment under the law. This rule should not be a barrier to new entrants, but

regulations regarding trade, specifically import regulations, might have the potential to be

a large barrier if the current rules or regulations were to change in the future. There are

no import quotas on textiles and clothing from foreign countries, nor are there significant

tariffs. In the future, trade restrictions or increases in tariffs would potentially prevent

new entrants into this industry, as most manufacturing of clothing occurs outside of the

United States.

Despite being a member of C-TPAT, which is not a sustainable advantage,

Chico’s does not have any advantage to new entrants in terms of government regulations.

None of the regulations would treat either party different than the other. Thus, Chico’s is

not in a better position than companies trying to enter the market in this respect.

There is very little that stops new competitors from entering the industry, but

Chico’s has established many advantages which provide some insulation from this threat.

The fact that Chico’s has a mature supply chain, experienced management, a large

26  

number of operational store locations with sales associates that provide personalized

service for the customer, and brand equity make it more difficult for a new company to

steal market share. The investment for a new company would be very large, considering

it would have to create a supply chain, develop and open new stores, and find a niche that

differentiates its product from that of Chico’s.

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. Due to declines in consumer discretionary spending,

companies find themselves struggling to adjust to decreased revenues. Consumers are

shopping at discount stores rather than at up-scale specialty stores, causing declines in

revenue, which in turn make high fixed costs more difficult to cover especially when debt

is less-readily available. Fixed costs arise in the supply chain from actually storing the

merchandise. Additionally, 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. Thus, the company would not

receive full price for the item and, in reality, may only sell the item at a highly-discounted

price. In addition to storage costs, the existing competition has to cover other essential

operating costs, salary, technology, and distribution costs (warehousing and logistics) to

compete in the industry. There are relatively few fixed manufacturing costs due to the

utilization of foreign suppliers, who provide their own machinery and tools.

With each company having the same goal of producing and selling the most

fashionable brands each season, it is difficult to differentiate products, and switching

27  

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

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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

29  

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. Thus, the consumer is price sensitive and wields

considerable power.

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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. If consumers do not demand the product Chico’s provides, the company will be

left with excess inventory and little revenue to pay its expenses. In addition, due to fast-

paced fashion cycles, excess inventory will have a higher obsolescence rate as time

passes. Chico’s entire business strategy revolves around the customer’s perception of the

product and its characteristics, as well as the service provided to them at the store level

and by other representatives of the company. The fact that Chico’s entire strategy

revolves around the customer magnifies the power of the end consumer.

2.5 Bargaining Power Between the Company and the Supplier

Merchandise is a large fraction of the buyer’s costs, so the buyer will be price

sensitive if a lower-cost supplier is readily available. Many companies use short-term

contracts with independent vendors to get the best deals. If the vendor wants repeat

business, they must adhere to the quality control requirements of the buyer because the

buyer can and will switch vendors rather easily. There are several non-monetary

switching costs that must be considered. First, it takes time to set up contracts even if

they are short-term. Second, it takes time to go over quality control and shipping

requirements. The main non-monetary expense relates to time. By switching vendors a

company loses valuable time in which its merchandise would have been produced. Thus,

there might be delays in orders which could ultimately affect the “bottom line.” When

switching costs are low, it favors the buyer, and, if they are high, it favors the supplier.

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In this industry, there is little threat of backwards integration.19 Companies do not

have the access to cheap labor, low cost raw materials, nor do they have the capacity to

manufacture their own merchandise. In fact, 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. Since there is little threat of backward integration, suppliers gain a

small advantage over the buyer. However, both groups are privy to all information

available in the market, and, thus, neither group has an advantage over the other due to

informational asymmetries.

Chico’s is less susceptible to the bargaining power of the supplier in that the

company maintains a diverse set of suppliers, including manufacturers in Peru,

Guatemala, Turkey, China, and India. In addition, it has “cut and sew” locations in

Mexico, Guatemala, and the United States.20 Chico’s purchases the raw materials and

provides them directly to the “cut and sew” operations. If one supplier is unable to meet

production levels or has quality control issues, Chico’s should be able to maintain

production levels by distributing the desired quota among already established suppliers.

Thus, due to Chico’s mature supply chain and diverse manufacturing channels, it is less

susceptible to the power of suppliers.

2.6 Bargaining Power of Suppliers

Suppliers, including manufacturing and labor, do not have a lot of power over

buyers because companies can find suppliers anywhere, especially in a global market.

Because many suppliers are foreign, buyers have to be aware of import laws, regulations,

and quotas than might increase costs or delay shipments of inventory. The product

                                                        19 Backwards integration is the act of a company taking over upstream supply chain operations. 20 Chico’s FAS, Inc. 2007 Annual Report, pg. 22 

32  

produced by the suppliers is extremely important to the buyers whose profitability

depends on the success of that product. Normally, this would provide the supplier with

power over the buyer, but, as mentioned before, there are many rival suppliers for the

companies in this industry to choose from which nullifies the power. A company will

incur several switching costs when changing suppliers, such as the opportunity cost of

lost time and various setup costs. If the company chooses to switch suppliers, it can be

easy or difficult depending on how similar the operations and manufacturing processes

are to the previous supplier used. If the supplier has different operations, then the

company will have to spend time working with the supplier to obtain the quality product

it desires. This will incur additional costs and delays in shipment of the product to the

store. Thus, there are many rival suppliers which decrease the power of the supplier, but

the switching costs involved can mitigate this to some degree.

As stated in the preceding section, 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. Additionally, Chico’s already has a mature supply chain with a large

number of manufacturers in diverse locations. However, Chico’s works hard to maintain

quality control within its supply chain. If a manufacturer does not comply with the

company’s policy, the company may begin to search for a new supplier. The fact that the

supplier market is highly concentrated is advantageous to Chico’s. However, trying to

find a supplier that meets Chico’s requirements may be time consuming and less cost

effective than retaining the current supplier. This provides the supplier with some power,

however Chico’s retains a considerable advantage in terms of bargaining power.

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Conclusion

The retail apparel industry is highly concentrated, competitive, and is currently

facing stagnant growth. Existing companies with rival products are constantly competing

to steal market share from other companies in the industry. To complete this task,

companies work hard to carry inventory that is perceived by the customer as the latest

fashion. Since end consumers have significant bargaining power in the industry,

companies must be aware of what the customer demands in order to survive each fiscal

year.

Like many companies within the industry, Chico’s focuses on its core business

and outsources it manufacturing. To differentiate itself from the competition, Chico’s

pays special attention to specialized customer service in which sales associates are trained

to offer advice, style types, and cross-selling ideas to the customer. In addition, using its

customer database, sales associates are provided information on color, style, and pattern

preferences of repeat customers. Chico’s business strategy revolves around customers’

wants and preferences. This provides the end consumer with considerable bargaining

power. However, with regard to suppliers, Chico’s has a mature supply chain in place

with a diverse group of manufacturers located in multiple countries. This makes the

company less susceptible to supplier power. Chico’s is part of an industry with few

barriers to entry, but it positions itself well within its target market and focuses on its core

business.

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3. Competitor Analysis

Overview

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 

35  

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 non-

Dillard’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

36  

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 

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write down assets related to the J. Jill acquisition. In addition, the J. Jill acquisition was

financed heavily by debt. The resulting interest payments have further depressed

operating results.

Due to these difficulties, Talbots has begun an internal re-evaluation process in an

attempt to revitalize the company. As a result of this process, 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.

3.3 Ann Taylor23

AnnTaylor Stores Corporation is a women’s career and casual wear retailer

established in 1945. Started as a primarily East Coast brand, the company has grown into

a national brand and generated $2.4B of revenue in fiscal year 2007. AnnTaylor targets

affluent women and provides them with “updated classic” products.

AnnTaylor operates multiple brands, including Ann Taylor, LOFT and Ann

Taylor Factory. Its product line is comprised of suits, separates, footwear and

accessories. Although AnnTaylor has an Internet storefront, it is primarily a brick-and-

mortar presence with 929 retail stores.

To differentiate itself from other competitors, AnnTaylor focuses on “updated

classic, yet stylish, professional and special occasion dressing.”24 It also pays special

attention to strengthening its brand names.

Like other companies in the industry, AnnTaylor is experiencing difficulties and

negative same-store sales growth due to poor macroeconomic conditions. In reaction, the

                                                        23 AnnTaylor Stores, Corp. 2007 Annual Report 24 AnnTaylor Stores, Corp. 2007 Annual Report, pg 2 

38  

company initiated a restructuring program that includes reviewing the cost structure of

the company, closing underperforming stores, and streamlining organizational structure.

We have selected AnnTaylor as our back-up acquisition candidate. An in-depth

analysis of AnnTaylor is located in the alternative acquisition candidate section.

3.4 Coldwater Creek25

Coldwater Creek is a women’s casual wear company founded in 1986. It

provides casual wear and accessories to women aged 35 and older. Founded as a direct

marketing company, Coldwater Creek has a penchant for sales innovation, expanding as

both a traditional retail presence and by experimenting with unusual retail formats.

Although historically a direct marketing company, Coldwater Creek’s expansion

strategy has resulted in the majority (70%) of its $1.15B per year revenues coming from

its brick-and-mortar retail stores. Coldwater Creek’s product line is made up of private-

label casual wear, and the company seeks to differentiate itself with unique designs and

high-quality apparel. Additional efforts to differentiate include early-stage experimental

format stores, such as Coldwater Creek’s “Spa” concept, which co-locates a spa with a

Coldwater Creek retail presence.

The strategic importance of nationwide marketing to Coldwater Creek is unique

among its competitors. It places a high emphasis on its ability to effectively place

advertisements in national publications and allocates resources that reflect this emphasis.

Like the rest of the industry, Coldwater Creek has experienced difficulties in

recent years. Increasing costs have cut into its “bottom line,” as has a large decrease in

same-store sales in recent years. Coldwater Creek is attempting to address its increasing

                                                        25 Coldwater Creek, Inc. 2007 Annual Report 

39  

supply chain costs by cutting out middlemen. Historically, Coldwater Creek used

intermediaries to source its products, but it has recently made a strategic decision to begin

dealing directly with upstream suppliers.

Coldwater Creek’s main strength is its willingness to experiment with growth

strategies to grow beyond its current position. It has grown from a direct marketing

company to a primarily retail company, and continues to experiment with sales models in

an attempt to attract new customers.

3.5 Christopher and Banks26

Christopher and Banks is a women’s apparel company founded in 1956. It targets

women aged 40 to 60 seeking casual fashion and accessories for work and leisure. It

generated $575M in revenue in fiscal year 2008. Christopher and Banks operates

multiple retail brands, including Christopher and Banks, CJ Banks (which focuses on

plus-sized clothing), and Acorn.

Christopher and Banks primarily operates a brick-and-mortar presence, with

relatively little direct-marketing revenue. It only recently opened a Web storefront in

February 2008. The majority of its stores are located within traditional mall spaces. For

all of its stores, Christopher and Banks uses a combination of externally branded and

private label products, attempting to provide a variety of coordinated products, which are

easily combined into complete outfits. To differentiate itself, Christopher and Banks

seeks to provide distinctive products in line with the current year’s fashion trends.

Like the rest of the industry, Christopher and Banks is experiencing difficulties

due to the macroeconomic environment, with stagnant same-store sales and decreasing

                                                        26 Christopher and Banks, Corp. 2007 Annual Report 

40  

margins across its brands. This led to a recent announcement to close all Acorn stores by

the end of 2008. Management primarily hopes to address the issue through

improvements to operating efficiencies, with programs in place to improve supply chain

efficiencies, improve direct marketing initiatives, and increase conservatism in store

expansion. Additionally, Christopher and Banks will expand select product lines (e.g.,

petites) in response to proven customer demand.

The initiatives to improve the supply chain may experience unexpected

difficulties. Christopher and Banks sources the majority of its products overseas through

third-party agents. The company is in the unenviable position of sourcing 47% of its

products through a single agent, who has recently informed Christopher and Banks that it

intends to cease operations. 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. In addition to its efforts to realize increased efficiencies, Christopher and

Banks intends to increase its marketing expenditures from 1% to 1.5% of sales. It is

hoped that this increase in marketing will drive additional traffic to existing stores and to

Christopher and Banks’s new websites, resulting in increased sales.

3.6 Limited Brands, Inc.27,28

Limited Brands, Inc. was originally founded as The Limited in 1963, specializing

in young women’s apparel. Over the years, Limited Brands has developed, acquired, and

                                                        27 Limited Brands, Inc. 2007 Annual Report 28 The discussion of Limited Brands, Inc. has been primarily restricted to the Victoria’s Secret segment, which comprises over 50% of Limited Brands’ net sales. Victoria’s Secret represents a special issue for Chico’s FAS with respect to the Soma Intimates line, and is the major reason why Limited Brands, Inc. is discussed. 

41  

occasionally divested itself of multiple specialty retailers, including The Limited,

Express, Victoria’s Secret, Bath & Body Works, Abercrombie & Fitch, and La Senza.

As currently constituted, Limited Brands primarily operates Victoria’s Secret and

Bath & Body Works. In fiscal year 2007, Limited Brands generated $10B in net sales.

Victoria’s Secret and Bath & Body Works collectively constitute over 80% of Limited

Brand’s total net sales. In 2007, the company divested itself of the underperforming

Express and The Limited segments and acquired La Senza.

The Victoria’s Secret segment sells women’s intimate apparel, personal care, and

beauty products. Recently-acquired La Senza is organized under the Victoria’s Secret

segment. Victoria’s Secret dominates the women’s intimate apparel market in North

America. In 2007, the segment had net sales of $5.6B across 1,300 store-fronts.

The Victoria’s Secret brand has tremendous mindshare in North America and is

one of the strongest brands in women’s intimate apparel. The company has prominent

advertising campaigns featuring fashion supermodels, direct catalog marketing

(Victoria’s Secret Direct), and a nationally televised, prime-time fashion show.

Despite Victoria’s Secret’s strong position, Limited Brands does not escape the

macroeconomic downturn that is plaguing the fashion industry. Net income increased for

fiscal year 2007, but the increase is primarily attributable to the acquisition of La Senza.

Same-store sales declined by 2% compared to 2006.

Additionally, Limited Brands has been plagued by serious supply chain

management issues. 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. Additionally, Victoria’s Secret Direct has had issues

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with a new distribution center, resulting in significant shipping delays and additional

costs to address the issue.

Limited Brands makes considerable use of debt to finance its activities. It

currently has $2.9B outstanding, a $1.5B revolving credit line, and $300M of debt that

can be issued from an outstanding shelf registration. 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.g., over $1B in

principal is due in 2012). This, however, is a remote risk for the company.

3.7 Other Competitors

There are many other competitors within the industry that might serve Chico’s

target demographic. Almost all major department stores will have floor space dedicated

to serving adult females of all ages. However, department stores do not consider Chico’s

target market to be their “mission.” Their business models are fundamentally different,

with the companies operating under a “big tent” philosophy, where they attempt to attract

customers of all kinds. Most of these department stores are roughly comparable to

Dillard’s in terms of strategy and the threat they pose to Chico’s.

Additionally, there are targeted retailers that have some overlap with Chico’s.

Abercrombie & Fitch and American Eagle Outfitters might best be described as

“overlap” competitors. Both target customers younger than 25 years of age, while

WH|BM targets customers older than 25 years of age.29,30 There is necessarily some

overlap in customer taste and some competition for customers at these edges, but the

primary focus is different.

                                                        29 Abercrombie & Fitch, Co. 2007 Annual Report  30 American Eagle Outfitters, Inc.  2007 Annual Report  

43  

There is constant threat of entry from new competitors or established brands

seeking entry into Chico’s target market. For example, Abercrombie & Fitch has

established two new brands – RUEHL and Gilly Hicks – specifically targeting women in

WH|BM’s 25-40 range.31 These new competitors are always lurking, eager to steal

market share at the smallest misstep.

Conclusion

Due to constant competition and ease of entry, companies in the fashion industry

are always a season away from disaster. 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. To this end, companies seek to build a strong brand identity and a

consistent process for identifying and delivering what the customer wants, when they

want it.

                                                        31 Abercrombie & Fitch, Co. 2007 Annual Report  

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4. Financial Ratio Analysis

Overview

After analyzing Chico’s competition, one must consider Chico’s financial health.

The following will analyze financial ratios for the years 2003 through 2007 for Chico’s

and for its industry. The selected ratios cover the major financial areas of liquidity,

activity, profitability, leverage, and stock market. For each family of ratios, we will

explain the general trend for Chico’s over the five-year period, isolating any individual

ratios by year that vary from this trend. We will also discuss the reasons for the overall

company trend. Second, for each year of the analysis, 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. To obtain a good representation of each family of

ratios, we will use a materiality of at least two times (2X). In other words, Chico’s ratios

will be considered materially different if they are at least 2X above or below the industry

average. Finally, we will discuss the strategic, operational, and/or tactical implications of

the firm’s position relative to the family of ratios. 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.

For the purposes of this analysis, our group selected five companies to comprise a

comparables/competitor basket for Chico’s. The five companies selected were:

Christopher & Banks Corporation, Coldwater Creek Inc., Dillard’s Inc., Talbots Inc., and

AnnTaylor Stores. These companies were selected based on similarities in industry,

market capitalization, target customer demographics, pricing points, and identification in

45  

Chico’s annual report.32 The stock market ratios for each company were found using the

Bloomberg terminal; the remaining ratios were found using Research Insight Web and

Wharton’s Research Data Services. The industry average for each ratio within each

family was calculated as a simple average of all five companies, with outlier data

excluded from the calculations. The data for the ratio families for Chico’s and the

industry averages can be found in Appendix A.

4.1 Liquidity Ratios

From 2003 through 2007, the trend of the liquidity ratios increased with a peak in

2005 and a subsequent decline through 2007. Generally, this resulted in a relatively flat,

five-year change in liquidity with the exception of the working capital per share and cash

flow per share ratios. These ratios ended at a higher level than 2003. Working capital

per share followed the family trajectory from 2003 through 2005 but declined at a slower

pace from 2005 through 2007. Cash flow per share followed the family trajectory but at

a slower (or flatter) pace.

With the exception of 2003 and 2005, Chico’s cash and short-term investments

remained stable in the $265 - 275M range. Likewise, operating cash flows remained in

the $210 - $290M range for most of the period. Accounts receivable and inventory,

however, grew with average five-year growth rates of 27% and 21%, respectively.

Accounts payable and accrued expenses grew 25% and 24%, respectively, from 2003

through 2007. Likely, 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.

                                                        32 Resources used: Bloomberg, Chico’s 2007 10K, Hoover’s Pro, and Google Finance 

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Compared to the industry, Chico’s quick ratio, working capital per share, and cash

flow per share statistics were materially different. From 2004 through 2007, Chico’s

quick ratio ranged from 2X to 2.5X that of the industry. The five-year quick ratio

average for Chico’s was 2.3 versus 1.3 for the industry; Chico’s five-year average was

almost 2X that of the industry. Related, the five-year average for the Chico’s current

ratio was 3.4 versus 2.6 for the industry, a difference of 1.3X. With the exception of

higher values in 2003, both the industry working capital per share and cash flow per share

ratios were 2X those of Chico’s.

From working capital per share and cash flow per share perspectives, Chico’s

liquidity position depends on its working capital management. Since 2005, Chico’s

working capital declined. Over the five-year period, receivables and inventories grew

because of increased demand and sales in stores and through the internet. Additionally,

Chico’s acquired WH|BM in 2003 and launched Soma Intimates in 2004. The company

also opened 592 new stores and acquired 15 stores from franchisees over the five-year

period.33 This growth also contributed to increased accounts payable over the period.

Increasing receivables is good if it means increased sales. However, it could be negative

if attributed to lower turnover of sales into cash, too-relaxed credit policies, and

ineffective monitoring of overdue client accounts, all of which reduce access to cash.

Increasing inventories is likewise good if it means increased demand and sales, but it

could be negative if attributed to slowing turnover or conversion to sales, which

ultimately leads to cash. Also, rising inventories could be an indication of obsolescence,

a key risk factor in the fashion industry. Finally, increasing accounts payable is good

                                                        33 Chico’s FAS, Inc. 2007 Annual Report, pg. 36 

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from a cash management perspective of delaying cash out the door, if the company

ensures that it is not incurring late fees on invoices or harming vendor relationships.

In addition to affecting the working capital per share and cash flow per share

ratios, inventory and receivables levels factor into the current and quick ratios. From

both an absolute and relative perspective, Chico’s current and quick ratios were strong.

Additionally, 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, we

have confidence in concluding that Chico’s liquidity position overall is strong.

Strategically, Chico’s better liquidity position gives it several advantages over its

competitors. This liquidity position allows the company, going forward, to pursue

positive NPV projects and to take on additional projects or investments if attractive

opportunities should arise. For example, 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. 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. These

same payment alternatives allow the company to incentivize existing employees and to

attract key outside personnel to the company. Abundant liquidity allows the company the

option of implementing a dividend-paying policy, a favorable movement from an

investor’s or analyst’s viewpoint. Strategically, a dividend-paying stock is more

attractive to the market because it indicates the company’s ability to generate cash flows

to pay dividends. Also, in addition to stock appreciation, dividends are another form of

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return on investment. Finally, Chico’s, with access to liquidity, is in a better operational

position than competitors to get through the current economic crisis.

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. 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.

4.2 Activity Ratios

From 2003 through 2007, Chico’s activity ratios, for the most part, remained

relatively flat with one major exception. The average collection period, the days to sell

inventory, and the operating cycle ratios ended with a slight increase in 2007, while the

inventory turnover and total assets turnover ratios ended with a slight decrease. The

largest outlier was the receivables turnover ratio, which showed a material, overall

decrease over the five-year period. 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.

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.

Given that the average collection period remained relatively flat for most of this same

time period indicates that Chico’s credit policies, although changing, remained effective

for the company and, in fact, relative to the industry as will be discussed later.

When compared to the industry, Chico’s ratios were materially different over the

five-year period for the following ratios: receivables turnover, average collection period,

days to sell inventory, and operating cycle in days. Regarding the receivables turnover

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ratio, Chico’s was more than double the industry standard for years 2003 through 2005,

greater than 1X the industry in 2006, and in line with the industry in 2007.

Related to the receivables turnover ratio is the average collection period in days.

As expected from the previous analysis, the industry’s average collection period was

materially over that of Chico’s. In 2003, the industry’s average was approximately 11X

that of Chico’s and decreased year-by-year ultimately to 2X in 2007, as Chico’s credit

policies relaxed over the five-year period.

The industry averages for both days to sell inventory and operating cycle in days

were higher than that of Chico’s. Days to sell inventory was about 2X Chico’s in all five

years, while the operating cycle steadily declined from 2.6X in 2003 to 2.4X in 2005 to

almost 2X in 2007.

Operationally, a higher receivables turnover ratio for Chico’s relative to the

industry indicates that, historically, 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.

As a smaller company relative to its comparables basket, Chico’s may have enforced

tighter credit policies to manage collection of sales (cash management). 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, resulting in a higher turnover

and a shorter collection period.

On the other hand, Chico’s tighter credit terms, historically, 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. Additionally, accounts

receivable accrues no interest and is, in effect, an interest-free loan to customers. The

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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,

therefore, collection of cash. Strategically, relaxed credit terms could have contributed to

increased sales. However, the slow-down in receivables turnover could have resulted in

lost investment opportunities for the company with cash “tied up” in receivables.

Given both historical points of view, the company is in line with the industry

receivables turnover ratio as of 2007 but has a faster collection period than the industry.

Going forward, this means that Chico’s credit and collection policies are more effective

than the industry, contributing to better cash management with respect to receivables.

Within this five-year period, the industry took longer than Chico’s to convert

inventory to sales, and this contributed to longer operating cycles. Again, 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.

4.3 Profitability Ratios

From 2003 through 2007, the overall trend of Chico’s profitability ratios was a

decline, with relatively little movement between 2003 and 2005 but a more rapid

decrease afterwards. All company profitability ratios closely exhibited this behavior.

From 2005 to 2007, Chico’s net income decreased 54% over the two-year period, while

sales, assets, and equity increased 22%, 25%, and 13%, respectively. Specifically for

2006 to 2007, Chico’s net income decreased 47%, with corresponding increases in sales,

assets, and equity of 5%, 18%, and 14%, respectively.

From 2005 to 2006, Chico’s experienced declines in profitability due to a product

offering that did not keep up with fashion demands, inadequate marketing, and

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inconsistency in applying its “most amazing personal service” strategy.34 Reasons cited

for profitability declines from 2006 to 2007 were similar: clothing that was not

compelling enough to the consumer, inadequate marketing, and consumer reaction to a

slowing economy.35

The industry’s trend over the same time period had the same overall result as that

of Chico’s – a decline. However, the industry’s decrease was slower, with the more rapid

decline occurring after 2006 versus 2005. When compared to the competitor basket,

Chico’s profitability ratios were materially over industry averages for all ratios and all

years. Chico’s operating margin after depreciation ratio moved from 2.5X the industry in

2003 to a peak of 3X the industry in 2004 and 2005 and to a subsequent decline to 2.7X

in 2007. Over the five-year period, Chico’s ROE was generally 2.1X the industry

average. Although Chico’s net profit margin, on average, was 2.5X that of the industry

from 2003 through 2006, the ratio spiked to 46.7X the industry in 2007. Likewise,

Chico’s ROA showed a four-year average of 2.1X the industry before spiking to 74.4X

the industry in 2007.

Comparing Chico’s 2006 to 2007 percent changes in net income, sales, assets, 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.36 Generally, the

industry had much larger declines between 2006 and 2007 in net income, specifically

Coldwater Creek, Dillard’s, and Talbots. In the cases of Coldwater Creek and Talbots, a

net income position in 2006 swung to a net loss position in 2007. Regarding sales, the

industry showed declines in some cases, Talbots and Dillard’s, while the remaining

                                                        34 Chico’s FAS, Inc. 2006 Annual Report, Letter to Shareholders 35 Chico’s FAS, Inc. 2007 Annual Report, Letter to Shareholders 36 Analysis using Google Finance financial statement data 

52  

comparables and Chico’s showed an average increase of 5%. The industry comparables

also had smaller increases in total assets and, in some cases, declines in assets, as was the

case for both Talbots and AnnTaylor Stores. All comparables had declines in equity

versus Chico’s increase in equity over the same period. A slowing economy was cited as

the main reason for the decline in profitability among the comparables’ various annual

reports.

Strategically, although Chico’s experienced declines in profitability for

macroeconomic reasons affecting the entire retail apparel industry, it is in a better

position relative to its comparables. 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. Additionally, the company is in a better position

to invest resources necessary to manage operations effectively. Profitable firms gain

favor with Wall Street analysts and potential investors. This is supported by Chico’s

better-than-industry stock market ratios discussed later. With profitability and liquidity,

the company could take the opportunity to implement a dividend-paying policy.

Dividend-paying stocks are attractive to shareholders and analysts. Finally, higher

profitability gives Chico’s the advantage of being able to withstand price wars or

significant variation of input costs.

4.4 Leverage Ratios

For the five-year period analyzed, Chico’s did not have debt in its capital

structure, which is significantly different than that of the industry average. The industry

utilized both debt and equity as components of capital structure. The industry pattern

over the five-year period showed a dip in leverage from 2003 through 2005 with a

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subsequent rise through 2007. Generally, this trend produced relatively little change in

leverage levels in 2007 versus 2003. Industry debt levels as a percent of equity were

below 25% over the five-year period; the industry relied more heavily on an equity

capital structure. Chico’s total assets-to-common equity ratio remained stable over the

five-year period 2003 through 2007. This ratio was slightly below, but in line, with both

the trend and level of the industry.

Strategically, Chico’s is in a better leverage position relative to its industry.

Because of its ability to generate positive net income and strong cash flows, Chico’s has

been able to finance projects internally without reliance on debt capital markets or cash

flows dedicated to interest payment requirements. Going forward, the company has the

option to utilize its lines of credit and/or take on additional forms of debt for unexpected,

positive NPV projects, for example. If Chico’s chooses this option, it will likely be able

to meet interest payments, as supported by Chico’s strong liquidity position discussed

above. Chico’s strong liquidity and financial position will likely allow it to obtain debt at

better rates than its competitors, giving it yet another strategic advantage in minimizing

financing costs.

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. In other words, were projects materially accretive to earnings

foregone to maintain a no debt policy and, instead, other projects undertaken that were

less accretive?

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4.5 Stock Market Ratios

For the time period 2003 through 2007, Chico’s stock market ratios followed the

same overall trend. This trend exhibited a peak-and-valley movement with increases

from 2003 to 2004, declines or remaining flat between 2004 and 2005, with the pattern

repeated in 2006 and 2007. Ratios in 2007 were not materially different, per the 2X

criteria, than those in 2003.

Chico’s stock market ratios were materially over the industry for price/book,

price/sales, price/cash flow, and price/EBITDA. Regarding the price/book ratio, Chico’s

was almost 4X the industry in 2003, about 3X from 2004 through 2006, and a little over

2X in 2007. Price/sales differences were larger with over 4X during years 2003, 2004,

and 2006, and 3X and 2.4X differences in 2005 and 2007, respectively. Price/cash flow

followed the same trajectory as price/sales, with larger differences in 2003, 2004, and

2006. Finally, price/EBITDA remained in the 2X to 2.5X range from 2003 through 2006

and declined to 1.4X in 2007.

Strategically, Chico’s has a competitive advantage over its industry - all stock

market ratios for Chico’s exceeded the industry averages. This shows that investors

placed a higher value on Chico’s stock relative to its competitors on the variables of

earnings, EBITDA, sales, book value, and cash flow. For example, a high price/earnings

or price/EBITDA ratio (as in Chico’s case) relative to the industry means that, at roughly

equal or even lower earnings, the market recognizes value and rewards accordingly

through a higher demand, resulting in a higher stock price. On the other hand, a low

price/earnings or price/EBITDA ratio may mean higher earnings per share, but the

market penalizes or undervalues the stock for other reasons, for example, low confidence

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in the company’s ability to generate future operating 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. 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. Finally, the higher price/cash flow ratio was a signal of the market’s

confidence in the company’s ability to generate cash flows.

Going forward, Chico’s strong stock market ratios give the company more edge in

being able to use its stock for potential acquisitions. Additionally, Chico’s stock can be

an attractive tool for compensation, relative to its competitors, for both existing

employees and as an incentive to attract key personnel from outside the company.

Finally, Chico’s favorable stock market ratio position may allow the company to obtain

external capital, if necessary, at lower costs than its competitors.

4.6 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. From a liquidity standpoint, Chico’s has strong current and quick ratios in

both an absolute and relative sense. However, working capital per share and cash flow

per share are lower than the industry. Chico’s working capital had an overall decline

over the five-year period due to increasing accounts receivable, inventories, and accounts

payable. The growth in these accounts was attributable to Chico’s growth through

acquisition and new store expansions during this same time period. Going forward,

Chico’s needs to ensure effective management of working capital accounts to mitigate

inefficiencies in collection of cash and obsolescence of inventory. The review of the

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activity ratios shows that Chico’s appears to be very capable at managing both

receivables and inventory, with better turnover ratios, receivables collection periods, and

shorter operating cycles than the industry. Given the strong current and quick ratios, the

explanation of growth in the working capital accounts over the five-year period, and the

overall positive position regarding activity ratios, we believe Chico’s liquidity position is

strong. This gives the company the flexibility over its industry to take on strategic

initiatives in addition to meeting operational requirements.

Although Chico’s profitability measurements exceed those of the industry, the

company’s declining performance in an absolute sense is a concern. The entire industry

has been and will continue to be affected by a degrading economy. However, Chico’s

has repeatedly cited an incorrect product offering and inadequate marketing as

contributors to its declining performance. In one case, degradation in customer service

was also cited. These variables are key competitive points in the fashion industry, and

the fact that Chico’s is a “repeat offender” is disturbing and could be detrimental if not

addressed going forward.

The fact that Chico’s has no debt and has been able to outperform its competitors

is its strongest point. With its liquidity position, Chico’s has been able to rely on itself to

finance its growth-by-acquisition strategy. Going forward, the company is in a good

position should the need for debt arise for attractive projects or for operational purposes.

Likely, the company’s strong liquidity and price multiples will allow the company to

obtain debt more cheaply than similar actions by competitors.

As discussed earlier, Chico’s profitability measures are materially over the

industry’s average. Most notably, Chico’s ROE and ROA are very strong relative to the

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industry. ROE is a highly-valued statistic reviewed by investors and Wall Street and, as a

result, is a key driver of stock price and the company’s price multiples. Furthermore,

Chico’s ability to generate high operating cash flows, along with its ability to generate

highly-positive returns, gives investors the expectation that the company will continue to

be profitable relative to competitors in the future.

With the strengths and weaknesses noted above, Chico’s has more strengths than

weaknesses and, going forward, appears to be in a better financial position overall as

compared to its industry. The economy is hitting the retail apparel industry very hard,

and the consumer’s reaction is decreased demand. Economic forecasts predict that the

economy will get worse before it begins its rebound. Although Chico’s has strategic and

operational advantages relative to its industry, it must pay attention to the profitability

issues cited in the last two years’ annual reports. 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, Chico’s will lose critical sales and its strategic/operational advantages. In the

current state of the economy, the company must be able to control costs and to figure out

how to cut prices to try to boost demand. Failure to do so will erode the company’s

income, cash flows, and liquidity position, with a resulting decline in Chico’s stock

market value and confidence levels.

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, activity, profitability,

leverage, and stock market. For each family of ratios, we explained the general trend for

Chico’s over the five-year period, isolating any individual ratios by year that varied from

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this trend; we also discussed the reasons for the overall company trend. Second, for each

year of the analysis, we compared Chico’s ratios to that of the industry and discussed

whether family or individual ratios were materially different than the industry standard,

using a materiality level of 2X over/under the industry average. Next, we discussed the

strategic, operational, and/or tactical implications of the firm’s position relative to the

family of ratios. Finally, after analyzing the aforementioned ratio families, we

indentified Chico’s overall strengths and weaknesses and speculated on the company’s

future financial condition.

5. Chico’s SWOT Analysis

Overview

Based on the retail apparel industry and Chico’s-specific analyses thus far, we

conducted a comprehensive analysis in order to assess Chico’s strengths, weaknesses,

threats, and opportunities.37 This analysis helped us to identify the challenges Chico’s

faces going forward and to determine specific strategic recommendations. The SWOT

matrix is shown in Table 1. The specific points within each section and their strategic

impacts are discussed in more detail in the subsections that follow. Post-acquisition

strategic initiatives derived from the SWOT analysis will be discussed later in the

strategy section.

                                                        37 We changed the order because we felt the information flowed better to lead up to opportunities. 

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Table 1. SWOT Matrix

STRENGTHS OPPORTUNITIES

• 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

• 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 THREATS

• 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

• 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

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• Exchange rate risk

• Changes in government regulation

5.1 Strengths

Chico’s has a strong, formalized customer interaction process. Chico’s and

WH|BM loyalty programs include the Passport Club and Black Book, respectively.

Operating as in-store credit cards, these programs provide perks, such as periodic

discounts, 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.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.

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,” which will, in turn, increase traffic into the store.

The use of a customer-tracking database helps Chico’s to better understand

customer preferences and the popularity of various inventory items. The database is a

tool to further allow Chico’s to enhance an existing customer’s shopping experience

through offering suggested items, discounts, advanced sales, free shipping, etc.39 The

loyalty programs, the focus on personalized attention, and the benefits from maintaining a

customer database incentivize existing customers to return to the store, a key motivator

given the current declining trends in consumer spending.

                                                        38 Chico’s FAS, Inc. 2007 Annual Report, pg. 6 39 Chico’s FAS, Inc. 2007 Annual Report, pg. 7 

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Based on the ratio analysis discussed earlier, Chico’s is very strong financially.

Chico’s has been able to fully fund growth and operations with operating cash flow.

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. However, Chico’s could

obtain debt at a lower cost, if needed. Chico’s strong liquidity position allows the

company to remain debt-free and to access cash for attractive, positive NPV projects.

Additionally, with high access to liquidity, the company is in a better operational position

than competitors to get through the current economic crisis.

Also detailed in the financial ratio analysis earlier in the paper, Chico’s is

managing inventory and receivables activities more efficiently than competitors. This

contributes to a faster conversion of inventory and receivables to cash, further supporting

Chico’s strong liquidity position and the advantages mentioned above that this allows.

Chico’s strong financial position in the aforementioned areas contributes to higher

stock market ratios relative to competitors. The market is placing a higher value on

Chico’s with regards to price/earnings, price/EBITDA, price/sales, price/book value, and

price/cash flow. This position improves the company’s visibility and reputation on Wall

Street and to potential investors. In turn, these reputation effects allow Chico’s stock to

be more easily used for potential acquisitions. Additionally, the company’s stock can be

an attractive tool for compensation, relative to its competitors, for both existing

employees and as an incentive to attract key personnel from outside the company.

Through the efforts of its customer service, brand equity has become one of

Chico’s main strengths. The company has been able to attract and maintain a loyal

customer base within its target market. As discussed previously, Chico’s has been able to

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consistently post higher profits than its competitors, and its stock market ratios have

shown the market’s tendency to place a higher value on Chico’s relative to the industry.

Strategically, brand equity gives Chico’s more visibility in the marketplace. 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,

especially as customers become more price sensitive in the current economic crisis.

Chico’s leadership base is solid. The top leaders have years of experience with

the company; have held various positions within the retail apparel industry, such as

AnnTaylor Stores, The Gap, and Macy’s; or have leadership experience at other

companies.40 For example, CEO Scott Edmonds started with the company as an

operations manager in 1993. Before coming to Chico’s, he was President of Ferguson

Enterprises, Inc – a plumbing and electrical wholesale company.41 With combined years

at the company and through retail industry experience, Chico’s leaders are familiar with

the industry and its historical “ebbs and flows.” They are well positioned to see the

company through the current economic crisis.

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.

Appointing high-level executives to brand management shows the company’s emphasis

on investing in its reputation and building brand equity. In addition, this structure allows

brand value and equity to be managed more holistically rather than being a by-product of

operations management.

                                                        40 Chico’s FAS, Inc. 2007 Annual Report, pg. 30-31 41 Chico’s FAS, Inc. 2007 Annual Report, pg. 30-31 

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Strategic outsourcing is a strength of the company. Chico’s uses foreign suppliers

and third-party manufacturers in China, India, Guatemala, Peru, and Turkey for its

clothing in order to take advantage of lower manufacturing cost structures in these

localities relative to the United States. Strategically, this allows Chico’s to maintain high

gross margins and effectively manage its pricing strategy.

The use of outlet stores is a strategic strength, especially given the current state of

the economy. Outlet stores allow for the disposal of slower-moving merchandise from

main stores and provide the opportunity to generate revenues from this merchandise.

Currently, approximately 5% of net sales are generated from the outlet stores; this

number may increase as consumers are more thrifty and looking for deals in the current

economy.42 The use of outlets reduces the potentially negative perception for certain

upscale customers of markdowns in the main stores.

Finally, Chico’s supply chain distribution is efficient with quick turnaround43

times, contributing to faster inventory turnover relative to the industry. Chico’s has one

distribution center in Winder, Georgia, and turnaround averages approximately 24 to 48

hours for nearby stores and two days to one week for stores further away.44 This is

impressive given that only one distribution center meets the needs of stores across the

United States (California, Texas, Florida, other states across the Western, Midwestern,

and Northeastern states), including the U.S. Virgin Islands and Puerto Rico.45

                                                        42 Chico’s FAS, Inc. 2007 Annual Report, pg. 11 43 Turnaround means the time from products leaving the distribution center to arriving at Chico’s and WH|BM stores. 44 Chico’s FAS, Inc. 2007 Annual Report, pg.12-13 45 Chico’s FAS, Inc. 2007 Annual Report, pg. 9 

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5.2 Weaknesses

Chico’s has areas in which improvement is possible. One such area is

profitability. 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. The

declines in the last two years have been due to a slowing economy, a product mix

mismatched with customer demand and fashion trends, and ineffective marketing. The

latter two are more directly controllable by the company and have detrimental strategic

impacts if not corrected. Ineffective product mixes and marketing strategies have yielded

negative same-store sales growth, reduced cash flow, potential degradation of brand

value, and deterioration of the financial strategic advantages (mentioned in the financial

ratios analysis) over the competitor basket. Recommendations on how to correct

inappropriate product mix, improve marketing, and reverse declining profitability are

discussed in the opportunities section below and further detailed in the strategy section.

Chico’s dependence on foreign suppliers and third-party manufacturers was

mentioned as a strength from a cost-savings perspective. However, this dependence is

also a weakness and a threat for the company. Due to geographic distance from Europe

and Asia, the company has difficulty exercising control over the quality of the inputs to

the products. Political or economic instability could lead to major disruptions in the

supply chain. The results could be detrimental to Chico’s – reduced flexibility, pricing

power, and market share.

Although currently efficient, Chico’s single distribution center concept is a

weakness for the company. Any disruption to the single location will be highly

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detrimental to the supply chain. Such a disruption could yield lost sales, negatively-

impacted customer relationships due to stock-outs, and diminished brand equity.

Chico’s recently engaged in a low-value added acquisition. Chico’s purchased the

Fitigues brand in January 2006. The brand operated through 12 free-standing retail

stores, catalog, and the Internet. By March 2007, Chico’s decided to no longer support

this brand because it did not meet “internal expectations.”46 Significant company time

and resources were invested in acquiring Fitigues and integrating it into existing

operations. The Fitigues failure was due to an incorrectly-defined target market and to

poor due diligence, especially in a time when the economy was in decline. As discussed

in the external analysis, economists are not predicting a rebound in the current economic

crisis until mid to late 2009. In a normal economy, misallocation of resources is harmful,

but it can be fatal during a declining economy. 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.

5.3 Threats

Chico’s is faced with many threats and challenges as it attempts to move forward

in the current economic crisis. Consumer reaction to the current crisis is a threat to the

entire retail apparel industry. The consumer’s disposable income has decreased and has

translated into decreased demand and sales, especially within the upscale fashion market.

This situation further stresses the importance of Chico’s being able to differentiate itself

in order to attract new customers and, more importantly, retain existing customers.

                                                        46 Chico’s FAS, Inc. 2007 Annual Report, pg. 2 

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As a high likelihood in the retail apparel industry, changing consumer tastes and

fashion trends can have significant impacts on a company. If a company is not well-

positioned to understand or forecast fashion demand, costs could increase unexpectedly

and significantly through lost sales, high levels of inventory, unsatisfied customers, and

degradation of brand equity. As mentioned earlier, 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.

As discussed earlier in the Five Forces analysis, the retail apparel industry

operates in a highly-competitive environment. There are relatively low barriers to entry

and the products are easily replicable. For the company to maintain its strategic

advantages and to improve its profitability, it is critical that Chico’s be able to

differentiate itself along one or more of the competitive points, such as customer service.

Our strategy recommendations, discussed later, will explore this point in greater detail.

As explained in the weaknesses section, Chico’s dependence on foreign suppliers

and third-party manufacturers also qualifies as a threat. Related to this dependence is

exchange rate risk. Exchange rate risk can affect Chico’s even if transactions are

conducted in U.S. Dollars, which is the case in most of the company’s business. Foreign

suppliers, manufacturers, 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.S. Dollar appreciates against their respective currencies. This may result in supply

chain disruptions or quality assurance issues for Chico’s with an additional impact of

customer dissatisfaction.

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The Internet is another threat to Chico’s. The Internet provides ease in comparing

costs across companies and generally competitive products. This threat may challenge

Chico’s strategy of personalized attention and opportunities to cross-sell items within the

store.

Today’s economy serves as a catalyst for companies to become even more cost-

conscious than they have been before. Significant increases in input costs or logistics

costs, for example, could interfere with Chico’s ability to effectively maintain appropriate

pricing levels. Given Chico’s dependence on one distribution center, increased logistics

and fuel costs could have a material, negative effect on profitability.

Finally, the U.S. will be led by a new presidential administration starting in

January 2009. Changes in government regulations regarding import/exports and trade

relations could potentially impact Chico’s costs associated with those activities.

5.4 Opportunities

Several opportunities arise from the various analyses on Chico’s and the summary

of the company’s strengths, weaknesses, and threats. First, Chico’s has the opportunity

to increase focus on its personalized attention strategy. This increased focus can be

accomplished through aligning the product mix with customer demand, strengthening

customer service, and improving marketing effectiveness. As stated earlier in the

financial ratio analysis, weaknesses in these areas led to a decline in Chico’s profitability

since 2005. Although more details will be provided in the strategy recommendation

section, the following will briefly explain the opportunities in these areas and the overall

strategic implications.

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To align the product mix and understand customer service issues, Chico’s needs

to study the reasons for the mismatch between product mix and customer demand. For

example, given that the winter product line is designed in the spring and produced in the

summer, were designs based on faulty data? Were fit/size, fabric, color, and/or

availability a problem? To help answer these and other questions, Chico’s could call

customers who stopped or decreased shopping at Chico’s since 2005. Focus groups of

current and past customers could be formed to obtain feedback on product offering and

customer service. 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, Chico’s can develop relationships with other companies to add

or enhance complementary products such as shoes, handbags, and jewelry to its existing

product mix. 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, manufacturing, etc.).

As Chico’s implements a deep internal review and if unprofitable stores are

closed, Chico’s should contact customers from those stores and help them find a nearby

location. Excellent customer service should be emphasized as a continuous process and

tied to management compensation. This will help to ensure excellent customer service,

which is part of Chico’s differentiation strategy.

From a marketing perspective, Chico’s should better utilize email, mail, print, and

broadcast advertising. Using loyalty club member lists and expansion in the

aforementioned mediums, Chico’s can broaden exposure to existing and potential

customers. Specific details are explained in the strategy section.

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Strategically, aligning the product mix with customer demand, strengthening

customer service, and improving marketing effectiveness will result in several benefits to

Chico’s. Chico’s products and customer service will gain more visibility in the

marketplace, which will build up brand equity and create demand. More satisfied

customers will increase loyalty and the probability of repeat same-store sales. These

increased sales will improve Chico’s profitability. Additionally, Chico’s can improve

profitability by halting any expansion and conducting a deep internal review on many

levels to essentially “clean house.” This point will specifically be explained in further

detail in our strategy recommendations later in the report.

Soma was launched in 2004. Per Chico’s 2007 Annual Report, the Soma brand

was initially positioned towards Chico’s target consumer but was repositioned in 2007 to

target a broader customer base.47 Currently, the Soma brand is sold in stand-alone stores.

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.

As will be detailed further in the strategy section, 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.

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. This does not                                                         47 Chico’s FAS, Inc. 2007 Annual Report, pg. 2 

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mean a significant capital investment but rather a lease of office space and the hiring of

one or two employees. This would help mitigate risks from potential issues such as

quality, consistency of fabric, fit, color, etc. with foreign suppliers and third-party

manufacturers. In addition, this office could work to establish relationships with various

suppliers to create a network which currently does not exist. Based on the success of this

concept in Asia, offices could be extended to Europe and/or other geographic regions

depending on Chico’s expansion efforts in the long-term.

Chico’s should evaluate the opportunity to build strategic relationships. For

example, Chico’s should consider expanding relationships with suppliers in Mexico.

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. Finally, since we are recommending that Chico’s halt store expansion

including outlets, the company should take advantage of closeout merchandise stores like

Tuesday Morning, Nordstrom Rack, and/or third-party channels to sell slow-moving

merchandise. 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. More details on building strategic

relationships are discussed later in the strategy recommendation section.

Also further detailed in the strategy recommendation section is an opportunity

Chico’s has to more actively manage exchange rate risk. As mentioned earlier, the

company pays all overseas manufacturing expenses in U.S. Dollars and is, therefore,

perfectly hedged. However, the company should investigate implementing a more active

currency risk management strategy. The strategic advantage of this is a better position in

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handling exchange rate risk from potential overseas expansion and indirect cost savings

by not paying suppliers to manage the risk.

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.

With numerous strengths, Chico’s is in an advantageous position to capitalize

successfully on its opportunities and to address weaknesses and threats. With an

understanding of Chico’s industry, its financial position, and its strengths, weaknesses,

threats, and opportunities, the next section will show that Chico’s is a strong candidate

for purchase.

6. Valuation

Overview

Having evaluated Chico’s strategic position and having confirmed it is a strong

competitor in the retail apparel market, we must verify that the purchase of Chico’s will

provide an acceptable return on investment over the next five years. The investment must

generate an internal rate of return (IRR) greater than Chico’s cost of capital. The

following analysis describes three valuation methods and provides a calculation of

minimum, optimal, maximum acquisition premiums, and IRR.

6.1 Discounted Cash Flow Analysis

To value Chico’s using the discounted cash flow valuation (DCF) method, we

determined the free cash flow (FCF) growth rate and the weighted average cost of capital

(WACC). Using Chico’s annual reports, we obtained operating cash flows and capital

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expenditures for the period 2002 through 2007. We determined an average FCF growth

rate of 2.32%. See Appendix B for a detailed DCF analysis.

Historically, Chico’s has had zero debt in its capital structure. Therefore, the

WACC is equal to Chico’s cost of equity. From Bloomberg, we obtained a market return

of 11.98%, and, from Google Finance, we obtained a beta of 1.65. We calculated a risk-

free rate of 3.78% by taking the average of 10-year Treasury note yields in October

2008.48 Using the Capital Asset Pricing Model (CAPM), the cost of equity was

calculated at 17.30%. We then projected Chico’s FCF for the next five years and the

terminal value. Using the sum of the discounted cash flows, total shareholder’s equity,

and the total shares outstanding, we calculated a book value per share (BV/S) of $5.39

(see Appendix C).

Then, we conducted a sensitivity analysis on the four drivers of the DCF valuation

- the risk-free rate, the market return rate, the FCF growth rate, and the beta. When the

risk-free rate was increased by 1.22% to 5%, the WACC decreased to 16.51% and the

BV/S increased to $5.41, while all other parameters remained the same. These changes

are the result of the WACC formula. When the risk-free rate increases, both the risk

premium and the WACC decrease. In addition, when the WACC decreases, the present

value of the discounted future cash flows increases. If the risk-free rate was decreased to

3%, the WACC increased to 17.81%, but the BV/S did not change from $5.39. When we

increased the FCF growth rate to 5%, the BV/S increased to $5.42. By decreasing the

FCF growth rate to 0%, the BV/S decreased to $5.38. The same trends were seen when

we increased the market return rate to 15% and decreased it to 7%. Increasing the rate

                                                        48 U.S. Treasury Department. Daily Treasury Yield Curve Rates, http://www.ustreas.gov/offices/domestic-finance/debt-management/interest-rate/yield_historical.shtml 

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caused the WACC to increase to 22.29% and produced a BV/S of $5.34, while a WACC

value of 7.00% produced a BV/S of $5.68. As stated above, by discounting the FCF at a

higher WACC value, BV/S was lower. Last, when we decreased beta from 1.65 to 1.00,

the WACC decreased to 11.98%, and the BV/S was $5.51, while the reverse was seen

when we increased beta to 2.00. In this case, the WACC increased to 20.17%, and the

BV/S value dropped to $5.36. Therefore, BV/S is more sensitive to the WACC than to

the FCF growth rate because the higher the WACC, the lower the sum of the DCF and

BV/S. Since the beta, risk-free rate, or the market return either cause an increase or

decrease in the WACC, the BV/S is sensitive to a high beta or market return and a low

risk-free rate, when all other parameters remain the same. See Appendix D for a detailed

sensitivity analysis.

6.2 Value Creation Model

Value creation models attempt to quantify the contribution of management to

returns. The model used in our analysis was derived from Rappaport’s Creating

Shareholder Value.49 Various parameters, including inflation, real return rate, expected

return, sales growth, operating margin, and incremental fixed and working capital

investment were estimated from sources, such as the company’s 10-K SEC filing. Based

on these parameters, cash flows were generated and discounted, and the contribution of

management was estimated. Sensitivity analysis was done by varying selected

parameters to estimate the impact of errors in the original parameter estimates, as well as

estimating the value of changes in management performance.

                                                        49 Rappaport, Alfred. Creating Shareholder Value, The Free Press, Macmillan, Inc., New York. 

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Our initial parameters (see Appendix E) resulted in an estimated value created of

$22M. Varying parameters resulted in the following dominant drivers (sales growth and

operating margins) of value created (see Figures 1 and 2).

Figure 1. Sales Growth v. Value Created

$‐$10,000 $20,000 $30,000 $40,000 $50,000 $60,000 $70,000 

1% 2% 3% 4% 5%

Value

 Created

Sales Growth

Sales Growth v. Value Created (millions)

Sales growth rate was found to be the dominant driver of increased value for

Chico’s. Value was increased at approximately the following rate ( is percentage point

increase over 1%):

The sales growth rate represents the single parameter which results in the

strongest potential for value creation. In addition, it is a variable over which management

has significant influence. Management can invest in marketing and other initiatives,

which result in increased sales, thereby creating value along these lines. Using the above

mathematical model, management can compare the cost of creating sales growth to the

value created and make decisions regarding the appropriateness of the investment.

Figure 2. Operating Margin v. Value Created

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$‐

$20,000 

$40,000 

$60,000 

$80,000 

$100,000 

$120,000 

$140,000 

5% 10% 15% 20% 25% 30%Value

 Created

Operating Margin

Operating Margin v. Value Created (millions)

Operating margin was the next largest factor in driving Chico’s performance.

Value was increased at approximately the following rate ( is percentage point increase

over 1%):

Like sales growth, operating margin represents a variable that makes a

considerable contribution to the company’s results and can be influenced by management

actions. Good management decisions can result in lowered costs or better capital

investments, yielding increased operating margins. Using the above mathematical model,

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. See Appendix F for a detailed sensitivity analysis.

6.3 Comparables Valuation

To construct a basket of Chico’s competitors, we gathered data from the

company’s 2007 annual report, the Hoover’s Pro database, Google Finance, and

Bloomberg. Chico’s competes with three types of companies – department stores,

specialty stores, and direct consumer retailers. Because the direct consumer retailers,

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suggested by the data sources, were private companies, we focused on the first two types.

Our selection of direct competitors in the United States was based on target demographic

markets, product price points, SIC codes (5621: Retail Women’s Clothing Stores),

current market capitalization, and low debt-to-equity structures (Chico’s has no debt).

Using Bloomberg, Chico’s 2007 10K, and Internet databases (e.g., Google Finance and

Wall Street Journal), we identified five direct competitors – Christopher & Banks,

Coldwater Creek, Dillard’s, Talbots, and Ann Taylor Stores (see Appendix G). The

companies are all mid- to upscale women’s retailers, which primarily target professional

and fashion conscious women over the age of 35. A general price/product search on the

competitors’ websites yielded an average price point of around $100 to $120, which is in

line with the prices Chico’s charges on its apparel products.

To find Chico’s intrinsic value, we used common current market multiples, such

as price/earnings, price/sales, price/book value, price/cash flow, price/EBITDA and

calculated average values for the comparables basket. The multiples valuation method

yields an intrinsic value of $2.44, which is lower than the current market price. See

Appendix H for a detailed multiples valuation.

6.4 Mergers and Acquisitions (M&A) Premium

To decide the appropriate premium to use in Chico’s acquisition transaction, we

completed a historical M&A premium analysis for the apparel industry. Based on deals

with available premium data, we calculated an average premium for the entire period

from 2005 to 2008 and for each of these years. The average premium was negative in

2005 and increased to 11.12% in 2008. On average, target companies were acquired at a

lower price than their market value. However, this trend changed in the last two years.

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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).

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Table 2: Chico’s Acquisition Premium – Sensitivity Analysis

Minimum Optimal Maximum Premium 0% 11.12% 41.55% Suggested purchase price $2.93 $3.26 $4.15 Current stock price $2.93 As of Oct 24th 2008.

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

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of $18.85 per share. See Appendix K for IRR calculations and highlighted cells in

Appendix L for results.

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.

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Conclusion

In our analysis, we provided a brief overview of Chico’s; described three

valuation methods, assumptions and results; calculated minimum, optimal, and maximum

acquisition premiums and prices; and calculated the IRR on the investment. We

recommend purchasing 100% of Chico’s outstanding shares at a price of $3.26/share for

a total acquisition value of $575.2M. Chico’s has a zero-debt capital structure and a

strong liquidity position as discussed in the financial ratio analysis section, and we

believe the company will successfully withstand the economic recession. In addition to a

strong balance sheet, the company generates high gross and operating margins and

positive FCF. From the valuation analyses, Chico’s creates value and can significantly

increase FCF by slowing down its current expansion strategy. Depending on the

magnitude of the slowdown, Chico’s can be expected to produce an IRR as high as

57.27% (optimal premium case), without considering the effects of any sales growth due

to additional stores. This IRR greatly exceeds Chico’s cost of capital of 17.30%. In

addition, slowing down growth will give Chico’s the opportunity to realize returns on

investments in new stores and approach market saturation points slowly, thereby reducing

the risk of over-expansion.

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7. Chico’s FAS Acquisition Strategy

Overview

Based on the internal and external analysis in the previous sections of this

document, 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. Chico’s

has historically had very positive financial and operational results and performed above

many of its direct competitors in the upscale apparel industry. In the current economic

recession, the company is able to generate substantial cash from operations and to fund

its growth strategy without financial leverage.

Under the umbrella of conglomerate Berkshire Hathaway, 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. Through the

acquisition, we will not make any major changes to the current business operations and

will keep the executives on board. We believe we can provide Chico’s with a sound

strategic turn-around plan, discussed later, that will increase the market capitalization

levels seen in 2006 and generate an optimal 57% IRR for AWWI. The following section

describes in detail the implementation of the friendly acquisition of Chico’s, and the

proposed post-acquisition strategy. Details of a company’s acquisition process, including

SEC regulations and filings, can be found in Appendix M.

7.1 AWWI’s Merger and Acquisition (M&A) Team

An essential element in any acquisition project is the people involved in the

negotiation. We have formed an M&A team of young professionals with diverse

backgrounds and expertise that increase the likelihood of a successful outcome. These

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diverse backgrounds include finance, accounting, marketing, and IT. 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.

7.2 Acquisition Objectives

Our M&A team has developed Chico’s acquisition strategy based on several

fundamental principles. First, the proposed transaction is a friendly acquisition in which

AWWI will acquire 100% of Chico’s outstanding shares. Currently, the company’s vast

majority of shares are institutional ownership (95%), 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.

Second, AWWI will either use 100% cash in the proposed transaction, or

implement a stock buyback and swap between Berkshire Hathaway’s Class B shares and

Chico’s common shares. This will prevent the dilution of existing holdings of

shareholders by not issuing new stock to use as a currency in the transaction. We will

also send a strong message to the investor community that AWWI is confident in

achieving financial, operational, and management synergies from the proposed

acquisition.50

Third, based on the long-standing tradition of Berkshire Hathaway acquisitions,

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 main

                                                        50 Note: the expected synergies with existing companies in the portfolio are subject to thorough due diligence, and this discussion is not part of the current project. 

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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.

7.3 Chico’s Takeover Prevention Mechanisms

To prevent a hostile takeover attempt, Chico’s has two anti-takeover mechanisms

in place. First, Chico’s has a staggered three-year Board of Directors. Chico’s Board

consists of eight directors elected for three-year terms. The Class I directors (two) serve

until 2009, Class II directors (three) serve until 2010, and Class III directors (three) serve

until 2011, respectively.51

In publicly-held companies, staggered boards have the effect of making hostile

takeover attempts more difficult. 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. More importantly, in combination with a poison pill, a staggered board

that cannot be dismantled or evaded is one of the most potent takeover defenses available

to U.S. companies. Although, from a corporate governance perspective, having a

staggered board can have both positive and negative implications; in our case, ousting the

Board would be very difficult.

Second, 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. Based on

Chico’s latest proxy statement, as of April 30, 2008, in the event of a change in control

with executive employment termination, the acquiring company must pay an extra $15M

in total executive severance packages. 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, Inc. 2008 Proxy Statement 

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increases in the initial offer. 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 believe we have a strong post-

acquisition strategy that, supported by the industry experience of current executives, will

help Chico’s increase same-store sales growth and emerge from the economic recession

as a key player in the upscale apparel industry.

7.4 Approach to Chico’s Shareholders

The cornerstone of the proposed acquisition of Chico’s is the negotiation with

current shareholders. As of August 30, 2008, Chico’s had 176.51M outstanding common

shares, of which 95% were held by institutional investors. Please refer to Appendix N for

detailed information about Chico’s major shareholders. Rather than approaching

institutional investors individually, we will meet and negotiate with Chico’s Board of

Directors. They represent the interests of shareholders, and we must convince them that

the acquisition will be successful. Paying for the outstanding stock with 100% cash

means that AWWI assumes the whole pre- and post-transaction risk of failure. We feel

confident that the acquisition will be successful, and potential synergies with existing

portfolio companies and operational efficiency will be achieved. It is expected that we

will face strong resistance from institutional investors. These are very sophisticated

investors, 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. 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; otherwise, we expect that there would not be 95% institutional

ownership of the company.

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The company’s strong balance sheet and the effective asset and supply chain

management are not appropriately leveraged to address the declining profitability,

ineffective marketing, and mismatched product mix in the last two years. 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.

In order to convince the Board of Directors and Chico’s shareholders, our team

recommends offering a premium above the current stock market price. The 11.12%

optimal control acquisition premium is based on the analysis of the historical M&A

transactions in the retail apparel industry. To increase the probability of a successful

negotiation, we have prepared two acquisition plans.

7.5 Plan A - 100% Cash Transaction

Our first bid in the negotiation is 100% cash for all outstanding shares of Chico’s.

At the time of the initial valuation, the offered purchase price was $3.26, representing a

control premium of 11.12% over the market price. However, since the initial company

valuation, Chico’s stock price declined from $2.93 to $1.89 on November 20, 2008.52

Applying the same initially-offered purchase price gives shareholders an acquisition

premium of 55% over the current market price. The offered premium is still conservative

and does not incorporate the full potential of Chico’s intrinsic value. 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. It is expected that the proposed premium is reasonably

high to induce shareholders to sell. However, we are prepared to increase the bid up to a

                                                        52 Google Finance 

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41.55% control premium above the market price in the initial valuation. As an additional

negotiating point, we present the option of a stock swap in Plan B.

7.6 Plan B - 100% Stock Buyback and Swap

The stock buyback and swap bid entails exchanging Berkshire Hathaway Class B

(BRK.B) shares with 100% of Chico’s shares. Please, refer to Appendix O for details on

BRK.A and BRK.B shares. We will repurchase a number of BRK.B shares with a value

equal to the acquisition transaction value and use these shares in the exchange deal.

Effectively, we will use 100% cash to buy back shares, and there are multiple benefits to

this transaction structure.

First, by repurchasing BRK.B shares for use in the transaction instead of issuing

new shares, we will not dilute existing Berkshire Hathaway shareholders’ equity.

Second, we offer Chico’s shareholders the opportunity to acquire the more stable BRK.B

stock, which in the last two years dropped only 26% in comparison with Chico’s stock,

which slumped 96% during the same period. Berkshire Hathaway is a greatly-diversified

company that is less vulnerable to economic shocks. Historically, Berkshire Hathaway’s

Class A and B stock have outperformed the S&P 500 index and have delivered an

annualized return of 25% since 1976.53 Last, Chico’s shareholders will be able to defer

paying capital gain taxes until the time they decide to sell their newly-owned BRK.B

stock.

The potential risk of this bid comes from the fact that stock swap transactions

usually generate negative market reaction. The market’s perception is that acquiring

companies will only choose this type of transaction when the stock is overvalued, in

                                                        53 Portfolio.com. Berkshire Hathaway, Incorporated Class A (BRKA), http://www.portfolio.com/resources/company-profiles/Berkshire-Hathaway-Incorporated-Class-A-778 

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which case, they use the cheapest source of capital to finance the acquisition. However,

we expect that the market reaction will be favorable because this transaction is

structurally different from other stock swaps. We are not diluting current equity stakes

by issuing new shares to be used in lieu of cash. We are instead repurchasing existing

shares to be used as a tax-advantaged means of transferring value.

Because of the large difference in the market price of both Chico’s and BRK.B

shares, the proposed transaction will have two elements – (1) We will exchange 219,627

BRK.B stock to acquire the majority of Chico’s outstanding stock (exchange ratio of

0.001244). The fact that Chico’s has 95% institutional ownership makes it easier to

conduct the swap transaction. (2) To shareholders who own less than 2,000 shares of

Chico’s stock, we will offer to purchase the stock with cash for a control premium of

11.12% as already discussed in Plan A.

7.7 Approach to Chico’s Executive Managers

Despite the fact that executive directors own a small percentage of Chico’s

outstanding shares, collectively, they are a significant stakeholder in the proposed

transaction and an integral part of implementing the post-acquisition strategy. As already

mentioned, executive directors have golden parachutes, which are intended to align their

wealth more closely with shareholders’ interests. We face a situation where Chico’s

executives, once faced with an acquisition attempt that might lead to a loss of their jobs,

are likely to oppose AWWI’s bid, even though this bid would increase shareholder

wealth. Therefore, we will approach them in a friendly manner offering them several key

opportunities.

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First, we will offer Chico’s executive managers the opportunity to stay with the

company and take part in implementing the proposed post-acquisition strategy. Current

executives have underperformed in the past two years, making inappropriate acquisition

decisions (e.g. Fitigues), following an overly aggressive expansion plan, and allowing a

product mix that has resulted in negative same-store sales for two consecutive years.

However, we should also give them credit because Chico’s has historically outperformed

its direct competitors. We would like to take advantage of the directors’ experience and

expertise and work together to increase the value for shareholders.

Second, our bid to executives includes access to abundant capital resources under

the umbrella of Berkshire Hathaway. In the future, Chico’s managers will not have to

worry about how to finance new projects because they will have easy access to capital;

they will also have the chance to communicate closely with executives from other

companies in the conglomerate and gain “know-how.”

Last, we will perform a thorough due diligence along with the compensation

committee and tie executive compensations more closely to Chico’s performance. In

particular, we will increase the proportion of their above-base compensation and re-

evaluate the stock option and restricted stock plans. According to our reasonably-

conservative financial projections, already discussed in the first part of this document, the

executives will be able to reap great benefits under the new company ownership.

7.8 Offer Price and Expected Return on Investment

Based on our initial valuation, we will take a conservative approach and

recommend purchasing 100% of Chico’s outstanding shares for $3.26 per share, which

represents an 11.12% control premium. Because of recent declines in the stock market,

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many stocks are trading at a discount relative to their recent prices. If we apply a

negative premium to the transaction, we will face strong resistance from shareholders,

causing a delay or 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 our walk-away price of $4.15, which

represents a control premium of 41.55% over Chico’s current market price (see Table 3).

Table 3. Chico’s Acquisition Premium – Sensitivity Analysis

Minimum Optimal Maximum Premium 0% 11.12% 41.55% Suggested purchase price $2.93 $3.26 $4.15 Current stock price $2.93 As of Oct 24th 2008.

Based on our initial valuation model of Chico’s, AWWI will achieve an IRR

considerably higher than Chico’s cost of capital. In our optimal offer of 11.12% control

premium, the IRR is 57% over the next five years. A sensitivity analysis of the IRR and

Chico’s purchase price yields a minimum rate of return of 48%, assuming we offer

Chico’s shareholders a maximum premium of 41.55% over the current share price.

Conclusion

Our main goal is to pursue a friendly acquisition of Chico’s. A hostile takeover

would be very expensive and extremely hard to accomplish because, first, Chico’s has a

three-year staggered Board of Directors and, second, executives have golden parachutes

in their employment contracts. To better position ourselves in the negotiation process,

our team has prepared two major deal propositions, which based on the initial valuation

analysis, will provide returns above Chico’s cost of capital. In particular, we offer an

11.12% control premium for all Chico’s outstanding shares based on the market price as

of October 24, 2008. This premium can be achieved through (1) purchasing Chico’s

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outstanding shares with 100% cash, or (2) repurchasing BRK.B shares and exchanging

them for 100% of Chico’s outstanding shares. Both approaches have advantages and

disadvantages, and we will use them to convince Chico’s shareholders to sell.

In addition to the acquisition premium, 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). The abundant resources under the

Berkshire Hathaway conglomerate, which can be used for future strategic initiatives,

would be a strong motivation for these executives to agree to the proposed merger. We

not only strive to avoid any disruption in operations, but also to avoid overpaying for

Chico’s. 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. To achieve this goal, we have set a maximum per-share

acquisition price of $4.15, representing a premium of 41.55% over Chico’s stock price as

of October 24, 2008. Even if we pay this high price for Chico’s, we expect that we

would still achieve a high return on investment of 48% over the next five years.

Should the negotiation with Chico’s Board fail, our M&A team will be ready to

approach the Board of Directors of our back-up acquisition candidate AnnTaylor. Please

refer to the alternative acquisition candidate section for a detailed analysis of AnnTaylor.

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8. Post-Acquisition Strategy

Overview

Based on the previous analyses thus far, our team has developed a set of post-

acquisition business strategy initiatives. All elements of the strategy are based on the

SWOT analysis and include marketing, financial and business development initiatives.

These initiatives require full commitment from current senior management and are

intended to create value for Berkshire Hathaway’s shareholders.

8.1 Align Product Mix and Strengthen Customer Service

Chico’s must be very careful about what messages it sends to clients, whether its

product lines correspond to market trends, and how it handles client requests. In this

respect, 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, given the fact that between 2005 and 2007, Chico’s same-store

sales growth declined, and its worsened financial position led the decline in the apparel

retail industry. While total sales revenue increased due to expansion of store fronts,

existing same-store sales decreased as customers were switching to competitive brands.

We have identified several lines of due diligence, which will help us identify the reasons

for the decline in same-store sales and, based on this, to develop a turnaround strategy.

First, we have to find out what Chico’s did well until 2005 and what went wrong

after that time. The big question is what changed from 2005 to 2007. A possible reason

is incorrect product design that was not in line with industry trends. Given the fact that

the fashion industry has quick-paced business cycles, Chico’s will not be able to respond

if its merchandise is not in line with customer demand. Also, we will analyze the ERP

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system of the company, the process of capturing data from customers, and most

importantly, the measurement and application of this data in developing new products.

We will call Chico’s pre-2005 repeat customers, who purchased less product between

2005 and 2007 to determine what they liked or disliked about Chico’s products, why they

stopped buying, why they switched to a competitive brand, and how they think we can

improve so that we win back their business. In addition, we will create focus groups with

our target customers and provide rewards for participating in the discussion. Potential

problems that could be identified in the marketing research are: design choices, fit/size,

fabric, color, and lack of product availability. We will not only seek our clients’ opinion,

but also that of our employees. Chico’s sales associates are the people who have constant

contact with our clients, and they can give us valuable feedback on product mix/design

preferences at the store level and help us bring lost clients back.

Second, in many organizations, leaders and managers express that they want

continuous improvement, but they fail to implement a process that will ensure it. We

must take care to ensure that our post-acquisition strategy is implemented. In this

respect, we have to focus on excellent customer service and continuously train our staff,

in particular sales associates, in delivering this service. Getting Chico’s employees

involved in the marketing research process, as mentioned above, organizing regular

workshops at successful stores, and tying their compensation to sales results will not only

empower them to deliver outstanding customer service, but it will also be reflected on

Chico’s income statement.

Next, the mismatched product mix has led to negative same-store sales growth in

the last two years. Usually, when people visit a fashion retailer, they not only look for a

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single item, but also for a collection of apparel and other accessories like jewelry, shoes,

hats, and bags. Customers can choose any combination of existing clothes and

accessories that fit their fashion tastes. The availability of an appropriate product mix

will increase the opportunity to cross-sell and improve the company’s sales and brand

equity. Therefore, we believe that Chico’s should improve its product lines by adding

more complementary products to the existing mix. It should hire style experts to find the

matching combinations of apparel and accessories to help sales associates guide

customers. More importantly, the company should collaborate with other apparel

accessory producers in a strategic relationship to add suitable styles of shoes, hats,

jewelry, and bags to Chico’s existing collection.

Finally, we will have to reach out to displaced customers from closing Chico’s

stores. To avoid a sales disruption, we will contact all loyal clients by email, mail, or

telephone; notify them about the location of the nearest Chico’s store; and offer coupons

or other promotional incentives. We will also reach out to customers, who have

relationships with specific store employees and offer a transition plan to nearby stores,

ideally matching the customers with their traditional salespeople. Rather than being part

of a one-time marketing research initiative, 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.

8.2 Improve Marketing Effectiveness

Following the acquisition of Chico’s, we plan to improve marketing effectiveness

by restructuring the current marketing strategy to better utilize email, mail, print, and

broadcast advertising. Our overall goal is to significantly improve same-store sales

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which have been declining over the past two fiscal years despite the use of these

previously-mentioned media channels. Using loyalty club member lists for both Chico’s

and WH|BM and catalog sign-up lists from individual stores, we plan to send out

monthly store catalogs and weekly email newsletters. Before mailing out catalogs, the

two lists will be cross-checked to make sure the same person does not receive more than

one catalog. This will keep our print costs down and save money on excess postage fees.

The catalog for Chico’s will contain the newest merchandise and accessories, while the

weekly newsletter will be specific to the customer and provide promotional information

for the nearest store locations. The catalog for WH|BM will contain the newest

merchandise and accessories as well as contain inserts with promotional information and

discount cards.

We plan to implement a print campaign in popular women’s magazines that

service Chico’s target demographic. As of fiscal year 2007, the advertising budget was

$82.7M or 4.8% of net sales.54 We plan to increase marketing expenses in an attempt to

address negative same-store sales growth. Once acquired, Chico’s will conduct an

analysis to determine the appropriate amount of the increase.

Chico’s will explore placing full page, color Chico’s ads in O, The Oprah

Magazine and Good Housekeeping and full page, black and white WH|BM ads in

Cosmopolitan magazine. In addition, we will explore placing half page, color ads for

Chico’s and half page, black and white ads for WH|BM in Elle, In Style, and Vogue

magazines. 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. We will also explore the purchase of                                                         54 Chico’s FAS, Inc. 2007 Annual Report, pg. 18 

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advertising space on the Cosmopolitan and O, The Oprah Magazine websites to display a

WH|BM and Chico’s promotion, respectively.

Last, we will explore a broadcast commercial campaign targeting our intended

demographic. 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. Two Chico’s commercials will

be produced to highlight the unique, quality products and accessories found in multiple

colors and sizes. These commercials will be approximately 30 seconds long and run in

conjunction with the following programs: The View, Oprah Winfrey, Rachel Ray, and

Live with Regis and Kelly.

8.3 Halt Expansion and Refocus on Existing Stores

It is our opinion that over the last two years, Chico’s has pursued an ill-advised

rapid expansion of its retail locations. In these last two years, the company has invested

$300M to open additional retail locations while losing focus on its core mission. This

loss of focus has led to negative same-store sales growth, and therefore cannot be wholly

attributed to the downturn in the macroeconomic environment.

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 believe that such an effort will result in a return to positive same-

store sales growth and allow the company to resume reasonable expansion activities in

the future.

As part of this process, we will establish a store benchmarking system to evaluate

the performance of stores over the past two years. These benchmarks will include a

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comparison of the individual store’s growth rate to the local economic environment,

measures of store efficiency based on per square foot results, overall operating income,

and expected future capital investments in the store as discussed below.

Each store must be evaluated in the context of its local economic environment.

By evaluating whether the store is under- or overperforming its local economic

environment, it is possible to evaluate the performance of management and personnel at

the location. If a store consistently does better than its local economic environment

would suggest, Chico’s should attempt to retain the staff irrespective of whether or not

the store is retained. Similarly, if a store consistently underperforms the local economic

environment, the store’s staff should be restructured even if the store is retained.

Additionally, the store’s overall efficiency must be evaluated. Per square footage

results would indicate whether a store is efficiently using its floor space compared to its

peers. Stores that vary significantly from the benchmark should be given special

attention; overperformers should be studied to determine if the keys to their success are

replicable elsewhere, and underperformers should be studied to see if the problems can be

remedied.

Overall operating income must also be considered. A store which underperforms

in terms of efficiency may still be worth keeping if it nonetheless provides significant

operating income. Similarly, a store which overperforms in terms of efficiency may not

be worth keeping if its operating income is negligible.

Expected capital expenditures in the near future should also be considered. 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. However, a low-performing store

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may be worth retaining if it is providing positive operating income and will require few

capital investments in the foreseeable future.

Using these metrics, Chico’s should determine a set of stores that are overall

underperformers and consider them as candidates for closure. These candidates should

be further evaluated for shutdown costs and the potential for each store’s

underperformance to be corrected. Stores with appropriate shutdown costs with little

prospect of sufficient performance improvement should be closed with all reasonable

haste.

Additionally, among those stores targeted for shutdown, management and staff

should be evaluated for individual performance capability. Chico’s should make an

attempt to relocate overperformers to nearby stores wherever possible. 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.

Negative same-store sales growth is a major problem for Chico’s company-wide.

In an effort to address this issue, managers of the remaining stores will be required to

develop and submit a plan for improving store sales in their local market. It is believed

that each store has localized problems and opportunities that a centralized plan may not

be able to remedy or exploit. 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. Both store-level and regional manager performance will be

evaluated based on the success (or lack thereof) of each store’s plan.

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Finally, halting expansion presents a potential problem in terms of outlet stores.

By having a general expansion freeze, 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. To plan for this possibility, we will

have Chico’s explore possible partnerships with third-party closeout retailers, 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.

8.4 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, we recommend that Chico’s integrate the Soma brand into

Chico’s stores over the next two years. We do not believe Soma can effectively compete

with Victoria’s Secret as a stand-alone store. 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. However, 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. Additionally, Chico’s will experience operational

savings from shutting down Soma’s separate storefronts.

Of Soma’s current apparel line, Chico’s should focus on undergarments,

shapewear and sleepwear and discontinue activewear and swimwear. This re-defining of

the Soma portfolio will help Chico’s focus on its classy, more formal-to-business-casual

image versus a casual, athletic one. This reduction in product line and the fact that

Chico’s was already renovating stores will facilitate integrating the Soma brand into

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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. The company should consult with

individuals experienced in the intimate apparel industry to make these decisions.

As most retail space is leased, the company should look for opportunities to shut

down Soma stand-alone stores as leases expire. Additionally, the company should

perform a cost-benefit analysis on lease breakage fees versus costs of operating stand-

alone stores. If fees are less than operating costs, Chico’s should terminate Soma leases.

From a reduction in force standpoint, Chico’s should retain top-performing Soma

management and sales associates.

8.4 Establish an Overseas Office in Asia

As discussed in the SWOT analysis section, to create a process to oversee

manufacturing and quality control, Chico’s should establish an office in Asia. 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. Given

recent concerns in manufacturing quality in China, the primary purpose is to enable

continuous evaluation and local enforcement of Chico’s quality standards with regards to

cost, style, fit, fabric, color, etc. Additional benefits include exploration of new suppliers

in the region as a contingency plan.

Based on the lessons learned from the office in China, this concept can be

expanded to Turkey and other geographic regions, as necessary. The company should

also evaluate if the one/two-employee office is sufficient or if there is a need for

additional employees and infrastructure.

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8.5 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. Given the

current economic recession and the U.S. trade deficit, the new government may apply

quotas, new tariffs, or other trade restrictions to Asian countries, in particular China. If

this happens, it would negatively affect Chico’s overall business. In the meanwhile, the

United States has a free trade agreement with Canada and Mexico under NAFTA, so it is

highly unlikely that the U.S. government will apply any trade restrictions to those

countries. Hence, in order to deal with this contingent threat, Chico’s should start

building strategic relationships with apparel suppliers in Mexico. It takes time to identify

reliable suppliers, make agreements and integrate into the supply chain, so the earlier

Chico’s starts looking for new suppliers, the better it will be able to address this threat.

As discussed in the financial ratio analysis section, Chico’s financial position is

better than the industry basket’s; however, Chico’s profitability has declined in recent

years. In order to improve profitability in this recessionary period, we recommend

Chico’s reduce capital expenditures in the short run. As part of the general freeze on

expansion, Chico’s will not open any new outlet stores. However, as Chico’s operates in

the fashion industry with high inventory turnover, Chico’s also needs to liquidate excess

inventories. Chico’s should take advantage of closeout merchandise stores, such as

Tuesday Morning, Nordstrom Rack, and/or other third-party channels to sell its obsolete

merchandise. Therefore, the company needs to establish relationships with these stores

as soon as possible, agree on merchandise pricing, frequency, and methods of disposing

excess inventory.

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8.6 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. This provides Chico’s with a perfect understanding

of its expenses going forward. All of its revenues are matched with its expenses in terms

of currencies. In essence, Chico’s has created a perfect hedge with an all-short U.S.

dollar position.

In terms of a passive hedging strategy, Chico’s current implementation is very

effective. Chico’s simply agrees to the contracts and lets its suppliers manage all

exchange rate risks. However, this presents a lost opportunity for Chico’s – not only

does Chico’s have the supplier manage all exchange rate risks, but Chico’s also permits

the supplier to reap all of the benefits of good risk management practices.

In the short-term, we believe that this is appropriate as it permits Chico’s to focus

on its core business activities. However, 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. These choices will increase Chico’s

exposure to exchange rate risk in the intermediate term. Additionally, we foresee a future

in which Chico’s may wish to engage in more aggressive international expansion in

Canada and possibly Europe.

Because of our near- and intermediate-term recommendations and our long-term

expectations, we believe that Chico’s should begin developing expertise in currency

exchange risk management. By developing this expertise, 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

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positions with respect to its suppliers. Suppliers do not take on the risk of exchange rate

fluctuations for free. 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.

To this end, we suggest that Chico’s start a small risk management division

consisting of two or three risk management professionals. 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.

If the results of the evaluation are favorable, Chico’s should develop a plan to implement

a risk management division that takes into account its increasing exposure to currency

risks.

8.7 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. However, when Chico’s does resume growth,

the company must evaluate the risks associated with a single distribution point and

determine if additional locations would better serve stores and customers.

Given the current state of the economy, Chico’s should maintain the proposed no-

growth strategy for at least two years. A cross-functional team should be formed now to

begin evaluating the opportunity for the company to resume expansion after two years.

In addition to domestic U.S. expansion, this team should look into the possibility of

expanding into Canada, in particular, the metropolitan cities of Toronto and Vancouver.

With geographic proximity, similar culture and demographic to the United States, we

believe Chico’s product offering and focus on personalized attention will transfer

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successfully. Strategically-placed distribution centers could help mitigate international

logistics costs.

Conclusion

Chico’s is a strong company experiencing difficulties due to the recent market

downturn and managerial missteps. Additionally, Chico’s has considerable opportunities

going forward to improve and solidify its position. We believe our aforementioned

strategy will permit Chico’s to address the 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. Additionally, we believe our strategy

will allow Chico’s to take advantage of opportunities going forward by improving

customer service, reintegrating Soma to take advantage of cross-selling opportunities, and

laying plans for a larger international presence in the future.

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9. Alternative Acquisition Candidate – AnnTaylor Stores, Corp.

We have decided to acquire Chico’s; however, should that acquisition fail, our

alternative acquisition candidate is AnnTaylor Stores Corporation. The following sections

will present our analysis of AnnTaylor’s financial position, SWOT, and valuation.

9.1 Company Overview

AnnTaylor is a women’s career and casual wear retailer established in

Connecticut in 1945. Started as a primarily East Coast brand, the company has grown

into a national brand with 929 retail stores nationwide and annual sales revenues of $2.4B

in 2007.55 AnnTaylor targets affluent women and provides them with “updated classics

products that are feminine, stylish, versatile, and polished.”56

AnnTaylor’s product line is comprised of women’s apparel, shoes, and

accessories under the Ann Taylor, LOFT, and Ann Taylor Factory brands. The LOFT

brand contributes the most significant part of the company’s sales revenue.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.58

Like other companies in the industry, AnnTaylor does not manufacture its apparel

merchandise but develops designs in-house and then outsources the production process to

independent manufacturers, primarily in Asia. The company experienced declines in

profitability due to the economic downturn that started in 2007. In an effort to enhance

profitability and improve overall operating effectiveness, the company initiated a multi-

year restructuring program. The program is expected to include reviewing company’s

                                                        55 AnnTaylor Stores, Corp. 2007 Annual Report, pg. 2 56 AnnTaylor website: http://www.anntaylorstorescorp.com/ 57 AnnTaylor Stores, Corp. 2007 Annual Report, pg. 2 58 AnnTaylor Stores, Corp. 2007 Annual Report, pg. 2 

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cost structure, closing underperforming stores over three years, and streamlining

corporate organization structure.

Besides closing underperforming stores, the company expects to spend about

$60M on new store openings and construction, store expansion or relocation, store

renovation, and refurbishment programs. Furthermore, the company plans to invest in its

information technology systems, corporate office, and distribution center.59 Management

hopes that these actions will help increase corporate efficiency and attract new customers.

With AnnTaylor’s current financial situation, it is expected that AnnTaylor will generate

enough cash from operations to finance its capital needs.

One of AnnTaylor’s strengths is its brand equity. This is a strategic advantage in

that a strong brand name can command a higher price than a weaker brand name.

Therefore, AnnTaylor pays special attention to strengthening its brands through effective

marketing and top-tier client services.

9.2 Financial Analysis

In order to assess AnnTaylor’s financial health, we examined its performance

over the past five years and compared it with that of the industry basket average. 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. Since AnnTaylor is one of the companies within the industry comparables

basket used to assess Chico’s, the only change made was a switch in position between

Chico’s and AnnTaylor in the basket. We added Chico’s into the basket and removed

AnnTaylor so that AnnTaylor could be compared to the basket. See Appendix P for the

                                                        59 AnnTaylor Stores, Corp. 2007 Annual Report, pg. 24 

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financial ratios. The following analysis uses a materiality of 2X above or below the

industry basket average.

Liquidity Ratios

AnnTaylor’s current ratio and quick ratio are slightly lower than those of the

industry average; however, they fluctuated noticeably from 2003 to 2007 and declined

last year. This trend is not present in the working capital and cash flow per share ratios.

Compared to the basket’s average, these ratios are materially higher. Therefore,

AnnTaylor is able to meet its current liabilities and generate enough cash from operations

to self-finance. Strategically, this position allows AnnTaylor to pursue positive NPV

projects and/or expand production should an attractive investment opportunity arise.

Furthermore, with respect to liquidity, AnnTaylor is in a better position compared to its

competitors to get through the current difficult economy.

Activity Ratios

In the past five years, AnnTaylor has consistently had a stable inventory turnover

ratio, which results in a relatively flat trend in the days to sell inventory ratio. The trend

of these two ratios is similar to that of the industry. However, there is a material

difference in the receivable turnover ratio and the average collection period. While the

industry has experienced a declining trend over the past five years, AnnTaylor has

maintained a consistent advantage in these areas. The company has consistently

maintained collection periods of approximately 3 days, which is 2/3 faster than the

industry basket. This results in a faster cash conversion cycle for AnnTaylor than the

industry basket. However, the industry basket has narrowed the gap by nearly 50% in the

past 5 years, eroding AnnTaylor’s advantage in this area.

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The similar inventory turnover ratio of both AnnTaylor and the basket shows that

AnnTaylor has no comparative advantage in this respect. However, it has a real

advantage in other areas. For example, AnnTaylor’s high receivables turnover ratio

implies that the company has tight credit policies. Operationally, it can be inferred that

AnnTaylor’s credit terms applied to its customers may be more effective than those of

AnnTaylor’s competitors. The tight credit policy has helped AnnTaylor to decrease its

operating cycle with a faster conversion from sales to cash and enjoy higher profitability.

However, it could also lead to losing customers in the economic recession period. Last

year, the company’s sales growth rate declined and caused a drop in profitability, which

will be discussed later. Strategically speaking, AnnTaylor’s activity ratios are strong,

supporting AnnTaylor’s solid position in liquidity and management of and access to cash.

Profitability Ratios

AnnTaylor’s profitability is very strong. Its operating margin was in line with the

industry between 2003 and 2006; however, it was materially higher in 2007. The

company’s profit margin is stable and also outperformed the basket average in the last

two years. Other ratios in the profitability family have the same trend. In 2007,

AnnTaylor had a relatively stable ROA whereas the industry basket dropped almost

100%. AnnTaylor’s ROE has almost doubled in the last four years, while the industry’s

average ROE movement decreased by 66%.

While the industry has experienced a declining trend in profitability, AnnTaylor

has managed to avoid this trend and was materially higher than the industry last year.

Strategically speaking, this suggests AnnTaylor has an advantage over its competitors,

possibly due to better operational strategies. Its recent high profitability results from its

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positive free cash flow, which allows AnnTaylor to engage in strategic initiatives and

increase the value to shareholders by buying back outstanding shares.

Leverage Ratios

From a financial leverage perspective, AnnTaylor has a zero debt to equity ratio,

meaning that the company has operated with no debt in the last four years. It has a strong

balance sheet with shareholder’s equity and internally-generated cash as a main source of

financing. All other debt ratios in this family show this position. Low financial leverage

is also a common characteristic of other companies in the women’s retail apparel

industry. Almost all of the companies in the basket have a low level of debt; on average,

long-term debt to equity is approximately 20%. However, Talbot’s is the only competitor

in the basket with a material difference in debt level and skews the data set. Talbot’s

position is the result of the unsuccessful J. Jill acquisition. Because of this, 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. 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. Even if demand for capital exceeds its

capacity, the company has the option to utilize its credit facility to take advantage of

attractive investment opportunities. 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.

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Stock Market Ratios

From 2003 to 2007, AnnTaylor’s price/earnings, price/cash flow, and

price/EBITDA were not materially different from that of the industry. These three ratios

followed the same trend - they were low in 2003, peaked in 2006, and dropped in 2007.

However, there was a significant difference in the price/book and price/sales ratios. The

industry average ratios are 2X higher than AnnTaylor’s between 2003 and 2006. 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.

Strategically speaking, AnnTaylor does not have any competitive advantages over

the industry basket regarding stock market ratios. Almost all of AnnTaylor’s price

multiples, except the price/book and price/sales ratios, are similar to the basket averages.

This trend shows that investors placed equal value on AnnTaylor’s stock and its

competitors’ on variables, such as earnings, cash flow, and EBITDA. The positive

market reaction to AnnTaylor’s stock last year, in terms of book value and sales, creates

opportunities for improvement. The company could start paying dividends and continue

repurchasing shares to increase the value to its shareholders. If this is successful, the

market would have better expectations for AnnTaylor’s performance.

Conclusion

Overall, AnnTaylor has several advantages over its competitors. It has a strong

liquidity position and generates enough cash to finance its operations. From an

operational perspective, the company has good credit policies, which allow it to collect

receivables from customers quickly. AnnTaylor maintained high profitability in difficult

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times, while the industry experienced losses. The company also has a strong balance

sheet with no current debt but a reserved credit facility.

All these strengths provide AnnTaylor with flexibility to take advantage of

positive NPV investment opportunities that might arise in the future. On the other hand,

AnnTaylor has areas for improvement, such as inventory management and profitability.

Its credit policies should also be reviewed to increase sales during these difficult

economic times.

9.3 AnnTaylor’s SWOT Analysis

Based on the retail apparel industry and AnnTaylor’s specific analyses thus far,

we conducted a comprehensive analysis in order to assess AnnTaylor’s strengths,

weaknesses, opportunities, and threats.

STRENGTHS OPPORTUNITIES

• Product mix

• Trained sale associates

• Brand equity

• Financial position

o Debt free

o Effective inventory and receivables management

• Restructuring program

• Increase in sales through Internet

• Debt financing

• Opening LOFT outlet stores

WEAKNESSES THREATS

• Declining profitability

• Underperforming stores

• Dependence on a single distribution facility

• Dependence on foreign

• Economic downturn

• Licensing its brand name from third-parties

• Changing client preference/fashion trend

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manufacturers • Competition

• Change in government regulations

Strengths

First, AnnTaylor has a good product mix consisting of apparel and accessories.

As it targets affluent women, the company focuses its attention on developing the right

merchandise mix among suits, separates, tops, footwear, and accessories. With the

availability of products that are complementary by design, AnnTaylor’s customers find it

easy to assemble coordinated outfits. This helps the company provide an updated classic

look aligned with the consumer’s personal preference.

Second, AnnTaylor has trained sales associates, who understand customers’

fashion tastes and preferences in respect to color, fabrics, and style. These associates

give advice and help customers in selecting merchandise in order to reflect personal

styles. The company’s “total wardrobing strategy” has proven effective and helped

increase client satisfaction and loyalty.

Third, AnnTaylor has a strong and nationally-recognized brand name. This is a

strategic advantage because a stronger brand can help a company command a higher

price and gross margin than a weaker brand. In addition, a strong brand can provide

more visibility for AnnTaylor in the marketplace, which could lead to repeat sales and

additional demand from new customers. AnnTaylor has invested money in marketing,

design, and customer service to strengthen the AnnTaylor and LOFT brands. Its brand

name is an asset and helps it stay strong in a competitive market with quick changes in

demand.

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Fourth, AnnTaylor maintains a strong financial position. As discussed in

AnnTaylor’s financial analysis section, AnnTaylor’s profitability is superior to the

industry basket. This means that the company is in a better position to generate positive

cash flows and maintain a debt-free capital structure. Additionally, because the company

has no debt it is likely to obtain better debt ratings and thereby have access to relatively

inexpensive debt.

Last, AnnTaylor manages its inventory and receivables effectively. The company

enjoys high inventory and receivables turnover, which means the company has shorter

operating cycles compared to its competitors. This also contributes to a faster cash

conversion cycle, allowing the company to maintain a strong financial position.

Weaknesses

AnnTaylor’s financial position is a strength when compared to the industry;

however, in the last year, declines in profitability present a weakness that must be

addressed. In fiscal year 2007, the company experienced negative same-store sales

growth. It also initiated a restructuring program, which cost over $32M. In a recession,

the company should focus on stabilizing same-store sales revenue and decreasing costs

where possible.

AnnTaylor has identified a number of stores, which have underperformed over the

past three years. As stated in the company’s restructuring program, 117 stores have

failed to yield acceptable long-term results. In response, the company will close those

stores, invest in opening new stores, and renovate existing ones.

The company has a single distribution facility in Louisville, KY. If there is a

disruption at the facility, company profits will be negatively affected due to stock outs

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and increased customer dissatisfaction. In turn, this could damage the company image

and ultimately decrease sales.

Outsourcing production processes to foreign manufacturers can provide the

company with low-cost merchandise. However, heavy dependence on foreign suppliers

is a potential weakness and threat to the company. AnnTaylor has limited control over

the quality of the raw materials and the resulting final product. This could lead to

disruptions in the supply chain with results similar to those from a disruption to the single

distribution facility described above.

Opportunities

AnnTaylor’s restructuring program provides an opportunity for the company to

improve profitability and overall corporate performance. This program will examine

AnnTaylor’s current retail stores, identifying and eliminating underperformers.

Furthermore, the company will renovate and expand existing stores, and open new ones

in attractive locations. The program will also review and streamline AnnTaylor’s cost

organizational structures. If successful, AnnTaylor will drive sales and reduce overhead,

ultimately leading to improved profitability.

The Internet provides AnnTaylor with an additional low-cost sales channel. This

channel has global reach and is available to consumers at any time, in any place, where

there is network access. The Internet is constantly increasing the number of consumers to

whom AnnTaylor can market.

Additionally, AnnTaylor’s design process is uniquely positioned to take

advantage of Internet automation in order to cross-sell products. AnnTaylor’s “total

wardrobing strategy” ensures that each of its products can be easily combined with other

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AnnTaylor products to create a complete outfit. 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. 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.

Another opportunity presented to AnnTaylor is debt financing. Currently, the

company has no debt and maintains a strong financial position, as shown in the

AnnTaylor’s financial ratios analysis. This gives AnnTaylor an advantage over its

competitors allowing it to obtain low-cost debt to finance potential investment

opportunities.

Opening new LOFT Outlets provides AnnTaylor with a good opportunity.

Currently, all AnnTaylor merchandise is sold through Ann Taylor, LOFT, and AnnTaylor

Factory stores. As we discussed in the industry and competitor analysis section, the

women’s retail apparel industry is characterized by high inventory turnover. Yet, this is

an area for improvement, as discussed earlier in the financial ratios analysis section.

Therefore, by opening LOFT outlets, AnnTaylor will be able to serve more customers,

increase sales, and manage inventory levels even more effectively.

Threats

First, the current economic slowdown is the primary threat to the company’s

performance. Because consumer spending depends heavily on disposable income, people

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tend to spend less on apparel in an economic recession. Therefore, the company’s sales

are expected to be negatively affected as the U.S. economy declines.

Second, AnnTaylor does not own the AnnTaylor brand in China; it licenses the

brand from Guangzhou Pan Yu San Yuet Fashion Manufactory Ltd. for the right to use

the AnnTaylor brand for manufacturing and exporting purposes in China. The license

agreement was signed in August 2005 and expires in June 2015. Hence, if there are any

disruptions in the agreement or the Chinese party stops licensing to AnnTaylor, the

company will lose its ability to manufacture and export under the AnnTaylor brand name

in China.

Third, the frequent change in fashion trends may bring both opportunities and

threats for the company. Should AnnTaylor fail to keep up with current fashion trends,

the company will experience a disastrous loss in sales, negatively impacting the

profitability and the brand name.

Competition and low barriers to entry present a constant threat to AnnTaylor.

Because strategic advantages erode rapidly in the industry due to rapid business cycles,

AnnTaylor must consistently execute at a high level in order to maintain its competitive

position. Additionally, AnnTaylor is forced to defend its market share against a wide

variety of competitors, including international, national and regional department stores,

specialty stores, and direct marketing businesses that offer similar products.

Finally, the United States will be led by a new presidential administration starting

in January 2009. Changes in government regulations regarding imports/exports and trade

relations could potentially affect AnnTaylor’s costs associated with those activities.

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Conclusion

As demonstrated in the SWOT analysis above and weighing the probabilities of

each point, we feel the strengths and the threats outweigh the weaknesses and the

opportunities. With numerous strengths, especially in its financial position, we feel

AnnTaylor can capitalize successfully on its opportunities and work towards addressing

its weaknesses and threats. Hopefully, going forward, the company's strengths can

provide the foundation to identify and take advantage of additional opportunities.

9.4 Valuation

Having evaluated AnnTaylor’s strategic and competitive position, we must verify

that the purchase of AnnTaylor will provide an acceptable return on investment over the

next five years. The investment must generate an IRR greater than AnnTaylor’s cost of

capital. We used two methods to calculate AnnTaylor’s stock intrinsic value:

price/earnings (P/E) and discounted cash flow (DCF) model. We used financial

databases, such as Bloomberg, Google Finance, and Research Insight Web, to obtain the

input parameters for our models.

First, we performed a P/E valuation to determine the company’s stock price. We

obtained the industry average P/E multiple (19.41) from the data contained in our Chico’s

financial ratio analysis. We also used AnnTaylor’s fiscal year 2007 earnings per share

(EPS) of $1.53 to estimate the current year’s EPS along with the EPS growth assumption

of 2%. This method provided us with a value per share of $30.29. This P/E model has

only two input variables: the industry average P/E and AnnTaylor’s EPS growth rate.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, where Expected EPS = EPSFY2007*(1+EPS Growth rate) 

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parameters change. Please refer to Appendix Q for more details regarding the P/E

valuation. To be conservative, we took into account a pessimistic scenario using a lower

P/E and an EPS growth rate than those of the base model. Even with this pessimistic

scenario, the lowest intrinsic value of AnnTaylor’s stock price was found to be $10.30,

which is still higher than the market price of $5.58/share as of 11/19/2008.

Second, we did a DCF valuation for AnnTaylor. We calculated the company’s

FCF, average growth rate, and WACC. Using information from AnnTaylor’s 2007

annual report and Research Insight Web, we obtained operating cash flows and capital

expenditures from 2003 to 2007 to calculate FCF. The average FCF growth rate for the

period was -0.22%. AnnTaylor has had no debt in the last four years; therefore, the

WACC is equal to its cost of equity. We used the same DCF method as Chico’s to value

AnnTaylor’s stock. The input parameters, such as a market return of 11.98%, stock beta

of 1.53, a risk-free rate of 3.78%, we obtained from the above-mentioned sources.61

Using the Capital Asset Pricing Model (CAPM), the cost of equity was calculated at

16.32%. We then projected AnnTaylor's FCF for the next five years and terminal value.

Using the sum of the DCF, the total shareholder's equity, and the total shares outstanding,

we calculated an intrinsic value per share of $25.45. Please refer to Appendix R for more

details on the DCF valuation. We also did a sensitivity analysis to see AnnTaylor’s stock

price variation by changing the FCF growth rate and the WACC.62 The lowest price

calculated from the sensitivity analysis was $21.75, which was still higher than

AnnTaylor’s market price as of 11/19/2008.

                                                        61 http://www.ustreas.gov/offices/domestic-finance/debt-management/interest-rate/yield.shtml 62 Note: for details regarding the rationale of the sensitivity analysis see Chico’s valuation section 

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9.5 Potential Acquisition of AnnTaylor Stores

AnnTaylor has been profitable over the last five years. It performed relatively

well in comparison with the industry basket. AnnTaylor’s strong financial position,

coupled with the similar market capitalization as that of Chico’s, makes it our top choice

for a back-up acquisition. Due to stock market declines, AnnTaylor’s market value and

P/E have become attractively low. The company’s solid strategy, stable performance,

and strong balance sheet make it a strong competitor in the retail apparel industry.

Because AnnTaylor is in the same industry and market as Chico’s, the same

acquisition premiums apply to both companies. The minimum, optimal, and maximum

premiums would be 0%, 11.12%, and 41.55%, respectively. If successful, AnnTaylor’s

acquisition will yield an IRR of 36.90%, compared to an IRR of 57% for Chico’s, at the

optimal premium (see Appendix S). Therefore, with a stock price of $5.58 (as of

11/19/2008), we recommend an optimal price of $6.20/share for the friendly acquisition

of AnnTaylor. If the attempt to acquire Chico’s should fail, AWWI should focus on

AnnTaylor as a suitable alternative.

Overall Project Conclusion

The preceding analyses discussed five aspects of the environment and the

industry, in which Chico’s operates; an analysis of Chico’s closest competitors on the

basis of product lines; a financial analysis evaluating the five ratio family trends; an

evaluation of Chico’s strengths, weaknesses, opportunities, and threats (SWOT); a

valuation of Chico’s as an acquisition candidate; AWWI’s acquisition strategy and post-

acquisition recommendations; and an evaluation of AnnTaylor as an alternative

acquisition candidate.

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Appendix A Chico’s Financial Ratios

2007 2006 2005 2004 2003 2007 2006 2005 2004 2003Liquidity Ratios

Current Ratio 2.7 3.3 4.4 3.8 2.8 1.8 2.4 2.6 2.6 3.4Quick Ratio 1.7 2.0 3.4 2.8 1.8 0.7 1.1 1.4 1.3 2.0Working Capital Per Share 1.7 1.9 2.3 1.5 0.7 2.7 4.0 4.3 3.6 3.8Cash Flow Per Share 1.0 1.3 1.3 1.0 0.7 1.8 3.2 2.7 2.4 2.1

Activity RatiosInventory Turnover 13.4 16.0 16.66 16.65 15.4 8.3 8.9 8.9 8.9 9.3Receivables Turnover 68.4 124.3 161.8 186.0 178.9 64.6 72.1 71.0 77.9 86.0Total Assets Turnover 1.5 1.6 1.6 1.8 2.0 1.7 1.8 1.8 1.9 2.0Average Collection Period (Days) 5.0 3.0 2.0 2.0 2.0 10.4 10.2 12.0 16.6 22.4Days to Sell Inventory 27.0 23.0 22.0 22.0 24.0 50.0 46.6 46.8 45.6 44.0Operating Cycle (Days) 32.0 26.0 24.0 24.0 26.0 60.6 56.6 58.6 62.2 66.4

Profitability RatiosOperating Margin Before Depreciation (%) 12.5 19.9 24.7 24.8 24.3 7.2 11.3 11.6 11.0 12.2Operating Margin After Depreciation (%) 7.1 15.8 21.2 21.4 21.3 2.6 7.0 7.5 7.1 8.8Pretax Profit Margin (%) 8.1 15.9 21.8 21.3 21.0 0.4 7.8 8.5 8.0 10.3Net Profit Margin (%) 5.3 10.1 13.8 13.2 13.0 -0.1 4.4 4.4 4.3 5.1Return on Assets (%) 7.3 15.8 19.4 19.7 21.3 0.1 7.2 7.3 7.3 9.0Return on Equity (%) 10.0 20.7 24.1 25.2 26.7 -4.2 12.1 12.1 11.9 12.4Return on Investments (%) 10.0 20.7 24.1 25.2 26.7 5.0 11.1 11.3 11.0 11.6

Leverage RatiosLong-Term Debt/Common Equity (%) 0.0 0.0 0.0 0.0 0.0 22.4 21.3 14.2 16.7 24.8Long-Term Debt/Shareholder Equity (%) 0.0 0.0 0.0 0.0 0.0 22.4 21.3 14.2 16.7 24.8Total Debt/Invested Capital (%) 0.0 0.0 0.0 0.0 0.0 19.0 16.9 11.0 11.4 17.6Total Debt/Total Assets (%) 0.0 0.0 0.0 0.0 0.0 10.8 10.7 7.2 7.6 12.4Total Assets/Common Equity 1.4 1.3 1.2 1.3 1.3 2.1 1.9 1.8 1.7 1.7

Market RatiosPrice Earnings Ratio (P/E) 22.3 39.8 31.7 32.3 23.3 19.4 22.1 22.3 21.3 13.0Price to Book Ratio 4.8 9.5 8.1 8.6 6.5 2.1 2.9 2.8 3.1 1.7Price/Sales 2.4 5.4 4.2 4.1 2.9 1.0 1.3 1.4 1.0 0.6Price/Cashflow 13.4 28.4 20.2 21.9 13.9 11.3 8.3 10.0 7.7 5.1Price/EBITDA 11.7 21.9 17.4 17.3 12.3 9.0 12.5 9.5 9.4 6.2

Chico's FAS Industry

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Appendix B Chico’s DCF Valuation

(in thousands) 2008 2007 2006 2005 2004 2003Operating Cash Flow* $208,647 $288,994 $268,406 $223,620 $145,380 $108,807Capital Expenditure* 202,223 218,311 147,635 93,065 52,300 64,742Free Cash Flow $6,424 $70,683 $120,771 $130,555 $93,080 $44,065Growth Rate -91% -41% -7% 40% 111%

Average Growth Rate 2.32%*CHS 10-K

Year Ended February

YearFree Cash Flow

(000)Discounted Free Cash Flow

(000)1 $6,424 $5,4772 $6,552 $4,7623 $6,684 $4,1414 $6,817 $3,6015 $6,954 $3,131

Terminal Value $18,079

Sum DCF (000) 39,191$ Total Liabilities/Equity (000)* 912,916Sum DCF +Total Liabilities/Equity (000) 952,107Common Stock Outstanding (000)** 176,540BV Per Share 5.39$

*Chico's 10K 2007**Yahoo! Finance

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Appendix C Chico’s Weighted Average Cost of Capital

Beta* 1.65Rf** 3.78%U.S. Market Return (10/25/08)*** 11.98%Risk Premium 8.19%Cost of Equity^ 17.30%*Google Finance**Average of 10-year Treasury Yields in October, 2008***Bloomberg Data^CHS has no debt --> WACC=Re (Bloomberg Value 15.08%)

WACC Calculation

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Appendix D Chico’s DCF Valuation: Sensitivity Analysis

0% 1% 2% 3% 4% 5% 6%9% 5.58 5.62 5.67 5.73 5.81 5.93 6.14

10% 5.54 5.57 5.60 5.65 5.70 5.78 5.9011% 5.50 5.53 5.55 5.59 5.63 5.68 5.76

W 12% 5.47 5.49 5.51 5.54 5.57 5.61 5.66A 13% 5.45 5.46 5.48 5.50 5.53 5.53 5.59C 14% 5.43 5.44 5.46 5.47 5.49 5.51 5.54C 15% 5.41 5.42 5.43 5.45 5.46 5.48 5.50

16% 5.40 5.40 5.41 5.43 5.44 5.45 5.4717% 5.38 5.39 5.40 5.41 5.42 5.42 5.4418% 5.37 5.38 5.38 5.39 5.40 5.41 5.4219% 5.36 5.36 5.37 5.38 5.39 5.39 5.4020% 5.35 5.35 5.36 5.37 5.37 5.38 5.3921% 5.34 5.34 5.35 5.36 5.36 5.37 5.38

Sensitivity AnalysisFCF Growth Rate

Risk-Free Rate* (%) WACC (%)

BV/Share ($)

3 17.81 5.394 17.16 5.405 16.51 5.416 15.86 5.427 15.21 5.438 14.56 5.459 13.91 5.46

10 13.26 5.48*All other parameters remain the same

Sensitivity Analysis of Risk-Free Rate

FCF Growth Rate* (%) BV/Share ($)0 5.381 5.382 5.393 5.44 5.415 5.42

*All other parameters remain the same

Sensitivity Analysis of FCF Growth

Market Return* (%) WACC (%)

BV/Share ($)

7 9.09 5.688 10.74 5.589 12.39 5.51

10 14.04 5.4611 15.69 5.4212 17.34 5.413 18.99 5.3714 20.64 5.3515 22.29 5.34

*All other parameters remain the same

Sensitivity Analysis of Market Return

Beta WACC BV/Share1.0 11.98 5.511.1 12.79 5.491.2 13.61 5.471.3 14.43 5.451.4 15.25 5.431.5 16.07 5.411.6 16.89 5.401.7 17.71 5.391.8 18.53 5.381.9 19.35 5.372.0 20.17 5.36

*All other parameters remain the same

Sensitivity Analysis of Beta

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Appendix E Chico’s Value Creation Model Cost of capital

Weight Cost Weighted CostDebt 0.00% 12.00% 0.00%Equity 100.00% 17.30% 17.30%Cost of capital 17.30%Cost of EquityExpected inflation rate 2.80%Real interest rate 1.00%Risk-free rate 3.80%Beta 1.65Expected return on Market 11.98% 13.92%Risk-free rate 3.80%Risk Premium 8.18%Risk free rate 3.80% 7%Equity Risk Premium 8.18%Cost of Equity 17.30%

All currency numbers in thousands

Business with the following Forecasts

(currency numbers are in 1,000's) Year Cash Flow

Present Value

Cumulative Present Value

Present value of Residual Value

Cumulative PV+ Residual Value

Increase in Value

Number of periods in forecast 5 1 71,147$ 60,654$ 60,654$ 366,297$ 426,951$ 5,709$ Sales (last historical period) 1714326 2 72,569$ 52,742$ 113,396$ 318,519$ 431,915$ 4,964$ Sales growth rate 2.00% (1) 3 74,021$ 45,863$ 159,258$ 276,973$ 436,232$ 4,317$ Operating profit margin 7% 4 75,501$ 39,881$ 199,139$ 240,846$ 439,985$ 3,754$ Incremental fixed capital invest. 7.29% (2) 5 77,011$ 34,679$ 233,818$ 209,432$ 443,249$ 3,264$ Incremental working capital invest. 2% (3) Total value Created => 22,008$ Cash income tax rate 40%Residual value income tax rate 60% Marketable Securities and Investments 260,469$ Cost of capital = WACC 17% Corporate Value 703,718$ Marketable secutities and investments 260469 less: Market value of debt 1,063,596$ Market value of debt and other obligations 1063596 Shareholder Value (359,878)$ Cash flow in year 1 71146.566

The material and methods of this spreadsheet are according to the "Creating Shareholder Value" by Alfred Rappaport, The Free Press, Macmillan, Inc. New York

(1) From management predictions in 10K -- negative or flat growth in same store sales, 4-7% increase in total stores; I estimate 2% growth from this(2) From 10K, 125 million in fixed capital investment in 2009(3) From 10K, -30 million in working capital investment in 2009, and has been decreasing since 2006.

Appendix F Chico’s Value Creation Model: Sensitivity Analysis

125  

Risk Free Rate Value Created (000)3% 23,791$ 4% 21,591$ 5% 19,661$ 6% 17,959$ 7% 16,448$ 8% 15,101$ 9% 13,895$

10% 12,812$

Sales Growth Value Created (000)1% 10,820$ 2% 22,008$ 3% 33,574$ 4% 45,530$ 5% 57,885$

Operating Margin Value Created (000)5% 12,451$

10% 35,371$ 15% 58,291$ 20% 81,212$ 25% 104,132$ 30% 127,052$

Appendix G Chico’s Direct Competitors

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Comparable Ticker Market Cap (in millions) Debt/Equity SIC Code* Demographic market (age)**Christopher & Banks CorpCBK 10.38 0 5621 Professional women (40-60)Coldwater Creek, Inc. CWTR n/a 4.6 5621 Professional women (45-65)Dillard's, Inc.*** DDS n/a 48.7 5311The Talbots, Inc. TLB n/a 92.7 5621 Professional women (35-55)Ann Taylor Stores Corp. ANN 9.64 0 5621 Professional women (25-55)Chico's CHS 22.38 0.31 5621 Professional women (over 35)

*Source: Hoover Pro** Sources: Bloomberg, firm's annual reports, Forbes, Google Finance*** Listed as a direct competitor in Chico's 2007 annual report

Appendix H Chico’s Comparables Valuation

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Comparable Ticker P/E P/S P/B P/CF P/EbitdaChristopher & Banks CorpCBK 10.38 0.29 0.67 4.35 3.03Coldwater Creek, Inc. CWTR n/a 0.3 0.98 4.06 32.45*Dillard's, Inc. DDS n/a 0.06 0.15 2.6 1.26The Talbots, Inc. TLB n/a 0.2 1.03 13.91* 4.58Ann Taylor Stores Corp. ANN 9.64 0.35 1.02 3.44 2.86Average Basket 10.01 0.24 0.77 3.61 2.38Chico's CHS 22.38 0.31 0.54 3.99 4.83

Multiples Basket Avg Chico's Intrinsic Value Current Price*P/E 10.01 0.13$ 1.30$ 2.90$ P/S 0.24 9.35$ 2.25$ 2.90$ P/B 0.77 5.37$ 4.14$ 2.90$ P/CF 3.61 0.73$ 2.63$ 2.90$ P/EBITDA 2.38 0.61$ 1.45$ 2.90$

2.35$

**As of Oct 24, 2008Source: Bloomberg

Average Intrinsic Value

*For the purposes of our analysis we excluded the P/CF and P/EBITDA multiples of Talbot’s and Coldwater Creek, because they skewed the results.

Appendix I M&A Premium Analysis: General Search

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Apparel Industry M&A average premiumGeneral Statistics

Source: Bloomberg TerminalIndustry ApparelPeriod 45 months from Jan 05 to Sep 08In which 6 months: no premium data available. We calculate Average premium based on available data only

Total Deal Value: 65,397.00 US$ millionTotal Companies' Market Value 100,021.07 US$ million

Overall 2008 2007 2006 2005Average M&A Premium * -34.62% 11.12% 7.19% 11.34% -69.37%Maximum Premium 54.39% 41.55% 54.39% 20.31% 32.67%Minimum Premium -94.81% -27.00% -27.00% -3.43% -94.81%

* suppose x is premium, D: Deal value, M: Company's Market valueD = M*(1+x) => x = D/M -1

Pros: Large scale M&A activities, more representative information

Cons: General information about M&A premium in Apparel Industry. There is no information about: Payment method (Cash, Stock); Deal Status (Pending, Completedor terminated)

Appendix J M&A Premium Analysis: Detailed Search

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Apparel - Retail Apparal Industry M&A PremiumDetail Search

Source: Bloomberg Terminal

Period Jan 2003 to Sep 2008

Criteria Search Current Deal Status: CompletedPayment Method: CashIndustry: Apparel & Retail (apparel)Extend: Global

Results:Total Deal value: 14,383.60 US$ mil.Total Companies' market value: 12,076.77 US$ mil.

Overall 2007 2006 2005 2004 2003Avg Premium * 19.10% 10.79% 16.21% 31.38% 17.34% 34.60%High 62.08% 55.10% 30.52% 37.97% 35.22% 62.08%Low -8.83% -4.72% 10.03% -8.83% -0.26% 22.34%

Pros: More matched with Chico's deal

Cons: There are so many deals without premium information.The available data (deal with premium data) may be not representative for wholepopulation

* suppose x is premium, D: Deal value, M: Company's Market valueD = M*(1+x) => x = D/M -1

Appendix K Chico’s Pro Forma Adjusted DCF Valuation

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(000) 2012 2011 2010 2009 2008 2007Operating Cash Flow^^ $296,497 $273,345 $252,000 $232,323 $279,907 $304,578Capital Expenditure** 59,299 54,669 50,400 46,465 52,223 65,511Same-Store Growth Rate*^ 8.47% 8.47% 8.47% -17% -8.1% 2.1%FCF $237,198 $218,676 $201,600 $185,858 $227,684 $239,067Growth Rate 8.47% 8.47% 8.47% -18% -5%

**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

*This is the same-store growth rate value if the company had forgone the 152.8M and 150M in capital expenditures on planning and opening of new, relocated, remodeled and expanded stores in FY2006 and FY 2007 respectively^FY2008 same-store growth rate from CHS 10-Q filed August 26, 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

Year Ended February

YearFree Cash Flow

(000)Discounted Cash Flow

(000)1 $201,600 $171,8662 $218,676 $158,9283 $237,198 $146,9644 $257,288 $135,9005 $279,081 $125,669

Terminal Value $302,719 $1,315,975

Sum DCF (000) $2,055,302Total Liabilities/Equity (000) 912,916Sum DCF +Total Liabilities/Equity (000) 2,968,218Common Stock Outstanding (000)* 176,540Pro forma Value Per Share $16.81*Yahoo Finance

Initial Stock Price* $2.93Shares Outstanding (000) 176,540 Market Cap (000) $517,262

YearPremium 0 1 2 3 4 5 Terminal IRR

0.00% ($517,262) $201,600 $218,676 $237,198 $257,288 $279,081 $3,428,299 61.86%11.21% (575,247) 201,600 218,676 237,198 257,288 279,081 3,428,299 57.27%41.55% (732,185) 201,600 218,676 237,198 257,288 279,081 3,428,299 47.81%

*As of Oct 24, 2008

Values in Thousands

Pro Forma Adjusted Free Cash Flow Model

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Appendix L Chico’s IRR Calculation and Sensitivity Analysis

10.00% 15.00% 20.00% 25.00% 30.00%0.00% 54.23% 51.75% 49.22% 46.62% 43.94%

FCF 7.00% 65.03% 62.38% 59.66% 56.88% 54.02%Growth 8.00% 66.57% 63.89% 61.15% 58.35% 55.46%

Rate 8.47% 67.30% 64.61% 61.86% 59.03% 56.13%9.00% 68.12% 65.41% 62.65% 59.81% 56.90%

10.00% 69.66% 66.93% 64.14% 61.28% 58.34%

10.00% 15.00% 20.00% 25.00% 30.00%0.00% 49.69% 47.37% 44.99% 42.54% 40.02%

FCF 7.00% 60.17% 57.68% 55.14% 52.52% 49.82%Growth 8.00% 61.67% 59.16% 56.59% 53.94% 51.22%

Rate 8.47% 62.37% 59.85% 57.27% 54.61% 51.88%9.00% 63.16% 60.63% 58.04% 55.37% 52.62%

10.00% 64.66% 62.11% 59.49% 56.79% 54.02%

10.00% 15.00% 20.00% 25.00% 30.00%0.00% 40.38% 38.35% 36.27% 34.11% 31.89%

FCF 7.00% 50.21% 48.04% 45.80% 43.50% 41.12%Growth 8.00% 51.61% 49.42% 47.17% 44.84% 42.44%

Rate 8.47% 52.27% 50.07% 47.81% 45.47% 43.06%9.00% 53.02% 50.80% 48.53% 46.18% 43.76%

10.00% 54.42% 52.19% 49.89% 47.52% 45.07%

Capital Expenditures Growth Rate

Optimal Premium IRR Sensitivity AnalysisCapital Expenditures Growth Rate

Minimum Premium IRR Sensitivity AnalysisCapital Expenditures Growth Rate

Maximum Premium IRR Sensitivity Analysis

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Appendix M Firm’s Acquisition Process, Regulations and Rules

The following section includes rules and regulations stipulated by the U.S.

Securities and Exchange Commission. Given the legal nature of these rules and

regulations, most of the text is directly from the following sources: SEC websites,

Wikipedia articles on mergers and acquisitions, Harvard Business School cases, and other

related sources as noted below.

Overview of the Acquisition Process and Filings:

All acquisitions usually follow a standard structure – (1) initial valuation, (2)

initial offer, (3) structuring the deal, (4) due diligence, (5) definitive agreement

negotiation, (6) closing phase. Both parties, the acquirer and the target, are required to

file various documents with the SEC at every step of the acquisition. The following is a

brief description of necessary filings.

Initial Offer63

After a company has identified a potential acquisition target and has done the

initial valuation, it has to file a letter of intent with the SEC. This letter is often used in

complex transactions, when the parties want to tie down the principal terms of the deal

early in the negotiation. A letter of intent (sometimes referred to as a memorandum of

intent, a term sheet, 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. These

key terms comprise of both binding and non-binding agreements.

Binding provisions:

• Confidentiality;

                                                        63 Professor William E. Fruhan, Jr., The Company Sale Process, Harvard Business School, Case 9-206-108, April 10, 2007 

133  

• Deal Termination i.e. “Drop Dead”;

• Break-Up Fee;

• Exclusivity;

• Non-Solicitation.

Non-binding provisions:

• Structure of transaction – payment by stock, or cash, or both; transfer of assets, or

stock, or both;

• Purchase price;

• Additional due diligence;

• Employment contracts;

• Non-compete agreements;

• Steps to closing;

• Warrants/indemnities.

Definite Merger Agreement64

Once the due diligence process is completed by both parties, a definite merger

agreement should be filed. The definite merger agreement is usually 50 to 100 pages

(excluding exhibits), and includes the following sections: the purchase price, when the

closing will occur, how the price will be paid, covenants including how the business will

be conducted pre-closing, closing conditions, and what happens if the deal is terminated.

There are some key negotiation points, such as:

• The ‘material adverse change’ clause;

• The ‘fiduciary out’ clause;

                                                        64 Professor William E. Fruhan, Jr., The Company Sale Process, Harvard Business School, Case 9-206-108, April 10, 2007 

134  

• The ‘breakup fee’;

• Consummation of debt financing to be used in the acquisition;

• The ‘antitrust out’;

• Escrows, contingent considerations;

• Expense reimbursement caps;

• Voting agreement and irrevocable proxy for management and directors;

• ‘Tail directors’ and officers’ liability insurance covering these individuals until

the period of continued legal liability following the sale expires (approximately

six years).

Pre-Merger Notification65

Before both parties close the deal, they have to arrange for certain U.S.

Government antitrust provisions. The Hart-Scott-Rodino Antitrust Improvements Act

provides that before certain mergers, tender offers or other acquisition transactions can

close, 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. The filing describes the proposed transaction and the parties to it.

Upon the filing, 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. It is unlawful to

close the transaction during the waiting period. Although the waiting period is generally

30 days, 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. Hart-Scott-Rodino Antitrust Improvements Act, http://en.wikipedia.org/wiki/Hart-Scott-Rodino_Antitrust_Improvements_Act 

135  

terminated early. Early terminations are made public in the Federal Register and posted

on the Federal Trade Commission website. Additionally, some types of transactions are

afforded the special treatment of shorter waiting periods.

The filing requirement is triggered only if the value of the transaction, and in

certain cases, the size of the parties, exceeds certain U.S. Dollar thresholds. For the

purpose of determining the "size of the parties" one assesses the size of the party to the

transaction, its ultimate parent entity, and all subsidiaries of that ultimate parent entity.

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. This rule is always invoked in insider trading cases and

in fraudulent accounting practices. It also applies to the issuance of equity by the bidder

in connection with a merger or acquisition.

The rule itself is relatively short. The formal title is "Rule 10b-5: Employment of

Manipulative and Deceptive Practices", and the complete text is the following:

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,

(a) To employ any device, scheme, or artifice to defraud,

(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, in the light of the circumstances under which they were made, not misleading, or

(c) To engage in any act, practice, or course of business, which operates or would operate as a fraud or deceit upon any person,

in connection with the purchase or sale of any security.

                                                        66 Carliss Y. Baldwin, Constance E. Bagley, James W. Quinn: M&A Legal Context: Standards Related to the Sale or Purchase of a Company, HBC 9-904-004, Feb 23, 2004 

136  

The SEC or any damaged investor can sue a company and its officers for violation

of the rule. In order for a defendant to be found liable in a civil case under Rule 10b-5,

each of the following seven elements/conditions should be met:

1. Connection with the sale or purchase of securities

2. Facts, not opinions

3. Material misrepresentation or omission

4. Belief and reliance

5. Scienter (or ‘knowingly or willfully’)

6. Causation

7. Interstate commerce

Under the SEC rule, damages typically consist of out-of-pocket loss, or ‘the

difference between what the investor paid (or received) and the fair market value of the

stock on the date of the transaction.’ Alternatively, ‘investors can elect to rescind the

transaction, returning what they received and getting back what they gave.’ Generally, it

is difficult for plaintiffs to prove all conditions needed to obtain a finding of liability in

Rule 10b-5.

Regulation M-A67

Under the Code of Federal Regulations Title 17: Commodity and Securities

Exchanges, Regulation M-A is the main framework for conducting mergers and

acquisitions in the United States. There are several required documents:

                                                        67 U.S. Securities and Exchange Commission. Title 17: Commodity and Securities Exchanges, http://ecfr.gpoaccess.gov/cgi/t/text/text-idx?c=ecfr&sid=20c66c74f60c4bb8392bcf9ad6fccea3&rgn=div5&view=text&node=17:2.0.1.1.11&idno=17#17:2.0.1.1.11.11 

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Summary term sheet. Provides security holders with a summary term sheet that

is written in plain English. The summary term sheet must briefly describe in bullet point

format the most material terms of the proposed transaction. The summary term sheet

must provide security holders with sufficient information to understand the essential

features and significance of the proposed transaction. The bullet points must cross-

reference a more detailed discussion contained in the disclosure document that is

disseminated to security holders.

Subject company information. This section includes the name and address of

the subject company (or the issuer in the case of an issuer tender offer), title and number

of securities, trading price, dividends information, and prior stock purchases.

Identity and background of filing person. Name and address, business and

background of entities, business and background of natural persons, current principal

occupation or employment, material occupations, a statement whether or not the person

was convicted in a criminal proceeding during the past five years, a statement whether or

not the person was a party to any judicial or administrative proceeding during the past

five years, and country of citizenship.

Terms of the transaction. A brief description of the transaction; the

consideration offered to security holders; the reasons for engaging in the transaction; 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, if material; a brief statement

as to the accounting treatment of the transaction, if material; and the federal income tax

consequences of the transaction, if material.

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Past contacts, transactions, negotiations, and agreements. A brief statement of

the nature and approximate dollar amount of any transaction; significant corporate events

in the past two years; negotiations or contacts; potential conflicts of interest between the

filing person and the subject company or its executives.

Purposes of the transaction and plans or proposals. The purposes of the

transaction; use of securities acquired; plans; subject company negotiations.

Source and amount of funds or other consideration. Source of funds; material

conditions; itemized statement of all expenses incurred or estimated to be incurred in

connection with the transaction; borrowed funds.

Interest in securities of the subject company. Securities ownership; securities

transactions during the past 60 days.

Persons/assets, retained, employed, compensated or used. Solicitations or

recommendations; employees and corporate assets.

Financial statements. Financial information; pro-forma information; summary

information.

Additional information. Agreements, regulatory requirements, and legal

proceedings.

The solicitation or recommendation. Solicitation or recommendation; reasons;

intent to tender; intent to tender or vote in a going-private transaction; recommendations

of other interested parties.

Companies engaged in M&A activities should also file documentation in

compliance with the following SEC regulations:

139  

Regulation S-X - governs the Form and content of and requirements for financial

statements.

Regulation S-K - provides standard instructions for filing forms under Securities

Act of 1933, Securities Exchange Act of 1934 and Energy Policy and Conservation Act

of 1975.

Regulation S-T - governs the electronic submission of documents submitted to

the Security and Exchange Commission together with EDGAR Filer Manual.

Regulation C - provides registration and filing requirements.

Williams Act68

The Williams Act of 1968 amended the Securities and Exchange Act of 1934 (15

U.S.C.A. § 78a et seq.) to require mandatory disclosure of information regarding cash

tender offers. When an individual, group, or corporation seeks to acquire control of

another corporation, it may make a tender offer. 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. Since the mid-1960s, cash tender offers for corporate takeovers have

become favored over the traditional alternative, the proxy campaign. A proxy campaign

is an attempt to obtain the votes of enough shareholders to gain control of the

corporation's board of directors.

Because of abuses with cash tender offers, Congress passed the Williams Act in

1968, which purpose is to require full and fair disclosure for the benefit of stockholders,

while at the same time providing the offering party and management equal opportunity to

fairly present their cases.

                                                        68 U.S. Securities and Exchange Commission. Williams Act, http://law.jrank.org/pages/11330/Williams-Act.html 

140  

The act requires any person, 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,

the purpose for which the offer is made, the plans the purchaser might have if successful,

and any contracts or understandings concerning the target corporation.

Filing and public disclosures with the SEC are also required of anyone, who

acquires more than 5% of the outstanding shares of any class of a corporation subject to

federal registration requirements. Copies of these disclosure statements must also be sent

to each national securities exchange where the securities are traded, making the

information available to shareholders and investors.

The law also imposes miscellaneous substantive restrictions on the mechanics of a

cash tender offer, and it imposes a broad prohibition against the use of false, misleading,

or incomplete statements in connection with a tender offer. The Williams Act gives the

SEC the authority to institute enforcement lawsuits.

Schedule 13-D69

Schedule 13D is commonly referred to as a “beneficial ownership report.” The

term "beneficial owner" is defined under SEC rules, and includes any person who directly

or indirectly shares voting power or investment power (the power to sell the security).

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, they are required to file a Schedule 13D with the SEC.

Schedule 13D reports the acquisition and other information within ten days after the

purchase. The schedule is filed with the SEC and is provided to the company that issued                                                         69 U.S. Securities and Exchange Commission. Schedule 13D, http://www.sec.gov/answers/sched13.htm 

141  

the securities and each exchange where the security is traded. Any material changes in

the facts contained in the schedule require a prompt amendment. The schedule is often

filed in connection with a tender offer.

Section 280 G of the IRS Code (Excess Golden Parachutes)70

In acquisitions of public companies, an increasing amount of attention is focused

on the executive severance arrangements that are triggered upon a change in control. The

change in control payments may result in the application of the IRS Section 280G

‘golden parachute’ provisions. To the extent Section 280G applies, the target corporation

may not deduct from its taxable income change in control payments made to an

executive, and 20% excise tax is imposed on the executive, who receives the payment.

This excise tax is in addition to normal payroll withholding tax and income tax and is

also non-deductable.

From a acquisition target perspective, 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. The important thing for potential acquirers, in

pricing the deal, is to understand several issues: the extent of the change in control

payments, the potential for disallowance of deductions and for the obligation of the target

company to make substantial payments to executives, and the opportunities for planning

to reduce any potential adverse impacts.71

                                                        70Tax Almanac. Internal Revenue Code:Sec. 280G, http://www.taxalmanac.org/index.php/Internal_Revenue_Code:Sec._280G 71 Christian McBurney. Golden Parachute Planning a Key in Acquisitions of Public Companies, Nov 2003 

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Appendix N Chico’s Institutional Ownership

Total Number of Shares Outstanding (Apr 30, 2008) 176,510,956 Number of Institutional Holders 283 % Institutional Ownership 95%

Top 15 Institutional Shareholders as of Apr 30, 2008Institution Name # Shares Held % OutstandingColumbia Wanger Asset Management, L.P. 10,197,000 5.8Snow Capital Management, L.P. 9,458,811 5.4Barclays Global Investors, N.A. 9,289,052 5.3Deutsche Asset Management Americas 7,485,690 4.2UBS Global Asset Management (Americas), Inc. 7,412,424 4.2Franklin Templeton Investments Corp. 7,093,180 4.0Templeton Investment Counsel, LLC 6,630,177 3.8State Street Global Advisors (US) 6,509,103 3.7Vanguard Group, Inc. 5,578,919 3.2UBS Global Asset Management (Switzerland) 5,512,927 3.1PRIMECAP Management Company 5,256,183 3.0Fidelity Management & Research 5,005,697 2.8Mazama Capital Management, Inc. 4,663,314 2.6Schneider Capital Management Corporation 4,644,900 2.6Frontier Capital Management Company, LLC 4,564,706 2.6

TOTAL: 99,302,083 56.3

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Appendix O Berkshire Hathaway Class A and Class B Stock72

The following section is a direct excerpt from a memo, written by Warren Buffett

to Berkshire Hathaway’s shareholders:

Berkshire Hathaway Inc. has two classes of common stock designated as Class A

and Class B. A share of Class B common stock has the rights of 1/30th of a share of

Class A 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). Each share of a Class A common stock is

convertible at any time, at the holder’s option, into 30 shares of Class B common stock.

This conversion privilege does not extend in the opposite direction. That is, holders of

Class B shares are not able to convert their stock into Class A shares. Both Class A & B

shareholders are entitled to attend the Berkshire Hathaway Annual Meeting, which is

held the first Saturday in May. The Class B can never sell for anything more than a tiny

fraction above 1/30th of the price of Class A. When it rises above 1/30th, arbitrage takes

place in which someone ¾ perhaps the NYSE specialist ¾ buys the A and converts it into

B. This pushes the prices back into a 1:30 ratio.

On the other hand, the B can sell for less than 1/30th the price of the A since

conversion doesn’t go in the reverse direction. All of this was spelled out in the

prospectus that accompanied the issuance of the Class B. When there is more demand for

the B (relative to supply) than for the A, the B will sell at roughly 1/30th of the price of

A. When there’s a lesser demand, it will fall to a discount. As of November 20, 2008,

BKR Class A share price was $77,500 and BKR Class B share price was $2,914.

                                                        72 Warren Buffet. Comparative Rights and Relative Prices of Berkshire Class A and Class B Stock, http://www.berkshirehathaway.com/compab.html 

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Appendix P AnnTaylor’s Financial Ratios

2007 2006 2005 2004 2003 2007 2006 2005 2004 2003Liquidity Ratios

Current Ratio 1.6 2.3 2.6 2.4 3.6 2.1 2.6 2.9 2.9 3.2Quick Ratio 0.5 1.3 1.5 1.1 2.2 0.9 1.3 1.8 1.6 2.0Working Capital Per Share 3.2 5.6 5.8 4.9 6.1 2.4 3.0 3.4 2.8 2.5Cash Flow Per Share 3.5 3.6 2.4 2.0 2.2 1.3 2.7 2.4 2.2 1.8

Activity RatiosInventory Turnover 9.9 10.7 9.6 9.2 8.9 9.0 10.0 10.3 10.4 10.6Receivables Turnover 143.4 139.5 139.8 148.0 139.0 45.8 68.3 76.5 87.4 95.9Total Assets Turnover 1.6 1.5 1.5 1.5 1.5 1.6 1.7 1.7 1.8 1.9Average Collection Period (Days) 3.0 3.0 3.0 2.0 3.0 10.8 10.2 11.8 16.6 22.2Days to Sell Inventory 37.0 34.0 38.0 40.0 41.0 48.0 44.4 43.6 42.0 40.6Operating Cycle (Days) 39.0 37.0 41.0 42.0 44.0 59.2 54.4 55.2 58.6 62.8

Profitability RatiosOperating Margin Before Depreciation (% 12.7 14.1 11.6 9.9 14.1 7.2 12.4 14.2 14.0 14.2Operating Margin After Depreciation (%) 7.8 9.6 7.1 5.7 10.8 2.5 8.2 10.3 10.2 10.9Pretax Profit Margin (%) 6.7 10.2 6.7 5.7 10.6 0.8 8.1 10.2 10.0 10.3Net Profit Margin (%) 4.1 6.1 4.0 3.4 6.4 0.1 5.2 6.4 6.3 6.4Return on Assets (%) 7.0 9.1 5.5 4.8 8.8 0.2 8.5 10.1 10.3 11.5Return on Equity (%) 11.6 13.6 7.9 6.8 12.2 4.8 13.5 15.3 15.5 15.3Return on Investments (%) 11.6 13.6 7.9 6.8 10.6 4.6 12.5 14.5 14.7 14.8

Leverage RatiosInterest Coverage Before Tax 75.1 108.1 67.4 30.2 26.3 -2.6 145.0 77.0 38.3 45.6Interest Coverage After Tax 45.8 65.1 40.3 18.4 16.2 -1.7 88.3 46.7 24.9 28.5Long-Term Debt/Common Equity (%) 0.0 0.0 0.0 0.0 15.1 22.4 21.3 14.2 16.7 27.2Long-Term Debt/Shareholder Equity (%) 0.0 0.0 0.0 0.0 15.1 22.4 21.3 14.2 16.7 27.2Total Debt/Invested Capital (%) 0.0 0.0 0.0 0.0 13.1 19.0 16.9 11.0 11.4 18.7Total Debt/Total Assets (%) 0.0 0.0 0.0 0.0 10.9 10.8 4.8 5.4 5.8 10.2Total Assets/Common Equity 1.7 1.5 1.4 1.4 1.4 2.1 1.9 1.7 1.7 1.7

AnnTaylor Stores Industry

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Appendix Q AnnTaylor’s Price/Earnings Valuation and Sensitivity

Price/Earnings Model

Valuation Calculation

Industry Average P/E multiple as of Jan 08 19.41

FY2007 EPS 1.53$

EPS Growth rate 2%

Share price = Expected EPS * P/E Multiple = 30.29$

Sensitivity Calculations

Sensitivity to P/E and Growth rate Assumption

7 9 11 13 15 17 19 21-4% 10.3$ 13.2$ 16.2$ 19.1$ 22.0$ 25.0$ 27.9$ 30.8$ -3% 10.4$ 13.4$ 16.3$ 19.3$ 22.3$ 25.2$ 28.2$ 31.2$ -2% 10.5$ 13.5$ 16.5$ 19.5$ 22.5$ 25.5$ 28.5$ 31.5$ -1% 10.6$ 13.6$ 16.7$ 19.7$ 22.7$ 25.7$ 28.8$ 31.8$ 0% 10.7$ 13.8$ 16.8$ 19.9$ 23.0$ 26.0$ 29.1$ 32.1$ 1% 10.8$ 13.9$ 17.0$ 20.1$ 23.2$ 26.3$ 29.4$ 32.5$ 2% 10.9$ 14.0$ 17.2$ 20.3$ 23.4$ 26.5$ 29.7$ 32.8$ 3% 11.0$ 14.2$ 17.3$ 20.5$ 23.6$ 26.8$ 29.9$ 33.1$ 4% 11.1$ 14.3$ 17.5$ 20.7$ 23.9$ 27.1$ 30.2$ 33.4$ 5% 11.2$ 14.5$ 17.7$ 20.9$ 24.1$ 27.3$ 30.5$ 33.7$ 6% 11.4$ 14.6$ 17.8$ 21.1$ 24.3$ 27.6$ 30.8$ 34.1$ 7% 11.5$ 14.7$ 18.0$ 21.3$ 24.6$ 27.8$ 31.1$ 34.4$

AnnTaylor historical EPS

2007 2006 2005 2004 2003EPS 1.53 1.98 1.13 0.88 1.42Growth rate -26% 56% 25% -48%Avg Growth 1.9%

Expected 2008 EPS 1.56$

P/E ratio

EPS

Gro

wth

Rat

e

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Appendix R AnnTaylor’s DCF Valuation and Sensitivity Analysis

Historical Free Cash Flow

Year 2007 2006 2005 2004 2003Operating Cash Flow (Thousands) 257,197 295,931 311,323 169,259 189,618

Beta* 1.53 Capital Expenditure 139,998 165,926 187,613 152,483 71,364 Rf** 3.78% FCF 117,199 130,005 123,710 16,776 118,254 U.S. Market Return (10/25/08)*** 11.98% -10% 5% 200% -195%Risk Premium 8.19% Average Growth -0.22%Return on Equity^ 16.32%*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%) Expected Future Free Cash Flow

Year 1 2 3 4 5Terminal

ValueDebt**** 0 Free Cash Flow (thousands) 117,199 116,936 116,674 116,413 116,152 700,616

Discounted Cash Flow 100,757.9 86,429.2 74,138.1 63,595.0 54,551.1 282,886.0Equity**** 803,032 Total Liabilities and Stockholders' Equity 803,032 Total 662,357$

Weighted Interest on all Liabilities 0WACC^ 16.3%

Sum DCF* 662,357$ Total Liabilities/Equity* 803,032$ Sum DCF +Total Liabilities/Equity* 1,465,389$ Common Stock Outstanding* 57,583Instrinsic Value Per Share 25.45$ *Value in Thousands

WACC CALCULATION

-2.22% -1.22% -0.22% 0.78% 1.78% 2.78% 3.78%10.3% 29.35 30.63 32.16 34.01 36.29 39.17 42.9211.3% 28.18 29.27 30.54 32.06 33.89 36.15 39.0112.3% 27.18 28.11 29.19 30.46 31.96 33.78 36.02

W 13.3% 26.31 27.12 28.04 29.11 30.37 31.86 33.66A 14.3% 25.55 26.25 27.06 27.97 29.04 30.28 31.76C 15.3% 24.87 25.50 26.20 27.00 27.91 28.96 30.20C 16.3% 24.28 24.83 25.45 26.15 26.94 27.84 28.89

17.3% 23.74 24.24 24.79 25.40 26.09 26.88 27.7818.3% 23.26 23.71 24.20 24.74 25.35 26.04 26.8219.3% 22.83 23.23 23.67 24.16 24.70 25.31 25.9920.3% 22.43 22.80 23.20 23.64 24.12 24.66 25.2621.3% 22.08 22.41 22.77 23.17 23.60 24.08 24.6222.3% 21.75 22.05 22.38 22.74 23.13 23.57 24.04

FCF Growth RateShare Price Sensitivity Analysis

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Appendix S AnnTaylor’s IRR Calculation

IRR Calculation

Initial Stock Price $5.58 (as of 11/19/2008)Common Stock Outstanding 57,583Market Cap (thousands) $321,313

Expected Cash Flow (thousands)

Premium/Year 0 1 2 3 4 5 6 IRR0% (321,313)$ 117,199$ 116,936$ 116,674$ 116,413$ 116,152$ 700,616$ 41.2%

11.21% (357,332)$ 117,199$ 116,936$ 116,674$ 116,413$ 116,152$ 700,616$ 36.9%41.55% (454,819)$ 117,199$ 116,936$ 116,674$ 116,413$ 116,152$ 700,616$ 28.0%