In a highly publicized war of words this week, rival men's suits retailers Jos. A. Bank and Men's Wearhouse dueled over the former's attempt to buy the latter -- at a share price the latter said "significantly" undervalues it.
As Jos. A. Bank ("Joe") tells it, its offer to pay $2.3 billion in cash for its rival would create the "leading men's apparel designer, manufacturer and retailer in the U.S." -- and significantly boost its own earnings per share in the process. From Men's Wearhouse's perspective, though, Joe is trying to buy it out on the cheap in a "highly opportunistic" ploy to take advantage of Men's Wearhouse's leadership turmoil and temporary sales weakness.
Who's right? Possibly, both of them are. After all, after Men's Wearhouse very publicly ousted its founder this past summer, the company does seem to have struggled. Sales were down a couple of percentage points in the most recent quarter, with earnings tumbling nearly 28%.
Two many tailors spoil the suit
Joe, meanwhile, is in no fine fettle itself, and would probably benefit from a merger. Its sales were down 11% last quarter, even steeper than MW, with profits plummeting 38%. Little wonder, then, that Joe is looking to take a rival off the rack, potentially reducing price competition in the industry.
The question that should concern investors: How much would be too much to pay for these benefits?
Offering to take out Men's Wearhouse for $48 a share -- Joe's bid --values its rival at just a hair over 20 times earnings -- a cheaper valuation than Joe's own shares command. Viewed on a price-to-sales basis, Joe would be getting an even better deal -- 0.9x Men's Wearhouse's annual revenue stream, when Joe's own shares sell for a 1.25 P/S ratio.
On the other hand, Men's Wearhouse is a less-profitable operation than the company that wants to buy it, earning operating profit margins fully 230 basis points lower than what Joe pulls down. And that's a situation unlikely to improve. Most analysts who follow these companies agree that, over the next five years, Joe is likely to grow its earnings at about 12% annually, versus only 8% for Men's Wearhouse.
While buying Men's Wearhouse would probably juice Joe's growth rate (inorganically, and temporarily), the relative plodding pace of its rival suggests that, after a merger, Men's Wearhouse might actually turn out to be a drag on Joe's growth. Result: Joe probably should be paying the lower P/S multiple for Men's Wearhouse shares -- and probably should not be paying nearly the same P/E as its own shares fetch.
Which brings us to the problem: Despite numbers that show Men's Wearhouse to be a clearly inferior operation to Joe, Men's Wearhouse has rejected Joe's overgenerous initial offer. The temptation will now arise to increase Joe's bid, to win over Men's Wearhouse.
Joe should resist that temptation. It's already offering to pay too much, and should walk away rather than overpay.
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The article Will Jos. A. Bank Waste Your Money Buying Men's Wearhouse? originally appeared on Fool.com.Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.