California Apparel News

It is a season of discontent for The Wet Seal Inc.—and a proxy fight for control of the board of the Foothill Ranch, Calif.–based specialty retailer is just the latest in the company’s woes. Clinton Group, based in New York, formally filed papers on Sept. 10 with the Securities and Exchange Commission to replace the Wet Seal board. Clinton Group owns
6.57 percent of Wet Seal’s Class A common stock.

Sales are plummeting. In August, the retailer posted net sales of $48.8 million and a same-store-sales decline of
18.3 percent compared with last year. It has not reported an increase in same-store sales since August 2011. However, its cash reserves are strong.Wet Seal has $146.5 million in cash, according to its recent financial documents.

The company has no chief executive officer. The last CEO, Susan McGalla, was ousted in July, and the company is searching for her replacement. In the meantime, the retailer is being directed by an “office of a chairman,” led by Hal Kahn, who serves on Wet Seal’s board of directors. He is assisted by Ken Seipel, the company’s president and chief operating officer, and Steve Benrubi, Wet Seal’s chief financial officer.

In July, a class-action racial-discrimination lawsuit against the retailer was filed in U.S. District Court in Santa Ana, Calif. Wet Seal denied any allegations of race discrimination, but the complaint has been widely reported in national media and looms over the reputation of the retailer.

Are changes fast enough?

With the backdrop of this turmoil, Wet Seal executives are attempting to reorient the retailer’s merchandising focus into being a fast-fashion business.

Wet Seal runs a fleet of 559 stores and maintains two divisions: the contemporary Arden B and the juniors Wet Seal, which has stores at top malls such as South Coast Plaza in Costa Mesa, Calif., and the Beverly Center in Los Angeles.

The move into fast fashion has been well-received by Wall Street analysts, but veteran analyst Jeff Van Sinderen of Los Angeles–based B. Riley & Co. lost confidence in Wet Seal’s leadership.

“We simply do not believe that the current team has the skill set necessary to successfully execute a turnaround/return to fast fashion, and that represents the greatest risk to salvaging shareholder value in our view,” he wrote in an unusually strongly worded Aug. 30 research note. “We feel that this situation calls for a sweeping board change and a swift implementation of a new, skilled team. Otherwise, we strongly believe that further and, perhaps, terminal erosion of shareholder value will occur.”Another veteran analyst, Liz Pierce of Roth Capital Partners, based in Newport Beach, Calif., believes Wet Seal is going in the right direction; however, gains will be hard won, she said.

“August comps underscore [Wet Seal’s] recent challenges, and while we are encouraged by the reinstatement of a ‘fast-fashion’ merchandising strategy, transitions can be lumpy,” Pierce wrote in an Aug. 30 research note.

The Wet Seal board promised to evaluate the offer from Clinton Group, but it also defined a board change as a bad idea.

“At this important juncture, bringing in a large number of new directors who are not familiar with the business will deleteriously affect the company’s ability to improve its performance in the coming months. That would not be in the best interests of all of our shareholders,” a board statement said. There are five members of the Wet Seal board: Henry D. Winterstein, Kenneth M. Reiss, Sidney M. Horn, Jonathan Duskin and the previously named Hal Kahn.

On Sept. 7, Wet Seal filed papers with the SEC noting that Winterstein had acquired more than 25,000 shares of Class A common stock in the company at a weighted average price of $3.06. Such purchases typically demonstrate a vote of confidence in the board of directors.

With Clinton Group and the current Wet Seal board vying for shareholder support, Van Sinderen forecast a resolution before Thanksgiving in what will be a tough struggle for the company. “You’ll see a continual flow in information. There can be a lot of twists and turns in this,” he said.

Eyes on executives

Hedge fund Clinton Group is in the business of leading activist fights and has demanded changes in leaderships of companies that have ranged from hamburger restaurant chain Red Robin International Inc. to community bank Porter Bancorp Inc., based in Louisville, Ky.

A weak board and strong cash reserves make Wet Seal an attractive target for a takeover by an activist group, said Ehud Kamar, a University of Southern California law professor who specializes in corporate governance and mergers and acquisitions.

With gambits for leadership change, activist groups often find success when they campaign to install a minority slate or just a few candidates on a board of directors, or when the activist group submits a business plan that shareholders deem superior, Kamar said.

Recent events should aid Clinton Group, said Howard Davidowitz, chairman of the New York–based Davidowitz & Associates, a national retail consulting and investment-banking firm. However, it is the job of Clinton Group to convince shareholders that Wet Seal management has lost control of the company, Davidowitz said.

“If you’re the Clinton Group, you’re going to say that this company cannot manage themselves. Why have they not been able to put a CEO in place?” Davidowitz said.

The Clinton Group also will be able to use the discrimination lawsuits as an argument to dump the board. In one lawsuit, plaintiff and former store manager Nicole Cogdell, who is African-American, claimed she was fired after Barbara Bachman, a former Wet Seal vice president, allegedly demanded that a blonde, blue-eyed manager was needed to run a store at the high-end King of Prussia Mall in Pennsylvania.

“She was in top management,” Davidowitz said of Bachman. “It is a major job. The Clinton Group will say, ‘This is how they run a business? We wouldn’t do this.’” Davidowitz forecast that the proxy fight will follow a familiar script. The group attempting to acquire the company will fail on its first attempt because the incumbent board will hold sway over Wet Seal’s major shareholders, he said.

“If the company continues to perform poorly, usually there’s an enhanced offer, then there’s a decent likelihood there’s going to be deal if the company stays weak,” he said.

However, the current board and Wet Seal shareholders will be driven by two very different agendas.

“They have a lot of cash; they are not desperate,” Davidowitz said of the board. “But shareholders are desperate. They are getting smashed.”