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Why Taking J. Crew Private Will Make the Retailer Even Bigger

Two private equity firms are close to snatching up J. Crew (JCG) for $43.50 a share in cash, or about $3 billion. That's a heck of a lot of selvedge denim and cashmere sweaters. However, at that price it's a bargain, and no one knows that better than current bidder and former owner Texas Pacific Group Capital (TPG Capital) which is vying for a 75 percent stake in the preppy retailer. LA-based Leonard Green & Partners want the other 25 percent. Together the firms would also buy out J. Crew CEO Mickey Drexler's 5.4 percent share.

TPG knows a good deal when it sees one and probably never took its eye off J. Crew after it cashed in handsomely on the retailer's IPO in 2006. TPG had initially acquired an 88 percent stake in J. Crew back in 1997 for nearly $500 million. Without having to report to shareholders, the private equity firm took a number of steps to boost J. Crew's profile, stepping over competitor Gap (GPS) and aiming for more upscale brand cachet. TPG eventually installed Mickey Drexler at the helm -- right after he was fired from Gap -- and sweetened the pot with a 12 percent stake in the company.

It was a huge leap of faith, as Gap was floundering under Drexler's direction, but TPG was convinced he still had the stuff to turn cashmere and denim into gold. It was right. In a few short years, Drexler polished up his "merchant prince" moniker and made a series of calculated fashion risks that paid off. Profit margins increased, as did net sales. Underperforming stores were shuttered and debt with interest rates of 14 percent or more was refinanced.

By the time J. Crew was ready for an IPO though, it was still heavily in debt. The stock offering raised about $375 million and allowed the retailer to pay down about half of the load. The balance sheet today tells a different, much more appealing story. Through diligence and fiscal prudence, J. Crew doesn't have any long-term debt and its annual net income nearly doubled between February of 2007 and this January, to $123.4 million.

Though J. Crew's earnings have looked as good as its fine leather shoes, consistently beating Wall Street estimates over the last four quarters, growth and revenues have slowed. Which means the time is ripe for a shake-up, Taking the company private can address some of the same issues: discounting, styles, inventory management, and expansion that it tackled in the late '90s, without having to bend to the pressures of shareholders.

J. Crew's not big on discounting, but TPG's actually getting a deal. The buyout price is now lower than the current share price -- which is still climbing as news of the acquisition makes its way across the Web.

The deal won't actually close until the first quarter of 2011. And it probably won't be until then that some big questions will be answered. Will Drexler stay on if he's no longer an owner? Will the partners still want him to lead or would they rather cast the net and find fresh blood?

One thing's sure: the brand's star is still rising. Of course, anything is possible, but at this point only a series of spectacularly bad decisions could change J. Crew's fortunes. And the team at TPG have proven to be savvy merchants themselves.

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