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Michaels Stores 080414
Michaels Stores 080414
Michaels Stores 080414
Michaels Stores 080414
Michaels Stores 080414
Michaels Stores 080414
Michaels Stores 080414
Michaels Stores 080414
Michaels Stores 080414
Michaels Stores 080414
Michaels Stores 080414
Michaels Stores 080414
Michaels Stores 080414
Michaels Stores 080414
Michaels Stores 080414
Michaels Stores 080414
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Michaels Stores 080414

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  • 1. DISTRESSED INVESTMENT COMMITTEE April 14, 2008ISSUER: Michaels Stores, Inc.ISSUE: $400 million 11.375% Senior Sub Notes due 11/1/16RECOMMENDATION: Purchase at 80.00 or below. CAPITAL STRUCTURE O/S Moodys / Price Net Lev Net Lev As of 2/2/08 ($MM) Coupon Maturity S&P 4/9/08 Thru Mkt Thru YTM ABL Revolver ($1.0BN) $ 97 L+225/125 10/31/11 B2/B 99.00 4.4% Term Loan A 2,321 L + 225 10/31/13 B2/B 86.50 3.7x 4.3x 7.9% Senior Notes 750 10.000% 11/1/14 B2/CCC 91.75 5.5x 5.6x 11.8% Senior Sub Notes 400 11.375% 11/1/16 Caa1/CCC 83.00 6.2x 6.3x 15.0% Sub Discount Notes 293 13.000% 11/1/16 Caa1/CCC 48.00 6.6x 6.9x 17.2% Other 2 Total 3,863 Cash 29 Net Debt 3,834 LTM Adjusted EBITDA $ 563Source: Company filings and NYLIM estimates.INVESTMENT THESIS SUMMARYWhile it is unlikely that Michaels Stores, Inc. (“Michaels” or “the Company”) is immune to theeffects of a consumer-led recession, we believe that the Company will be able to weather thecurrent economic downturn better than most retailers and that the yield/return of the SeniorSubordinated Notes adequately compensates the investor for the associated risks. With a historyof growth and margin improvement, Michaels enters this down-cycle with high leverage andstrong cash flow. While we anticipate that near-term EBITDA will decline on a Y/Y basis in2008, we expect the Company to continue to maintain its market-leading position, grow its storebase, produce positive cash flow, build liquidity and deleverage its balance sheet. Securities’ re-pricing risk, nevertheless, remains a concern in the current credit environment, and werecommend accumulating a long position later in the cycle.SITUATION OVERVIEWMichaels was taken private in October 2006 by Bain Capital and The Blackstone Group at a totaltransaction value of $6.0 billion, or approximately 10x then-estimated 2006 adjusted EBITDA.The transaction was funded with $4.2 billion of debt (7x leverage) and $1.7 billion of sponsorequity; to-date, neither Bain nor Blackstone has taken a dividend.Authored by Ronald Rich
  • 2. COMPANY OVERVIEWWith fiscal 2007 (ended 2/2/08) net sales of $3.9 billion and adjusted EBITDA of $563 million,Michaels is the largest arts and crafts specialty retailer in North America. Operating 1,129 retailstores in the U.S. and Canada, Michaels has increased its store base by 225 stores over the pastfive years and has posted a net sales and adjusted EBITDA CAGR of 6.2% and 10.0%,respectively, over the same period. Michaels competes across many industries, including floral,fine art, general and kids crafts, scrapbooking and paper crafting, home décor, jewelry &beading, candles, photo frames, and custom framing. MICHAELS STORES 1,200 600 1,100 500 1,000 400 No. Stores Dollars 900 300 800 200 100 700 - 600 2000 2001 2002 2003 2004 2005 2006 (a) 2007 Adjusted EBITDA Total No. Stores HISTORICAL ANNUAL FINANCIALS$ in millions 2000 2001 2002 2003 2004 2005 2006 (a) 2007 Net Sales $ 2,249 $ 2,531 $ 2,856 $ 3,091 $ 3,393 $ 3,676 $ 3,843 $ 3,862 Cost of Sales 1,345 1,488 1,598 1,732 1,900 2,037 2,086 2,089 Occupancy Expense 150 173 206 225 244 263 278 294 Gross Profit 755 870 1,052 1,134 1,250 1,376 1,479 1,479 Adjusted EBITDA (b) $ 214 $ 257 $ 349 $ 387 $ 432 $ 511 $ 599 $ 563 Same Store Sales, Y/Y 5.0% 5.0% 4.2% 2.5% 4.7% 3.6% 0.3% -0.7% Merchandise Margin 40.2% 41.2% 44.1% 44.0% 44.0% 44.6% 45.7% 45.9% Gross Margin 33.6% 34.4% 36.8% 36.7% 36.8% 37.4% 38.5% 38.3% Adjusted EBITDA Margin 9.5% 10.2% 12.2% 12.5% 12.7% 13.9% 15.6% 14.6%(a) Fiscal 2006 contains 53 weeks.(b) Adjusted EBITDA contains addbacks for share-based comp (FY05 forward), transaction fees, non-recurring professional fees, and sponsor fees.Source: Company filings and NYLIM estimates.The Company operates two principal retail formats: Michaels Stores and Aaron Brothers;Michaels recently discontinued its Recollections and Star Decorators concepts, which had totaled8 stores.Michaels Stores is the leading arts and crafts retail chain in North America, with 963 locationsthroughout 48 states and in Canada. Michaels offers a broad selection of arts, crafts, framing, 2
  • 3. floral, wall decor, and seasonal merchandise, as well as on-site education and advice for thecrafter and do-it-yourself home decorator. Its merchandising strategy is to provide the broadestselection of arts and crafts products in a convenient location with an appealing storeenvironment. Each store has an average of 18,500 square feet of selling space and carries, onaverage, over 42,000 basic SKUs. The Company’s broad product offering, combined withfriendly and knowledgeable sales associates, educational in-store events, and project sheets anddisplays, provides customers with a one-stop shopping experience that supports and encouragestheir creativity. According to commissioned surveys of Michaels’ customers, the Company’saverage customer purchases an average of over 6 items per transaction, spends approximately$22 per visit, and shops for crafts supplies at least twice a month, with approximately half oftheir visits to Michaels.Aaron Brothers is the Company’s specialty framing supplies and services retail store, offering anextensive assortment of ready-made frames and mats for the do-it-yourselfer, quality art suppliesfor the student and professional, and top-of-the-line, custom framing services. The Companyoperates 166 Aaron Brothers stores located across 11 states, which is consistent with Aaron’sstore count over the past few years. Aaron Brothers stores have an average of 5,600 square feetof selling space and carry nearly 6,500 basic SKUs. 3
  • 4. INDUSTRY OVERVIEWMichaels competes in the large and growing U.S. and Canadian arts and crafts industry. The artsand crafts market broadly includes a diverse set of categories, including general crafts(scrapbooking, beading, jewelry making, rubber stamping), needle crafts (cross stitching,crocheting, knitting, home décor sewing), painting/ finishing (home décor painting, art anddrawing, stenciling, decorative painting) and floral crafts (floral arranging, wreath making).Crafting is one of the leading leisure activities in the U.S., enjoying broad participation within58% of all U.S. households, according to the Craft and Hobby Association (“CHA”). This highlevel of household participation is driven by the low cost per hour of entertainment and thelasting value that crafting projects offer relative to other entertainment alternatives. Floral Crafts 10% General Crafts Painting & 41% Finishing Crafts 24% Needle & Sewing Crafts 25%There appears to be a muted correlation between arts and crafts market growth and broadermacroeconomic trends, such as GDP growth, interest rates, unemployment rates, and changes inrelative purchasing power. According to the CHA, the U.S. arts and crafts market generatedapproximately $31.8 billion in sales in 2007, a 7.6% increase from 2006; since the CHA begantracking this data, there has not been an annual decline in any year, including during the 2001recession when the industry grew by 11.3%. This consistent market growth is driven bypopulation growth and household participation growth, as well as an increase in annual spendingper household. In addition to the core arts and crafts market, Michaels’ addressable marketincludes the $8 billion framing market, bringing the total estimated addressable market for theCompany to $40 billion. According to Bain & Company, the overall U.S. arts and crafts industryis forecasted to grow at a rate of 2.6% per annum between 2005 and 2011. This growth isexpected to be driven by a 1.1% increase in the number of households, a 1.5% increase inaverage annual expenditure, and flat participation rates.The arts and crafts market is composed of avid and loyal consumers, which creates a relativelystable market dynamic. According to surveys published by CHA, the average arts and craftscustomer typically purchases 5-10 items for a given project and shops for crafts supplies at leasttwice a month. The most enthusiastic customers (those who spend more than 9 hours per weekon arts and crafts) comprise 12% of crafting households and account for 25% of all craft sales. 4
  • 5. CompetitionThe crafts market isserved by specialty chainstores, mass merchants,department stores,discount retailers andindependent “mom andpop” stores. Discountstores and craft chainstores account for thelargest share of craftpurchases, followed byfabric & craft stores.Discount stores have thehighest loyalty rate, a result of convenience and price. Crafters are also loyal to craft chainstores, due primarily to the broad merchandise selection. Retail arts and crafts sales are highly fragmented, with the top four arts and crafts retailers comprising approximately 21% of the market (including framing). Michaels, the industry leader, commands 10% of the industry, with nearly twice as much in sales as its nearest competitor. The remaining 80+% is sold through a variety of retail channels including smaller local chains and indirect competitors. Of the five major arts and crafts retailers, only four (Michaels, Jo-Ann Stores, Hobby Lobby, and A.C. Moore) have annual sales in excess of $500 million, two of which do not have a national presence (Hobby Lobby and A.C. Moore). In addition toAs of 2006.Source: Craft & Hobby Association having leading market share, Michaels also generates considerably higher EBITDA margin, approximatelythree times that of Jo-Ann Stores. COMPETITOR METRICS Hobby $ in millions Michaels Jo-Ann Lobby AC Moore No. Stores 1,129 774 389 133 Market Share 10% 5% 4% 1% Same Store Sales Growth -0.7% 3.7% NA -10.3% Net Sales $ 3,862 $ 1,879 NA $ 560 Adjusted EBITDA $ 563 $ 89 NA $ 20 Adjusted EBITDA Margin 14.6% 4.7% NA 3.6% EV/Adjusted EBITDA Private 5.3x Private 7.0x Source: Company filings and NYLIM estimates. 5
  • 6. RECENT FINANCIAL PERFORMANCEFinancial performance for the fourth fiscal quarter ended February 2, 2008, was lower thanexpected. Company sales are seasonal, with nearly 35% of annual sales occurring in the fourthquarter due to holiday-associated sales. Quarterly same store sales declined 3.4% Y/Y in 4Q07,driven primarily by lower sales and pricing in the Christmas décor and home accentsdepartments. Gross margin, which includes occupancy expense, decreased 184bps Y/Y to40.0%, driven by a decrease in merchandise margin and associated lower overhead absorption;merchandise margin declined 128bps Y/Y to 45.7% as a greater portion of seasonal and higherticket items was sold on clearance and markdown. NYLIM-calculated adjusted EBITDA for4Q07 declined 9% Y/Y to $259 million from $284 million in 4Q06 (as adjusted from $304million for the 53rd week in fiscal 2006 for comparability) with adjusted EBITDA margin of19.9%, down 190bps from 21.8% in the prior year (as adjusted from 22.3% for the 53rd week).Adjusted EBITDA for fiscal 2007 was $563 million, down $10 million from $573 million infiscal 2006 (as adjusted from $599 million for the 53rd week).As of February 2, 2008, we estimate that Michaels had liquidity of $606 million, comprised of$29 million of cash and $577 million of revolver availability; additionally, Michaels generated$268 million of cash from operations in fiscal 2007. QUARTERLY HISTORICAL FINANCIALS $ in millions 1Q06 2Q06 3Q06 4Q06 (a) 1Q07 2Q07 3Q07 4Q07 Net Sales $ 832 $ 768 $ 896 $ 1,361 $ 844 $ 793 $ 940 $ 1,301 Cost of Sales 444 423 506 722 444 429 521 706 Occupancy Expense 69 70 70 70 72 73 74 75 Gross Profit 319 275 319 569 328 291 345 520 Adjusted EBITDA (b) $ 118 $ 77 $ 98 $ 304 $ 104 $ 81 $ 118 $ 259 LTM Adjusted EBITDA - - - 599 583 586 606 563 Same Store Sales, Y/Y -3.0% -0.3% 3.3% 0.8% -0.5% 0.8% 1.9% -3.4% Merchandise Margin 46.7% 44.9% 43.5% 47.0% 47.4% 46.0% 44.6% 45.7% Gross Margin 38.3% 35.8% 35.6% 41.8% 38.8% 36.7% 36.7% 40.0% Adjusted EBITDA Margin 14.1% 10.0% 10.9% 22.3% 12.3% 10.2% 12.6% 19.9% LTM Adj. EBITDA Margin - - - 15.5% 15.1% 15.0% 15.4% 14.6% Net Leverage Ratio - - - 6.6x 6.9x 6.9x 6.8x 6.8x Interest Coverage Ratio - - - 5.7x 2.9x 2.0x 1.6x 1.5x Net Leverage, rent-adj. - - - 7.0x 7.3x 7.3x 7.2x 7.2x Interest Coverage, rent-adj. - - - 3.0x 2.2x 1.8x 1.5x 1.5x (a) 4Q06 contains 14 weeks. (b) Adjusted EBITDA contains addbacks for share-based comp, transaction fees, non-recurring professional fees, and sponsor fees. Source: Company filings and NYLIM estimates.FINANCIAL PROJECTIONSWhile we project that Michaels will post lower Y/Y EBITDA in fiscal 2008, driven by aconsumer-challenged environment, we expect the Company to perform relatively well throughthe current economic recession. Though Company management predicts a 2H08 economicrecovery, our base case assumes that the current consumer malaise continues through the secondhalf of the year. As a result, we expect that same store sales will decline Y/Y, gross margins willdegrade as lower sales volumes drive lower overhead absorption, SG&A will increase on a per 6
  • 7. store basis in-line with inflation, resulting in lower EBITDA margin; partially offsetting thelower EBITDA margin, will be EBITDA generated by Michaels’ new store openings.Given our key drivers, we project fiscal 2008 adjusted EBITDA of $544 million, down $19million Y/Y, with associated cash flow from operations of $248 million; cash flow in fiscal 2008should benefit from declining LIBOR by approximately $75 million (Michaels has not swappedits floating rate exposure). Quarterly projections are exhibited in the Appendix. BASE CASE FINANCIAL PROJECTIONS $ in millions 2007A 2008 2009 KEY DRIVERS Same Store Sales -0.7% -1.1% 0.0% Net Sales, Y/Y (a) 2.1% 3.3% 3.9% Merchandise Margin, bps Y/Y 20 27 50 Gross Margin, bps Y/Y (19) 9 37 Adjusted EBITDA Margin 14.6% 13.6% 13.5% PROJECTED INCOME STATEMENT Net Sales $ 3,862 $ 3,988 $ 4,147 Cost of Sales 2,089 2,146 2,211 Occupancy Expense 294 311 329 Gross Profit 1,479 1,531 1,607 SG&A 1,051 1,108 1,174 Related Party Expenses 17 24 25 Store Pre-Opening Costs 6 6 7 Operating Income 405 393 401 Depreciation 125 128 135 Other Addbacks 33 23 23 Adjusted EBITDA (b) $ 563 $ 544 $ 559 PROJECTED CASH FLOW Adjusted EBITDA $ 563 $ 544 $ 559 Cash Taxes (11) (42) (55) Cash Interest (288) (238) (218) Change in Working Capital 52 (2) (5) Sponsor Fees (14) (14) (14) Other (35) - - CASH FROM OPERATIONS 268 248 267 Capital Expenditures (100) (120) (120) Term Loan Amortization (24) (24) (24) Revolver Draw / (Repayment) (110) (97) - Other (35) - - NET CHANGE IN CASH $ (1) $ 8 $ 124 Beginning Cash Balance 30 29 37 Ending Cash Balance 29 37 161 LIQUIDITY Cash $ 29 $ 37 $ 161 Revolver Availability 577 692 697 Total 606 730 858 CREDIT METRICS Net Leverage 6.8x 6.9x 6.5x Interest Coverage 1.5x 2.0x 2.1x Net Leverage, rent-adjusted 7.2x 7.3x 7.1x Interest Coverage, rent-adj. 1.5x 1.8x 1.8x (a) 2007 Y/Y change has been adjusted to account for the 53rd week in fiscal 2006. (b) Adjusted EBITDA contains addbacks for share-based comp, transaction fees, non-recurring professional fees, and sponsor fees. Source: Company filings and NYLIM estimates. 7
  • 8. The sensitivity table below shows the resulting 2008 projected adjusted EBITDA given varyinglevels for the change in same store sales and merchandise margin. The small box marks our basecase scenario. 2008 PROJECTED ADJUSTED EBITDA Same Store Sales Y/Y 544 1% 0% -1% -2% -3% -4% -5% 75 600 581 563 544 525 506 487 50 590 571 553 534 515 497 478 Merchandise 25 580 561 543 524 506 487 468 Margin - 570 551 533 514 496 477 459 bps Y/Y (25) 560 541 523 504 486 468 449 (50) 549 531 513 494 476 458 440 (75) 539 521 503 485 466 448 430 (100) 529 511 493 475 457 439 420 (125) 519 501 483 465 447 429 411 Source: NYLIM estimates.INVESTMENT THESISWhile it is unlikely that Michaels Stores is immune to the effects of a consumer-led recession,we believe that the Company will be able to weather the current economic downturn better thanmost retailers. With a history of growth and margin improvement, Michaels enters this down-cycle with high leverage and strong cash flow. While we anticipate that near-term EBITDA willsuffer on a Y/Y basis, we expect the Company to continue to maintain its market-leadingposition, grow its store base, produce positive cash flow, build liquidity and deleverage itsbalance sheet.Market LeaderMichaels Stores is the largest national arts and crafts specialty retailer within the estimated $40billion U.S. arts and crafts and framing market, with an estimated 10% market share. Michaels’market share is roughly twice that of its largest direct competitor, while none of its keycompetitors possess the broad geographic footprint of its store base. The Company plans to openan additional 45 Michaels Stores in the first three quarters of fiscal 2008, driving incrementalEBITDA. Additionally, Michaels EBITDA margin at 14.6% is 3.1x that of Jo-Ann Stores and4.6x that of A.C. Moore.Recession ResistantUnlike most retailers, Michaels’ sales have historically been relatively unaffected by economicdownturns. During recessionary times, consumers have tended to allocate leisure spendingtoward relatively inexpensive and long-lasting forms of entertainment, such as crafting. Duringthe two previous economic downturns, Michaels continued to report positive comparable storesales growth, specifically 9.1% in 1990, 9.1% in 1991, 4.6% in 2001 and 4.2% in 2002. Webelieve that the current cycle will be less forgiving to Michaels’ performance, given slowingcategory growth, and that the Company will likely experience moderate declining same storesales during the current downturn. 8
  • 9. Long-Term Margin ImprovementMichaels management has targeted long-term EBITDA margin of 24%, almost 1,000 bps abovefiscal 2007 levels, and expects to achieve 25% of it over the next three to five years. Thistranslates to approximately 50 – 75 bps of margin improvement per year. Product Sourcing - Michaels currently sources less than 10% of its products directly from international manufacturers, providing the Company with the long-term opportunity to enhance margin, decrease supply-chain costs and realize overall lower product costs. Michaels plans to increase the percentage of its less complex products that it sources directly from international manufacturers, thereby disintermediating the domestic distributor. The Company has started to take steps to achieve this initiative with the hiring of a consulting firm, the category-by-category review of its sourcing opportunities, and the formation of a strategic sourcing team that is headed by a new senior vice president who comes from Office Depot with over 20 years of experience in global sourcing. Hybrid Distribution Network - Michaels expects to improve margin by reducing costs associated with drop-shipping products directly to store locations. Management is in the process of shifting to a hybrid distribution model. Under this model, the Company estimates that approximately 85% to 95% of its inventory will be shipped from the vendor to a distribution center; Michaels currently has eight distribution centers across the country. Management expects to complete the transition to the hybrid model in fiscal 2008.Continued Cash GenerationWe project that liquidity will improve $124 million and $128 million Y/Y to $730 million and$858 million in fiscal 2008 and 2009, respectively, from an estimated $606 million at the end offiscal 2007. Net leverage is projected to increase to 6.9x in fiscal 2008 from 6.8x in the prioryear, and decline to 6.5x by the end of fiscal 2009; using S&P guidance, projected credit metricsshould not result in a ratings change.Potential for Continued GrowthMichaels plans to continue to open new stores and remodel/relocate existing stores. TheCompany has a proven track record of successful new store expansion. Consequently, Michaels’growth capital spending has resulted in over 99% of the Company’s fully-ramped store basehaving positive store-level EBIT. New stores exhibit very attractive economics with a post-taxcash payback period of three years. The Company plans to open approximately 45 new Michaelsstores per year, with U.S. and Canadian markets estimated to be capable of supportingapproximately 1,300 stores at current ROIC hurdles (>25%).Enterprise Value Coverage to the NotesIn reviewing Michaels Stores’ public trading range from January 2000 through October 2006, asprovided by Capital IQ, we calculate an average EV/EBITDA multiple of 8.7x. At a morefavorable point in the cycle, a leading specialty retailer such as Michaels could garner an 8x –10x valuation multiple; in the current environment, we believe that a 7x EV/EBITDA multiple ismore appropriate. 9
  • 10. MICHAELS STORES HISTORIC PUBLIC VALUATION MULTIPLE 13.0x 12.0x 11.0x 10.0x 9.0x 8.0x 7.0x 6.0x 5.0x 4.0x 00 00 01 01 02 02 03 03 04 04 05 05 06 06 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q Qtr Avg EV / EBITDA Multiple Source: Capital IQ PUBLIC SPECIALTY RETAIL COMPARABLES Sally Jo-Ann $ in millions Michaels Beauty AC Moore Stores Ticker Private SBH ACMR JAS EV/Adjusted EBITDA Private 9.9x 7.0x 5.3x Net Sales $ 3,862 $ 2,540 $ 560 $ 1,879 EBITDA Margin 14.6% 12.6% 3.6% 4.7% Net Leverage 6.8x 5.5x NM 1.8x Interest Coverage 1.5x 2.1x 11.2x 7.0x Source: Company filings, Capital IQ and NYLIM estimates.Applying a 7x multiple to our projected fiscal 2008 adjusted EBITDA of $544 million, we findthe Senior Sub Notes value covered 2.1x [EV ($544MM x 7) plus cash ($39MM) less senior debt($3.0BN) / Sr. Sub. Notes ($400MM)]. The chart below delineates sensitivities to our base caseassumptions. 2008 SENIOR SUB NOTE VALUE COVERAGE 2008 Projected Adjusted EBITDA $ 600 $ 575 $ 550 $ 525 $ 500 $ 475 $ 450 8.0x 448% 398% 348% 298% 248% 198% 148% 7.5x 373% 326% 279% 232% 185% 139% 92% EV/EBITDA 7.0x 298% 254% 210% 167% 123% 79% 35% Multiple 6.5x 223% 182% 142% 101% 60% 20% -21% 6.0x 148% 110% 73% 35% -2% -40% -77% 5.5x 73% 39% 4% -30% -65% -99% -133% 5.0x -2% -33% -65% -96% -127% -158% -190% Source: NYLIM estimates.Covenant-Lite Credit FacilityFollowing an environment of low credit spreads, a covenant breach in today’s environment hasoften led to a material re-pricing. While we may otherwise take comfort in a credit facility’s 10
  • 11. maintenance covenants, we believe that investors in the Company’s unsecured debt arebeneficiaries of the covenant-lite bank facility credit agreement. Without the covenants,Michael’s unsecured debt is not exposed to secured debt re-pricing and the commensurate valuedrain from increased interest expense, as well as to a reduction in liquidity that could result froma breach; in addition, given our view of Michaels’ near-term fundamentals, we do not believethat this lack of credit protection will result in an impairment to the Notes’ credit quality.Sponsor InvolvementMichaels Stores was purchased by Bain Capital and The Blackstone Group in October 2006 with$1.7 billion of sponsor equity; to-date, neither private equity firm has taken capital out of theCompany. As for a near-term dividend recapitalization (market conditions aside), debtincurrence is limited by a Fixed Charge Coverage (“FCC”) Ratio of 2.0x; this covenant, though,does not apply to debt drawn under the revolver (estimated $577 million available) and excludescertain carve-outs for foreign subsidiaries, capital leases and a Restricted Payments basket of $75million, among others. By our projections, Michaels’ FCC ratio does not exceed 2.0x until 2009.We find the sponsors’ current substantial equity investment and presence on the Board ofDirectors comforting and we trust that they will leverage their resources to help managementexecute its initiatives. Bain Capital has extensive retail experience, with acquisitions that haveincluded Toys “R” Us, Burger King, AMC Theatres, Staples, Burlington Coat Factory,Brookstone and Dominos Pizza.INVESTMENT RECOMMENDATIONWe recommend the purchase of up to $15 million (par) of Michaels’ 11.375% SeniorSubordinated Notes at 80.00 or below, equivalent to 15.7% YTM or greater. Given our view ofMichael’s performance through the current down-cycle, we believe that a 15.7% yield isadequate compensation for our perceived risks. Even in an environment that will likely lead todeclining same store sales and degrading margin, Michaels should continue to generate positivecash flow and pay down debt; additionally, at no point during our projection period do we expectthe Notes to be value impaired. While we do not foresee a positive near-term catalyst, we wouldexpect accelerated principal appreciation when the consumer cycle turns, driving positive Y/Ycomps, valuation multiple expansion and spread tightening. 11.375% SENIOR SUB NOTE IRR Base Case Sensitivity Analysis Exit Price 100.00 90.00 80.00 70.00 60.00 Year 2009 28% 22% 15% 7% 0% 2010 23% 19% 15% 10% 6% 2011 20% 17% 15% 12% 9% * Assumes entry price of 80.00. Source: NYLIM estimates. 11
  • 12. Strengths· Market leader, category killer· Recession resistant, historically· Relatively strong margins with opportunity for improvement· Opportunity for growth, highly fragmented market· Continued cash and liquidity generation through downturn in economic cycle· Strong sponsor oversight and involvement· Covenant-lite credit facility provides flexibilityWeaknesses· Consumer will be affected by recession· Near-term financial performance will likely be down Y/Y· Recent management changes that include the hiring of the current CEO, Brian Cornell, and the resigning of the COO and CFO, both of whom had also held the title of Co-President.· High leverage· Re-pricing risk to Notes 12
  • 13. APPENDIX BASE CASE FINANCIAL PROJECTIONS$ in millions 1Q08 2Q08 3Q08 4Q08 2008 2009 KEY DRIVERSSame Store Sales -2.0% -1.5% -1.5% 0.0% -1.1% 0.0%Net Sales, Y/Y 1.5% 2.5% 2.4% 4.3% 3.3% 3.9%Merchandise Margin, bps Y/Y 0 0 0 0 27 50Gross Margin, bps Y/Y 0 0 0 0 9 37Adjusted EBITDA Margin 0.0% 0.0% 0.0% 0.0% 13.6% 13.5% PROJECTED INCOME STATEMENTNet Sales $ 857 $ 813 $ 963 $ 1,357 $ 3,990 $ 4,147Cost of Sales 449 437 531 730 2,148 2,211Occupancy Expense 76 77 78 79 311 329Gross Profit 332 298 354 548 1,532 1,607SG&A 269 256 276 308 1,109 1,174Related Party Expenses 6 6 6 6 24 25Store Pre-Opening Costs 2 2 2 - 6 7Operating Income 55 34 70 234 393 401Addbacks 38 38 38 38 151 158Adjusted EBITDA 93 72 108 272 544 559 PROJECTED CASH FLOWAdjusted EBITDA $ 93 $ 72 $ 108 $ 272 $ 544 $ 559Cash Taxes - - - (42) (42) (55)Cash Interest (90) (30) (89) (28) (238) (218)Change in Working Capital (123) (47) (49) 217 (2) (5)Sponsor Fees (4) (4) (4) (4) (14) (14)Capital Expenditures (30) (30) (30) (30) (120) (120)CASH BEFORE FINANCINGS (154) (39) (64) 386 129 147Term Loan Amortization (6) (6) (6) (6) (24) (24)Revolver Draw / (Repayment) 161 45 70 (373) (97) -NET CHANGE IN CASH $ 1 $ - $ - $ 7 $ 8 $ 124Beginning Cash Balance 29 30 30 30 29 37Ending Cash Balance 30 30 30 37 37 161 LIQUIDITYCash $ 30 $ 30 $ 30 $ 37 $ 37 $ 161Revolver Availability 497 456 578 693 693 697Total 527 486 608 730 730 858 CREDIT METRICSNet Leverage 0.0x 0.0x 0.0x 0.0x 0.0x 6.5xInterest Coverage 7.3x 7.5x 7.8x 6.9x 6.9x 2.1xNet Leverage, rent-adjusted 7.5x 7.7x 7.8x 7.3x 7.3x 7.1xInterest Coverage, rent-adjusted 1.5x 1.6x 1.6x 1.7x 1.7x 1.8x* Adjusted EBITDA contains addbacks for share-based comp, transaction fees, non-recurring professional fees, and sponsor fees.Source: Company filings and NYLIM estimates. 13
  • 14. MANAGEMENT TEAMBrian Cornell, Chief Executive Officer. On June 4, 2007, Michaels Stores announced thatBrian Cornell was named the new Chief Executive Officer of the company. Brian Cornellrecently served as Executive Vice President and Chief Marketing Officer of Safeway, Inc., wherehe was responsible for the merchandising, marketing, manufacturing, supply chain, and onlinebusiness. Prior to joining Safeway in 2004, he was President of Pepsi-Cola North America’sFoodservice Division and SVP of Sales for Pepsi-Cola North America. He also held othermanagement roles at Pepsi and Tropicana Product International. He is a director of Home Depotand was one of OfficeMax Inc.Thomas M. Bazzone, Executive Vice President – Specialty Businesses. Mr. Bazzone waspromoted to Executive Vice President–Specialty Businesses in March 2006. Prior to hispromotion, he served as President of the Recollections and Star Decorators Wholesale businessessince May 2004. He came to Michaels from Restoration Hardware where he was Executive VicePresident, Chief Operating Officer and Director from July 2001 to December 2003. Previously,he was with Red Envelope, where he held the position of President and Chief Operating Officerfrom July 1999 to July 2001. Mr. Bazzone also held executive positions with Williams-Sonomafrom May 1995 through January 1997.Thomas C. DeCaro, Executive Vice President – Supply Chain. Mr. DeCaro becameExecutive Vice President–Supply Chain in June 2005. Prior to this, Mr. DeCaro had served asSenior Vice President–Inventory Management since joining the Company in August 2000. From1998 until joining Michaels, he was Vice President–Merchandise for Disneyland Resort. Prior tothis, he held the position of Senior Vice President–Merchandise Planning and Allocation forKohl’s Department Stores from February 1996 to April 1998. In addition, Mr. DeCaro has heldvarious positions in Merchandise Planning and Allocation and Finance for The Disney Store,The Limited Stores, May Department Stores, and Sanger Harris Department Stores.Harvey S. Kanter, Executive Vice President – Chief Merchant. Mr. Kanter was promoted toExecutive Vice President–Chief Merchant in March 2006. Prior to his promotion, he served asPresident of Aaron Brothers, a subsidiary of Michaels, since April 2003. From 1995 until joiningthe Company, Mr. Kanter held various positions with Eddie Bauer, Inc. From 2002 until 2003,he was Managing Director of the Home and Non-Apparel divisions and from 1998 until 2002, hewas Managing Director of the Home division.Lisa Klinger, SVP and Acting CFO. Lisa K. Klinger serves as Acting Chief Financial Officer;the former CFO and President, Jeff Boyer, resigned effective April 4, 2008. Ms. Klinger joinedthe Company in June 2005 as Vice President - Treasurer, and had served as Senior VicePresident - Finance and Treasurer, a position held since February 2007. During her tenure, sheassisted in the go-private transaction and ensuing debt issuance and has led the consolidatedFinance organization including Treasury, Investor Relations, Corporate Finance, Merchandise &Marketing Finance, Store Planning & Analysis, Supply Chain Finance and Non-MerchandiseProcurement. 14
  • 15. BOARD OF DIRECTORSJoshua Bekenstein. Mr. Bekenstein is a Managing Director at Bain Capital Private Equity andBain Capital, LLC. He co-founded the firm in 1984 and has been a Managing Director of thefirm since 1986. Prior to Bain, Mr. Bekenstein was a Consultant at Bain & Company, where heworked on strategic consulting projects for a number of Fortune 500 clients. Mr. Bekenstein hasbeen a Director at Sealy Corp. since December 1997 and also serves as a Director at KB ToysInc. He has been a Director of Specialty Retailers Inc. since December 1988 and is a Member ofits Compensation Committee and served as its Vice Chairman and Chief Financial Officer fromMay 1992 to March 1996.Michael Chae. Mr. Chae is a Senior Managing Director at The Blackstone Group, PrivateEquity Group. Since joining Blackstone in 1997, he has been involved in the execution ofBlackstone’s investments in Centennial Communications, Crowley Digital (Salmon PCS),Extended Stay America, PaeTec Communications, iPCS, Michael’s Stores, The NielsenCompanies (formerly VNU), and Universo Online and in acquisitions by American Axle &Manufacturing and the reorganization of Transtar. Mr. Chae focuses on investments in the mediaand communications, and retail sectors.Todd Cook. Mr. Cook is a Principal at Bain Capital Private Equity and Bain Capital, LLC. Mr.Cook joined the firm in 1996. Previously, he was a Consultant at Bain & Company.Matthew Kabaker. Mr. Kabaker is a Principal at The Blackstone Group, Private Equity Group.Since joining the firm, Mr. Kabaker has been involved in Blackstone’s investments in RepublicTechnologies, Ritvik Toys, LiveWire Ventures, the London International Financial Futures &Options Exchange (LIFFE), Aspen Insurance, Ariel Insurance, Healthmarkets, TRWAutomotive, Financial Guaranty Insurance Company (FGIC), and Sungard. He currently serveson the board of directors of Ariel Insurance, TRW Automotive, FGIC, and Healthmarkets.Lewis Klessel. Lewis Klessel serves as Executive Vice President, private equity portfoliopractice of Bain Capital Partners. Prior to joining Bain Capital Partners, Mr. Klessel held avariety of operating and strategy leadership positions from 1997 to 2005 at The Home Depot,Inc., as President of Maintenance Warehouse, a wholly-owned subsidiary that distributedmaintenance products to facility management customers in the multi-housing, lodging, health-care and commercial sectors. Mr. Klessel has been Director of Michaels Stores Inc. since 2006.Matthew Levin. Mr. Levin is a Managing Director at Bain Capital Private Equity and BainCapital, LLC. He joined the firm in 1992 and became a Managing Director in 2000. Previously,Mr. Levin was a Consultant at Bain & Company Inc. from 1988 to 1991, where he consulted inthe consumer products and manufacturing industries. He was a Director at NutraceuticalInternational Corp. since December 1996 and also from its inception to January 1995.David McVeigh. Mr. McVeigh is an Executive Director at The Blackstone Group, PrivateEquity Group since 2006. He brings additional expertise to the firms growing portfoliomanagement team in monitoring and advising on strategy and operational performance ofBlackstones increasingly high-profile and international group of portfolio companies. Prior to 15
  • 16. joining Blackstone Mr. McVeigh was a Partner with McKinsey and Company as well as a leaderof the North American Chemicals and Northeast Energy and Materials practices.James Quella. Mr. Quella is a Senior Managing Director and Senior Operating Partner at TheBlackstone Group, Private Equity Group. Mr. Quella is responsible for monitoring the strategyand operational performance of Blackstone portfolio companies and providing direct assistancein the oversight of large investments. He is also a member of the firm’s Private EquityInvestment Committee. Prior to joining Blackstone in 2004, Mr. Quella was a Managing Directorand Senior Operating Partner with DLJ Merchant Banking Partners-CSFB Private Equity sinceJuly 2000 when CSFB merged with DLJ. In October 1992, he founded the Financial ServicesPractice Group and also managed it until December 1995.SPONSORSBain Capital. Established in 1984, Bain Capital is one of the worlds leading private investmentfirms whose affiliates manage over $50 billion in assets. The investment activities of BainCapitals affiliates include private equity & venture capital as well as long/short public equity,credit products and global macro hedge funds. Since its inception in 1984, Bain Capital hascompleted over 240 equity investments. Bain is an active investor in the Retail and ConsumerProducts industry, having invested in over 45 companies, focusing on segments that includetraditional retailers, on-line merchandising, consumer products, food and restaurants, andconsumer services. Among others, acquisitions have included Toys “R” Us, Burger King, AMCTheatres, Staples, Burlington Coat Factory, Brookstone and Dominos Pizza.The Blackstone Group. Established in 1987, Blackstone is a leader in private equity investing,having managed five general private equity funds, as well as one specialized fund focusing onmedia and communications-related investments. It pursues transactions throughout the world,including not only typical leveraged buyout acquisitions of seasoned companies but alsotransactions involving start-up businesses in established industries, turnarounds, minorityinvestments, corporate partnerships and industry consolidations. 16

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