Hot Topic, Inc. (HOTT) is Getting Hot: Abercrombie & Fitch Co. (ANF), Body Central Corp (BODY)

Recently, the private equity firm Sycamore has announced that it would take Hot Topic, Inc. (NASDAQ:HOTT) private for around $14 per share, with a total transaction value of $600 million. A price tag of $14 per share represented a 29% premium to Hot Topic, Inc. (NASDAQ:HOTT)’s closing price on Wednesday. Let’s take a closer look into Hot Topic to see whether or not this price is fair for this specialty retailer.

Business snapshot

Hot Topic, Inc. (NASDAQ:HOTT) is considered a mall and web-based specialty retailer of apparel, accessories, music and gift items, operating under two main concepts: Hot Topic, Inc. (NASDAQ:HOTT) and Torrid. The majority of Hot Topic’s revenue, 32% of its revenue, was generated from fashion accessories sales, while license and music each accounted for 27% of the total Hot Topic, Inc. (NASDAQ:HOTT)’s sales. The fashion apparel ranked fourth, accounting for only 12% of the Hot Topic’s sales. In contrast, Torrid generated the majority of its revenue from apparel sales that represented 77% of the total sales in Torrid while the accessories accounted only 23% of sales.

Consistent cash flow on conservative balance sheet

In the past five years, Hot Topic has experienced a sluggish operating performance. Revenue has decreased consistently from $728 million in 2007 to $698 million in 2011, while the net income dropped from $16 million to -$2 million in the same period. Hot Topic, Inc. (NASDAQ:HOTT) had small positive comparable store sales growth in only two out of the past five years. In 2011, its comp store sales growth was as small as 0.6%.

Source: Hot Topic’s 10-K filing

The operating performance seems to be much better in 2012 when it reported the comparable store sales growth of 3.4%. In addition, the 2012 sales have increased to nearly $742 million. On a positive side, Hot Topic is considered a consistent cash flow generator. Since 2007, the operating cash flow has fluctuated in the range of $35 million to $77 million while the free cash flow has been in the range of $3 million to $54 million. The good thing is that Hot Topic doesn’t employ any leverage in its operation. As of October 2012, it had $185 million in total stockholders’ equity, $59 million in cash and short-term investments, and no debt.