GSI Commerce Inc. has signed a definitive agreement to acquire Retail Convergence Inc., a Boston, Mass.-based company that operates RueLaLa.com, a leader in the private sale space and SmartBargains.com, an off-price e-commerce marketplace.

The acquisition of Rue La La and SmartBargains.com furthers GSI’s evolution as an innovative global e-commerce platform capable of managing all aspects of online sales and interactive marketing for leading retailers and consumer brands.

The transaction is valued at up to $350 million, including $180 million at closing (50 percent cash, 50 percent stock) and an earn-out of up to $170 million. To reach the maximum earn-out, RCI will need to achieve non-GAAP income from operations (commonly referred to as adjusted EBITDA) of $51.9 million in fiscal year 2012 (a complete description of the earn-out is contained later in this release). At the end of September 2009, RCI had cash of $7.5 million and no debt. In 2010, RCI is expected to generate at least $230.0 million of revenue, $7.0 million of income from operations and $15.0 million of non-GAAP income from operations (1).

“We are excited to enter the private sale market with industry-leader Rue La La. We believe this new way of shopping will continue its remarkable growth trajectory, based on its benefits to brands, retailers and consumers,” said Michael G. Rubin, chairman, president and CEO of GSI. “Rue La La’s short, intense events are entertaining and engaging. They have proven to be an effective solution for brands and retailers to sell significant opportunistic merchandise in a compressed time period,” said Rubin.

Launched in April 2008, Rue La La is a members-only, e-commerce destination offering premier brands at discount prices during two-day private sale events in the fashion, accessories, footwear, home, jewelry and other emerging merchandise categories. Since inception, Rue La La has featured private sale events from more than 300 brands.

SmartBargains.com, launched in 1999, is a leading consumer marketplace for the sale of off-price merchandise across a wide cross-section of categories.

“The private sale sector is changing e-commerce through exceptional levels of virality, dynamic customer experience and highly engaged members,” said Ben Fischman, CEO of Retail Convergence. “Since launching in April, 2008, Rue La La has experienced tremendous growth and we are excited to further our momentum by becoming part of the GSI family. GSI’s extensive infrastructure, marketing services expertise and relationships with retailers and brands will provide brands and members with an even more robust experience, accelerating Rue La La’s global potential and positioning us for leadership in this exciting e-commerce segment.”

Fischman will continue to lead Rue La La and SmartBargains.com, reporting to Michael Rubin. RCI’s experienced and growing team of nearly 200 associates will remain intact following the acquisition to support the continued expansion of Rue La La and SmartBargains.com.

“Rue La La can offer GSI’s clients access to a new way of selling opportunistic inventory in a manner that enhances their brand image and further drives consumer engagement,” said Rubin. “It is an excellent strategic fit for GSI adding a new growth pillar. Rue La La positions us to continue adding value to our clients and provides meaningful cross-sell opportunities among all of our services.”

Rue La La’s membership has grown to more than 1.2 million members in 18 months and continues to grow rapidly, driven by highly effective viral marketing and email marketing services, powered by e-Dialog, GSI’s e-mail marketing division. Rue La La’s engaged membership base, with approximately 10 percent of its members visiting the site daily, and high repeat purchase rate have led to rapid growth of net revenues with estimated third quarter 2009 net revenues expected to increase almost five times from the third quarter of 2008.

 
 
1Q08
 
2Q08
 
3Q08
 
4Q08
 
1Q09
 
2Q09
 
3Q09E

Rue La La Net Revenue
(U.S. $ in millions)
 
0.3
 
2.2
 
5.8
 
12.0
 
15.6
 
23.0
 
28.0


RCI’s attractive cash flow model is driven by low customer-acquisition costs that reflect the viral marketing nature of its business and low capital intensity. RCI generates double-digit inventory turns, healthy gross margins (low- to mid-30 percent range), and since inception has spent less than $5.0 million of capital expenditures per fiscal year.

The acquisition of RCI is expected to be accretive to GSI’s non-GAAP income from operations per share beginning in fiscal year 2010. On a trailing 12 month-basis ending September 2009, RCI has achieved the following:


(U.S. $ in millions)
 

LTM ended
Sept 08


 

LTM ended
Sept 09


 
 $ VAR
 
 %
Change

Net Revenues
 
$81.1
 
$134.6
 
$53.6
 
66%

Income/(loss) from Operations
 
$(7.5)
 
$(0.5)
 
$ 6.9
 
NM


Non-GAAP Income/(loss) from Operations
 
$(4.7)(2)
 
$3.2(2)
 
$7.9
 
NM

Cash flow from operations
 
$(6.8)
 
$9.5
 
$16.3
 
NM

Free cash flow
 
$(9.5) (3)
 
$3.8(3)
 
$13.3
 
NM

GSI is expected to record approximately $2.0 million of transaction related expenses in the fourth quarter of fiscal year 2009 and approximately $2.0 million to $4.0 million of integration-related expenses in fiscal year 2010.

Description of Earn-out

The agreement includes an earn-out of up to $170 million over a three-year period beginning with fiscal year 2010 that is tied to RCI’s achievement of performance targets. The earn-out payment for each year is determined by multiplying the implied transaction multiple by the non-GAAP income from operations (NGIO) and subtracting all previous payments, up to the maximum payment for the earn-out year.
 
 
 2010
 
 2011
 
 2012

NGIO needed for target payment
 
$18.3
 
$34.4
 
$51.9

Target payment
 
$40.0
 
$55.0
 
$75.0

Implied transaction multiple
 
12.00x
 
8.00x
 
6.75x

Minimum NGIO to receive any payment
 
$15.0
 
$22.5
 
$26.7

Maximum cumulative payment
 
$40.0
 
$95.0
 
$170.0

For GAAP purposes, the earn-out received by RCI’s shareholders and employees in accordance with their pro rata ownership percentage will be treated as purchase price and the portion received by RCI’s shareholders and employees above their pro rata ownership percentage will be treated as compensation expense. However, for the purposes of calculating non-GAAP income from operations, GSI will exclude compensation expense related to the earn-out as well as integration expenses and related purchase accounting valuation adjustments.

The acquisition is expected to close within 30 days and is subject to customary closing conditions and expiration or termination of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act. Following the close of the transaction GSI will report the results of RCI in a new reporting segment that will be called Consumer Engagement.

GSI Commerce was advised on the transaction by BofA Merrill Lynch and Blank Rome LLP served as legal advisor. Retail Convergence was advised on the transaction by Cowen & Company LLC and Goulston & Storrs served as legal advisor.