Cherokee Stock Offering Aims at Reducing Debts : Finance: The sale follows only a year after a leveraged buyout saddled the apparel maker with much higher interest expenses.

The apparel industry has long been considered a tough way to make a buck. But the owners of Cherokee Inc., a Sunland clothing maker, have found a way to make a paper profit of more than $40 million in just one year by combining the apparel business with high finance.

Cherokee--known best for its casual women’s clothes--hopes to raise between $40 million and $48 million in a public stock offering, according to a filing that Cherokee made June 8 with the federal Securities and Exchange Commission.

Only a year ago, some investors and top managers of the company--then known as the Cherokee Group--bought the company from its shareholders in a $174-million leveraged buyout, after a bitter fight with the company’s founder, James P. Argyropoulos. The group included chief executive Robert Margolis, chief financial officer Cary D. Cooper, and apparel division president Jay L. Kester, as well as investors Jeffrey S. Deutschman and Everett M. Clayton III.

But to accomplish the deal, they had to borrow about $164 million, saddling the company with $21.1 million in interest expenses in the nine months that ended March 3, contrasted with about $20,000 in interest expenses for the Cherokee Group for the like period a year earlier, before the acquisition.

Such high fixed costs could be a problem in the fashion business, where fickle customers and the health of retailers--a problem recently--can send sales swinging.

By selling the stock, Cherokee’s present owners can reduce the company’s debt and make themselves a big paper profit on the stock they own in Cherokee, while keeping control of the apparel maker.

Here’s how it works: The public offering will consist of 4 million Class B shares expected to sell for between $10 and $12 per share, according to Cherokee’s stock registration filing with the SEC. For the purposes of calculations in its SEC filing, Cherokee assumed that the stock would sell at about the midpoint of that range, $11 per share. Because the 4 million shares would represent a little less than 40% of the company, that would give all the stock in Cherokee an apparent market value of about $111 million.

But the Class B shares being offered to the public will only have a one-tenth vote each. So the owners will retain 90% of the voting rights in the company.

And on paper, at least, the offering will give those same owners a handsome profit. Those managers and investors paid $1.06 a share (adjusted for a stock split) for their 4.9 million Class A shares in Cherokee. But after the offering, each of those shares would be worth about $11 each, giving the owners a paper profit of $9.94 per share--or a total of $48.6 million. But that is just a paper profit for now since the shares in the offering are being sold by the company, not the owners.

If the Class B shares do sell for $11 apiece, the offering will also give Cherokee net proceeds--after underwriting costs--of $39.6 million.

If the offering had been completed by March 3, the company’s total debt on that date would have been $158 million instead of $193 million, according to the company’s SEC filing.

And if the company’s debts had been that much smaller during the entire fiscal year that ended June 2, Cherokee’s cash interest payments would have been $13.4 million, instead of the actual $17.4 million the company paid, according to the filing.

The filing said Cherokee can cover its debt payments without the proceeds of the offering even if the interest rate on some of the bonds jumps in 1992 from 15.5% to 17.5%--as it could under the terms of their sale.

But there are good reasons to reduce the debt. Not only is the apparel business notoriously subject to whim and the current state of fashion, but it is also dependent upon the fortunes of retailers, some of whom have been having financial troubles recently. The last half of 1989 was a slow period in clothing sales, which led to smaller clothing orders early this year. And problems with companies like Campeau, which has two retailing subsidiaries in bankruptcy, and Macy’s, which is struggling under a huge debt load, have led to reduced orders to manufacturers.

Analysts said Cherokee may be somewhat insulated from problems in the retail industry because it sells mostly to companies whose finances are secure, like Mervyn’s, which is a division of the Dayton Hudson chain.

Cherokee’s is “a pretty nice roster of clients to have,” said Andrew Regan, a retail analyst for Donaldson Lufkin & Jenrette in New York.

“I think Bobby Margolis sleeps better at night having invoices at Mervyn’s,” said Alan Millstein, publisher of the Fashion Network Report, a trade publication in New York.

And Cherokee has been thriving recently. The company’s sales for the nine months that ended March 3 were up 27%, to $152 million from $120 million a year earlier. After interest costs, however, the company lost $398,000 during the latest nine-month period, contrasted with a profit of $5.61 million for the Cherokee Group a year before, prior to the acquisition.

In the last year, while closing its own company-owned retail stores, Cherokee persuaded 641 of the about 11,000 stores that sell its clothes to set up special Cherokee brand sections. Among the stores that have set up such sections are some in the Mervyn’s chain, which overall accounted for 18.5% of Cherokee’s sales in the nine months that ended March 3.

“They’ve just been on the mark in styling,” said Angela Uttaro, who follows Cherokee for the bond-research firm Standard & Poor’s Corp. in New York.

Cherokee was founded as a shoe company by Argyropoulos in 1973. But after Margolis engineered an expansion into clothing, the company’s sales grew from $34 million in 1980 to $169 million in 1989. That’s when Margolis, Cooper, Kester and the Deutschman Clayton & Co. investment group launched their takeover bid for the company. Argyropoulos opposed them, but failed to block the deal in court and resigned.

Given recent problems in the retail industry, Cherokee could find less enthusiasm for its stock than if the industry were strong now. Uttaro said recent stock offerings from other apparel makers have received lukewarm responses from Wall Street. Investors could also be discouraged by the limited voting power of the stock that Cherokee wants to sell.

But Millstein said enough investors could be attracted by Cherokee’s growth to buy up the fairly small amount of stock in the offering. “They have shown an enormous ability to finesse all opposition in the area of finances,” Millstein said of Cherokee’s owners. “They’ve proven that they are brilliant pirouetters when it comes to finance.”