House of Fabrics in Initial Acquisition Talks : Retailing: A deal with rival Hancock Fabrics would be part of company’s Chapter 11 reorganization plan.

House of Fabrics Inc., a struggling fabric retailer that has been in Chapter 11 bankruptcy proceedings for a year, said Wednesday that it is discussing being acquired by one of its chief rivals.

The Sherman Oaks-based company said it is holding “preliminary discussions” with Hancock Fabrics Inc. of Tupelo, Miss., a slightly smaller but more financially stable fabric retailer and wholesaler.

Any transaction would have to be part of House of Fabrics’ bankruptcy reorganization plan and would require approval by creditors and certain government entities, the firms said. In the meantime, House of Fabrics said it has hired the investment banking firm of Houlihan, Lokey, Howard & Zukin Inc. to help it evaluate its “strategic alternatives,” including a possible deal with Hancock Fabrics.

House of Fabrics has been hurt by intense competition in the fabric retailing business and a long period of sluggishness in the Southern California economy. The company has already slashed its number of stores from 624 in mid-1994 to 361 currently.

In its fiscal year ended Jan. 31, House of Fabrics lost $9.07 million on sales of $416.3 million.

Despite the heavy discounting that has plagued fabric retailers, however, Hancock Fabrics has posted respectable results. In its latest fiscal year, the company earned $10.1 million on $366.8 million in sales.

With 505 stores in 33 states, Hancock stands to benefit from an industrywide consolidation, analysts say. The company also supplies nearly 200 independent wholesale customers.