Analysts Cotton to Deal for House of Fabrics : Textiles: Industry watchers say an acquisition of the Sherman Oaks-based chain by Hancock could be the best possible outcome.

If House of Fabrics Inc. agrees to be acquired by Hancock Fabrics Inc., it would bring an end to the independence of a venerable retail chain well-known throughout Southern California.

But, analysts say, such a deal could be the best possible outcome for the Sherman Oaks-based fabrics merchant, which has struggled during the past few years due to intense industry competition, a sluggish retail environment and an ill-timed expansion.

A year ago, House of Fabrics filed for Chapter 11 bankruptcy protection and has since been trying to reorganize and pay off its debts. In a little more than a year, it has slashed its number of stores from 624 to 361.

Then on Wednesday, House of Fabrics announced that it was having talks with Hancock Fabrics of Tupelo, Miss., a comparably sized but more financially stable rival, which could result in House of Fabrics being acquired.

House of Fabrics also said that it had hired the investment banking firm Houlihan, Lokey, Howard & Zukin Inc. to help evaluate its alternatives.

Although the companies stressed that negotiations are at an early stage, analysts said their combination would make sense.

“It would be a great geographic fit,” said Al Madison, an analyst at Parker / Hunter Inc., a regional brokerage firm in Pittsburgh. The majority of Hancock’s 505 stores are in the South and Midwest, while House of Fabrics has a greater concentration in the West.

By acquiring House of Fabrics, Hancock would also strengthen its position in the rapidly consolidating industry, Madison said. In the last few years, major chains have been acquired, downsized or--like House of Fabrics--entered bankruptcy proceedings. Hancock, known for fiscal conservatism, is now considered the second-leading company in the industry after Fabri-Centers of America.

In the six months that ended July 30, Hancock earned $2.14 million on sales of $171.6 million.

By contrast, House of Fabrics lost $19 million in the six months that ended July 31, while its sales plunged 35% to $145.7 million.

House of Fabrics’ first store opened in 1946 on Wilshire Boulevard. The company went public in 1965 and continued to expand profitably until the early 1990s. That’s when it gambled on an ambitious strategy to expand beyond its traditional outlets and open “superstores”--this at a time when the economy was weak and fabric retailers were launching fierce price wars.

The superstores were among the first that House of Fabrics targeted for closure. Recently, the company has abandoned heavy discounting in favor of a strategy of everyday low prices.

Analyst James Schmitt at Westcountry Financial, a Somis stock market research firm, said Hancock and House of Fabrics would be an “excellent fit.”

“Any time you can have that happen in an industry that’s overbuilt, that’s fine,” he said. Schmitt expects a deal to be embraced by House of Fabric stockholders, whose shares are currently worth just 50 cents apiece.

Indeed, after a year of bankruptcy, shareholders are anxious for the company to pursue such options, said Michael Angel, an attorney for the committee that represents House of Fabrics shareholders. However, he said, it’s too soon to tell if a deal with Hancock would pass muster with the shareholders. “The equity committee intends to ensure that the shareholders will have a voice in the outcome of the negotiations.”

Any transaction between the two companies would also have to be approved by House of Fabrics’ creditors and certain government entities. Analyst Schmitt said this presents a potential stumbling block because the company’s bank lenders and unsecured creditors would want some assurances that their bills would be paid.