Looking for investor faith in True Religion

November 20, 2012, 6:41 PM UTC

FORTUNE — When a savvy entrepreneur has an idea, miraculously sells it to investors with few — if any — sales, and then spends 10 years building a brand into a success that becomes one of the most recognizable in the U.S. denim industry, it’s tough to give up control.

That’s the dilemma facing Jeffrey Lubell, the founder and chief executive of True Religion Apparel (TRLG). The company has been fielding offers for several months and announced in October it had officially set up a committee to review strategic alternatives.

It’s been a rocky process as several offers, which had been on the table, are now gone.  One remains, according to several people familiar with the situation. But it’s no slam-dunk. And some wonder if Lubell’s personal interest in retaining control of the company is an issue.  Indeed, the company’s filings indicate Lubell will receive a golden parachute of more than $25 million if there is a change of control at the company – a hefty sum for a company with a $620 million market cap and one that suitors would need to factor in to any bid.

True Religion has been on a tear since going public in 2003:  Sales are expected to top $450 million this year, a far cry from the $2.3 million posted at the end of its first year as a public company, but there have been some missteps in recent years that have slowed down growth.

It’s come a long way from the single 6,000-square foot warehouse it leased in El Segundo, Calif., in 2003 to operating 119 retail stores and outlets in the U.S. and 28 internationally at the end of the latest quarter.  In addition, True Religion also sells its apparel in department stores, such as Bloomingdales, Saks and Nordstrom, and in specialty boutique stores.

MORE: 7 major management shakeups of 2012

For Lubell, it’s not just about numbers and spreadsheets.  He’s been deeply entrenched in every aspect of the company’s strategic planning and meteoric rise, even wearing the hat of “chief merchant,” which means he oversees every fabric decision, every color choice, every double-threaded stitch design and every product line that leaves the showroom.  Holding the title of chief merchant in addition to CEO is rare in the industry, says Diana Katz, an analyst at Lazard Capital Markets.

Growing up in Brooklyn, the son of an apparel manufacturer, Lubell took a keen interest in fashion, particularly denim, early on. As a teenager, he used to embellish Levi’s with patches, slashes and even album covers from such bands as the Grateful Dead and the Allman Brothers.

His family moved to L.A. in 1976, where he worked briefly in sporting goods. When he wanted to work for his dad, his father suggested he learn about textiles first, and that’s what he did. For the next 20 years, he worked at various textile companies, sharpening his knowledge and skills with fabric and fashion design, and eventually formed his own firm, Jeffrey Lubell Textiles. He also helped build Bella Dahl,  Jefri Jeans, and Hippie Jeans, where he learned through trial and error what worked and what didn’t. After encountering disagreements with other owners, he concluded he wanted to run his own company. In November 2002, he launched Guru Denim, which was later renamed True Religion.

With little more than a vision and a dream, Lubell shopped for investors to finance his new jean company even though he had few, if any, sales or a track record to back up his pitch. But he was the ultimate salesman and networker, picking the brains of such people as fashion maven Mickey Drexler, according to people who knew him back then.  He managed to convince some big-name investors to come onboard, and they helped him take his pie-in-the-sky dream into a public company through a reverse merger with Gusana Explorations, a shell company that had been a mineral  exploration company.  “It was a public company of basically an idea,” says Ronald Bookbinder, a senior analyst at Benchmark Co.

“He was a very good salesman.”

Charles Lesser, who was brought in as the company’s first chief financial officer, was immediately impressed with Lubell’s enthusiasm and passion at their first meeting in 2003.  “He had a plan and an idea – he had a vision for the jeans, what the company was going to look like and what the stores would look like,” recalled Lesser.

Using the motto “it’s all about the fit,” Lubell created a premium denim company that combined 1970s-inspired bohemian chic with modern embellishments. Its twisted seams, large colorful stitching, and bling along with a horseshoe on the backpockets and guitar-playing Buddha logo became True Religion trademarks.  They retailed for between $250 and $300 a pop.

MORE: 2012 Businessperson of the Year

Lubell had an unusual marketing strategy. When his first shipment of  jeans to the Fred Segal boutique in L.A. only sold two pairs the first month, Lubell offered to give the sales people free jeans if they’d wear them on the floor. He was convinced that if people saw the jeans on someone, they’d buy them, and he was right. When he returned a few days later, the entire shipment was sold. Lubell used a similar strategy of offering free jeans to salespeople at Ron Herman and Barneys New York stores.

“And the company took off – they broke even on that first year of operation,” says Bookbinder. “The initial investors did very well.”

Over time, Swarovski crystals, rivets, chains and other embellishments were added, and different fabrics, ranging from corduroy to leather, were also brought into the mix.

The jeans were a hit, sales surged, and celebrities, ranging from Kate Hudson to Jennifer Lopez to Beyoncé, began sporting the jeans, which fueled sales further.

“We were in the right place at the right time with a great product and a very good business philosophy, which was to be lean and watch every penny,” says Lesser, who oversaw the company’s finances as its annual revenue grew from $2.7 million in 2003 to $160 million (and a market cap of $520 million) when he left in 2007.

“When you’re making premium jeans with 50% margins, that’s not the norm in the apparel business.”

However, the recession along with a series of missteps in recent years have derailed the company’s growth trajectory.  When skinny jeans hit the scene, Lubell dismissed it as a short-term fad and was slow to adopt the trend. He considered True Religion to be a leader, not a follower – one that set trends, not followed them. “He thought they’d trend back to bell bottoms and wider bottoms, but it never happened,” says Katz.

The delay cost the company in sales, especially on the women’s side, as customers started flocking to other premium denim companies, such as J Brand and Paige Denim, which were offering the style.

When the economy tanked, people started seeking out simple, cleaner-cut styled jeans at cheaper prices. Suddenly, True Religion faced competition from low-end retailers, such as Forever 21.

MORE: Globalism goes backward

The company has since introduced skinny jeans and even attempted a lower-priced line by hastily rolling out a simple, cleaner jean that contained a smaller, slimmer logo across the top of the backpocket – a strategy that didn’t go over well with customers.  “True Religion has the large contrasting stitching and a huge label on the back where people can tell someone is wearing True Religion a couple of blocks away,” says Bookbinder. “This product didn’t look like True Religion.” It flopped as True Religion loyalists had little interest, and new customers were turned off by the $230 pricetag when rivals were offering a similar jean for $150. “It was a fashion miss – they misread the market,” says Eric Beder, a managing director at Brean Capital LLC

The botched line has since been discounted, discontinued and sold off.

Even the company’s marketing was off the mark. At a time when the industry was trending toward colored denim, True Religion’s ads were in black and white.

And then there are the counterfeiters.  The company has faced headaches from cheap knockoffs being sold on eBay at cut-rate prices.

Then there was the company’s disastrous international expansion. Efforts to extend the brand outside the U.S. have been costly and riddled with distribution and other problems.  International sales, which accounted for as much as 30% of sales in 2005, now account for about 17%, says Bookbinder.

“They expanded a bit too much after having a great run for about a five-year period,” says Douglas Hand, a founding member of the law firm Hand Baldachin Amburgey LLP.

All of this has taken a toll on the company’s profit margins and stock:  Operating margins are currently around 17%, almost 50% lower than the 33% margins reported at its 2005 peak, according to Katz. The company fell short of analysts’ expectations in the second quarter and lowered guidance for the year.  This caused a selloff in the company’s stock: Shares tumbled as much as 47% this year to $20.22 from its high of $37.82 in February 2012. The shares were trading at $25.40 early Tuesday afternoon.

The company is taking steps to address the missteps and slowdown:  It introduced a skinny jean with a slightly lower $170 pricepoint, brought in a new designer with 28 years of experience to handle the troubled women’s line, is trying to expand its lines to include more sportswear and even yoga clothing, and hired new managers to fix the international distribution issues. The impact of the new women’s designer likely won’t be seen until the Summer and Fall of 2013, noted Katz.

And of course, the company is looking at strategic alternatives, which many industry experts believe could reignite the company’s growth.

When luxury designer Ralph Lauren, who owned more than 90% of his company, accepted a badly-needed cash infusion from Goldman Sachs back in 1994, it diluted his ownership stake. However, it also helped kickstart the company’s growth and today the brand is flourishing, said Howard Davidowitz, chairman of Davidowitz & Associates Inc., a retail consulting and investment banking services firm.

MORE: What business should do to restore competitiveness

Many believe True Religion needs to expand into other lines and accessories, such as handbags, shoes and jewelry, as well as other pricepoints. If it doesn’t, growth will stall, says Hand. “They have a very good business, and it makes money and they don’t have any debt, but the public markets are always asking, ‘What’s next?’”

To do so, new blood and new money needs to be brought in, which would happen in a takeover.

While True Religion has been wildly successful with Lubell at the helm as both CEO and chief merchant, it’s always a good idea to bring in fresh faces, says Davidowitz.

“Jeff is a great men’s designer – he knows the product, he knows denim inside out, but his business has gotten too big for him to do both men’s and women’s together,” says Beder.

However, convincing Lubell to give up the reins could be a challenge.  “It’s his company — he started it and there’s always a lot of emotion attached to something like that,” says Bookbinder.

This isn’t the first time True Religion has considered a sale. In 2006, the company shopped itself, mainly because Lubell needed to sell stock to cover his divorce settlement. Most of Lubell’s personal wealth was tied up in the company, where he held a 52% stake.  However, no deal was reached during the sale process  and Lubell wound up doing a secondary offering in 2007 to sell shares, leaving him with less than 5% of the company’s stock. “Certainly back in 2007 he wasn’t ready to relinquish control – and was probably pleasantly relieved when nothing happened,” says Lesser.

But industry experts believe interest among private equity players is likely much higher today than it was in 2006. The huge success of Michael Kors’ company, whose stock has been on fire, more than doubling since its December 2011 IPO, has generated considerable attention to upscale apparel companies, says Hand.

Also, True Religion is currently sitting on a wad of cash – about $8 a share – which makes it attractive to private equity suitors.  And despite the missteps, the company’s revenues are continuing to increase.  “We’re forecasting $461 million for this year, which is up 71% from 2008,” says Bookbinder.  However, earnings will be flat due to fashion missteps and smaller margins, he says.

Still, this chunk of cash, along with the fact the company is still making money and has no debt, means True Religion has no pressing need to sell.

Beder sees a fair selling price in the $32- to $36-a-share range.  He noted that 60% of the company’s revenue comes from men’s fashion, which has remained strong. “It’s the women’s business that has been very tough,” he says, adding that rivals, such as 7 For All Mankind (VFC), have also struggled with this sector as women have been buying more dresses and leggings rather than premium denim over the past few years.

He says the company can afford to wait and see if its strategic plan and new designers boost the women’s line next year.  “They have $8 a share in cash and a 3% dividend yield,” says Beder. “So investors would be getting a 3% yield to wait.”