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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
Yeah, there’s a lot of bad ‘isms’ floatin’ around this world, but one of the worst is commercialism. Make a buck, make a buck. Even in Brooklyn it’s the same — don’t care what Christmas stands for, just make a buck, make a buck.
— Alfred the janitor, Miracle on 34th Street
Shareholders of Macy’s — whose flagship store provides the setting for the classic 1947 Christmas film — could make a few bucks in an LBO. But for creditors and customers, the history of leveraged retailer buyouts has been . . . mixed at best.
The department store received a $5.8bn leveraged buyout offer earlier this month, the WSJ reported. Macy’s stock gained 19 per cent Monday on news of the $21-per-share offer from Brigade Capital Management and Arkhouse Management.
The rally indicated that investors find the buyers’ interest convincing, and shares closed at $20.77 per share, only slightly lower than the reported offer price. (One caveat for would-be merger arb traders: Brigade and Arkhouse reportedly floated the possibility of raising their offer price after due diligence, so some probability of that should be reflected in Macy’s stock as well.)
Macy’s has travelled a rough road for nine years or so, to put it gently, as department stores got shouldered out of shoppers’ budgets by Amazon and fast-fashion giants. In that time it has also fielded an activist campaign from Starboard Value and a takeover approach from Hudson’s Bay, neither of which were successful.
One could argue that classic retailers are due for a comeback today, because of 1) trendsetters’ fatigue with cheap stuff 2) the renaissance of thrifting and Y2K fashion and 3) regulator concerns about fast-fashion brands. We’ll see what happens when Shein floats.
Monday’s stock-market price action seemed hopeful about that idea, with department stores Kohl’s and Nordstrom posting gains of more than 7 per cent in the absence of other news. Even Etsy got a piece of the action, up 5.8 per cent.
Still, management hasn’t responded publicly to the Dec 1 offer. And it isn’t clear what exactly the investors want to do with the company post-buyout. The interest of Arkhouse, a private investor best known for real estate, brings to mind Starboard’s 2015 suggestion that Macy’s spin out its real estate holdings or even do a sale-leaseback transaction for its flagship store.
Could Macy’s experience a leveraged-turnaround miracle without 34th Street? [ed: ughhhhh.] While 2015 was a very different time for CRE markets, department stores do have the benefit of not being office buildings. Mall real estate has already gone through its apocalyptic market meltdown.
UBS analyst Jay Sole is sceptical of the real estate story, however. He argues that a $21-per-share price overvalues Macy’s properties. And even if brick-and-mortar retail has already seen its meltdown, broader CRE markets aren’t especially attractive after two years of steep Fed rate increases:
We’re surprised a real estate focused investor would be interested in buying M given we haven’t believed the NPV of M’s real estate is worth $21/sh., especially given today’s high interest rates. We also believe M is worth less than $21/sh. due to ongoing share loss to off-price retailers and other competitors. However, what matters is the investor group sees value in M and/or its real estate. This likely boosts market sentiment around [softline retail] stocks. Plus, if the investor group’s intent is to create value by selling M’s real estate, it likely means major market share will become available to M’s competitors, such as TJX, KSS, and JWN.
Still, Macy’s current creditors might not mind a deal. About 80 per cent of the retailer’s outstanding bonds have change-of-control provisions, according to CreditSights. (That’s all of the bonds issued after 2005.) If we make the fairly big assumption that the private buyers won’t play hardball with creditors, that would mean they get bought out at 101.
And the maths do work out, CreditSights’ retail analysts write, partly because Macys’ leverage of 2.3x ebitda (including leases).
Problem is, the maths looked workable for prior department-store LBOs as well:
Owing to relatively low starting leverage, the theoretical/on-paper math for a LBO works for M, as it does for many of its peers. The real-life experience of LBOs in the department store space has been much less fruitful, with post-LBO Neiman and Belk landing in Chapter 11, while other outside-influenced department stores have also met the same fate. Deals like a bid for Kohl’s as well as the Nordstrom family’s attempted MBO/LBO have ultimately failed to get off the ground on the realities of high funding costs . . .
With rising debt financing costs, average equity contributions to LBOs have also been on the rise — reportedly eclipsing the 50% mark, on average. In this exercise, we model a 40% equity check from sponsors, but show post-transaction metrics . . . in a range of 30-50% sponsor equity. At these levels, and assuming a blended 9.5% borrowing rate on secured/unsecured transaction funding, we show M being able to modestly sustain positive FCF ($526mn) based on FY24e Ebitda expectations and recently forecasted capex spending . . . [with] some cushion for either poor execution or further weakening of macro conditions.
And about that real estate:
It seems possible that a near-simultaneous deal could be structured to monetize all or some of the company’s sizeable and unencumbered real estate holdings, which might reduce the size of the required equity check — but at the same time, weigh on M’s Ebitda generation ability, assuming a leaseback of the properties. If not, the real estate would likely form the basis of primary security for deal financing.
Maybe it’ll work!? And in the spirit of the season, we will leave readers with the words of fictional Macy’s employee Mr Shellhammer:
. . . maybe [they’re] only a little crazy, like painters or composers or . . . or some of those men in Washington.
