Monday, August 5, 2013

Structuring the Deal: Hudson’s Bay - Saks Acquisition

Canadian based Hudson’s Bay (HBC) agreed to acquire the New York luxury retailer Saks (SKS) for $2.9B ($2.4B equity plus $500MM assumed debt) Deal. The 9X EBITDA ($16 p/s) purchase price multiple represents a 20% premium to pre bid prices, and is consistent with recent transactions. HBC is controlled by NRDC LLC, a U.S. based real estate investment firm which owns Lord & Taylor (LT) department stores. The deal is funded with $1B of new equity supplied by the Ontario Teachers Pension Plan ($500MM), Canadian private equity firm West Face Capital ($250MM) and another $250MM from the public. Also, $1.9B in senior secured loans and $400MM in unsecured notes will be raised. The combined debt will initially exceed 5.7X EBITDA before reducing to a more manageable 4X after synergies. Management will remain in NY and $100MM in synergies are expected. The transaction was positively received with HBC’s shares jumping 6% on the announcement despite the potential dilutive stock placement. This is significant as HBC had a disappointing 2012 IPO. Investors were concerned over the entry of American competitors into HBC’s Canadian market.

Leveraged retailers are always problematic  -especially for those like SKS whose turnarounds are still in progress. Some commentators have rightly questioned the wisdom of the acquisition. They view it similar to the still troubled Eddie Lampert 2004 Sears/Kmart combination Sears.  SKS is a muddled brand lagging behind luxury retailers Nordstrom, which is planning to enter Canada, and private equity owned Neiman Marcus.

Ignored, however, is that the transaction is as much a real estate play as it is retail. SKS’ real estate value is estimated at $1.8B before debt with their signature Fifth Avenue location alone worth over $800MM.  The after debt p/s value of the real estate is $6.  Combined with LT’s real estate NRBC-HBC can monetize and unlock the real estate value thru techniques like a Real Estate Investment Trust (REIT) to create substantial tax benefits. A  Sale Leaseback (SLB) could then be used to raise proceeds to quickly deleverage the transaction from its high initial 5.7X leverage level. The combined LT and SKS real estate assets could support a $3.5B+ REIT, which could then be used to reduce debt. Rents would be stepped-up, and potential conflicts between retail and REIT units will need to be sorted out.

Undoubtedly, this is a high risk transaction given its relative size to HBC. They wisely sought joint venture type equity from sophisticated deep pocket investors to offset the risk. Also, the deal is structured more like an asset based real estate transaction than a traditional strategic retail acquisition. NRDC’s experience adds a degree of comfort in this area. Of course, they still have to complete the turnaround of SKS, achieve the promised synergies and adjust to higher rents. The expected use of clever financial engineering techniques like SLB and REIT appear to have enough value potential that the market awarded HBC a significant price increase. Hopefully, they can successful execute the deal and not disappoint investors. Bottom line-this is deal worth watching.


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