NEW YORK — At least one Wall Street analyst who’s examined Federated Department Stores’ strike at R.H. Macy & Co. feels it’s a good deal for the Cincinnati-based organization as both a merger and a simple investment.
Michael Exstein, of Kidder Peabody, said the biggest plus is that it places Federated in a “unique position to influence the fate of its primary competitor.” He does caution, however, that the process has just begun and “is likely to move in unforeseen ways.”
Assuming the merger is completed, both Federated and Macy would be able to operate more efficiently in a retail climate that faces intensifying competition and slower sales growth, Exstein said in the research report.
Macy’s would benefit from Federated’s own bankruptcy experience and its operating structure.
Exstein pointed out that Federated, which emerged from bankruptcy proceedings on Feb. 4, 1992, has been able to increase its EBITDA (earnings before interest, taxes, depreciation and amortization) from 7.6 percent of sales in fiscal 1991 to an expected 10 percent in fiscal 1993.
He expects Federated to be able to bring this margin to a level comparable to the department store industry average of 11 to 13 percent without strong sales growth. Macy’s, he added, has a similar potential for improving operating margins.
Exstein said a reasonable valuation for Macy’s is $3.3 billion, assuming Macy’s records a 7 percent EBITDA as a percent of sales. Macy’s EBITDA for the trailing four months was 3.8 percent of sales, but Federated and most analysts believe that’s depressed.
A $3.3 billion valuation would result in a substantial writeoff of Macy’s outstanding debt, according to Exstein’s report.
Exstein doesn’t expect Federated to overpay because its initial move “was in the conservative fashion.”
If the merger doesn’t happen, Federated’s $109 million cash investment will still yield a lucrative return, according to Exstein’s calculations.
Exstein pointed out that the spread between the accrued interest on the security and Federated’s cost of borrowing is 6 to 7 percent. The Prudential loan pays interest at 12 percent a year and is secured by mortgages on 70 Macy stores.
Federated’s payback will depend on whether Federated is paid the full 12 percent interest and on when Macy’s emerges from bankruptcy.
Assuming Federated gets the full 12 percent, it would receive a 91.1 percent return if Macy’s emerges from Chapter 11 by January 1995. At the same interest rate, Federated would still receive a 57.5 percent return if Macy’s emerges in January 1996, and 46.3 percent if the Chapter 11 stretches on to January 1997.
Federated’s involvement now should expedite the bankruptcy process, Exstein said. Macy’s has been in bankruptcy for two years and the most optimistic emergence date is 1995. In contrast, Federated was able to work through its bankruptcy proceedings in two years.
“By simply setting the events into motion, we have little doubt that Federated stands to benefit in the future,” Exstein concludes. “The issue now is only time and magnitude.”