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Breaking Up Saks Inc.: Bon-Ton Buys Division But No SFA Sale Near

After weeks and weeks of wrangling over price, Saks Inc. agreed to sell its northern department store group to Bon-Ton Stores Inc.

NEW YORK — A deal is finally done.

After weeks and weeks of wrangling over price, Saks Inc. agreed to sell its northern department store group to Bon-Ton Stores Inc. for $1.1 billion in cash, plus about $85 million in liabilities, leaving only the $30 million Club Libby Lu tween specialty chain still on Saks’ official “for sale” list.

While speculation continues that Saks might also sell its $2.7 billion Saks Fifth Avenue Enterprises, it’s believed management, for now, wants to focus on trying to turn around the luxury business after a particularly difficult 2005, and that it would not seriously explore a sale until next year at the earliest.

“I don’t ever comment on hypothetical transactions. That is my policy,” said R. Brad Martin, chairman and chief executive officer of Saks Inc., in an interview Monday.

Robert Buchanan, analyst with A.G. Edwards & Sons Inc., said in a research report that there is a “remote possibility that Brad Martin and the rest of the Saks board would eventually opt to sell the remainder of Saks [SFA, Off 5th outlets and Parisian]. In that event, the possibility of which we put at less than 20 percent, SKS common could perhaps rise above the current stock price, but again, we doubt that such a deal gets consummated, with SKS management having given no strong indication that it intends to sell the remainder of the business.”

“If lackluster operating results continue at SFAE, we believe the division may be put up for sale in 2006,” said Deborah Weinswig, broadlines retail analyst at Smith Barney, in a research note.

According to a research note from Todd Slater at Lazard Capital Markets: “We believe that the sale of SKS’ southern and northern department store assets will presage movement on its remaining two largest assets, Parisian and Saks Fifth Avenue. Although Saks has not officially marketed these chains, both business are, in our opinion, positioned to sell quickly once returns on investments begin paying off.”

Slater wrote in his note that Saks Inc. stock could be worth around $25 a share, with margin improvement. On news of the deal Monday of the sale of the northern group, Saks’ stock leaped 9 percent, or $1.49, to $18.45, while Bon-Ton soared 20 percent, or $3.39, to $20.05.

With the addition of the 142-unit, $2.2 billion northern group, Bon-Ton will emerge as the nation’s second-largest regional department store retailer, with 280 stores and $3.5 billion in annual sales. Dillard’s remains the largest, with more than $6 billion in sales.

The northern group includes 31 Carson Pirie Scott stores, accounting for about one-third of the group’s volume, as well as 14 Bergner’s stores, 10 Boston Stores, 40 Herberger’s and 47 Younkers. The stores are located in 12 Midwest states.

“This gives Bon-Ton a platform for growth,” said Byron “Bud” Bergren, president and ceo of the York, Pa.-based Bon-Ton chain, in a conference call. “It’s a great fit for Bon-Ton. The customer base, merchandise assortment, store size and target locations are all similar. Like our Elder-Beerman acquisition in 2003, there is very little geographic overlap.”

He added that, by 2008, Bon-Ton will achieve expense reductions of $33 million, through consolidations with the Saks northern group, which is based in Milwaukee.

The past year’s flurry of department store transactions — Neiman Marcus Group got sold to Texas Pacific Group and Warburg Pincus, May Department Stores was taken over by Federated Department Stores and the Saks Inc. southern group was sold to Belk — all went for one or more times annual sales. Based on that, Bon-Ton got a good deal, paying roughly half the volume of the northern group.

“It’s a fair transaction for both parties, one I believe is in the interest of the shareholders,” Martin said. The northern group is a “terrific business with a strong cash flow and solid real estate.”

Still, the disposition of the northern group, as well as the southern department store groups (which Belk bought for $623 million in July) marks the unraveling of Martin’s strategy launched in the Nineties to combine moderate middle-market regional chains, along with the upscale Saks Fifth Avenue, under the Saks Inc. umbrella and to try to attain synergies.

Though many analysts have questioned the strategy, Martin defended it on Monday. Asked if he was now second-guessing it, he replied: “Absolutely not. None of these businesses would have survived. We created opportunities for shareholders and employees. Clearly, we benefited from the consolidating nature of the industry. We acquired these companies and made them better over time.”

During Martin’s buying spree, Saks Inc. picked up Proffitt’s, Younkers, Herberger’s, Carson Pirie Scott, The Boston Store and Bergner’s.

Asked what Saks Inc. would do with the proceeds from the northern group sale, Martin said since Saks’ remaining assets have good cash flow and are not very highly leveraged, “we believe the bulk of the cash will be returned to shareholders,” possibly through share re-purchases, a special cash dividend or a combination of the two.

As far as investing more in SFA, Martin said: “The physical locations are in terrific shape. We have already invested hundreds of millions into that store base and expect Saks Fifth Avenue to be a cash-generating business going forward. The flagship is running strong increases and we will continuously invest capital there.”

Asked if there was a time frame for turning around the Saks Fifth Avenue business, Martin replied that, after a tough 2001, 2002 was a “decent” year, 2003 saw solid increases and 2004 saw solid increases over 2003. “There was a lot of progress until we got to 2005, which is disappointing. It’s going to get fixed. I expect continued improvement going forward.”

He did not give a timetable for the turnaround, though other Saks management have said it’s at least a three-year process and that the company is currently about 18 months into it.

Martin spoke very highly about the $700 million Parisian division. “We continue to make great progress. We are very excited about the future of that business.”

Bergren said integrations of the northern group into Bon-Ton would start in the spring of 2006, after the closing of the deal, which is expected early in the first quarter of next year. Financing details will be disclosed around the time of the closing. Bank of America is expected to be a major lender.

“Retail is a mature and highly competitive business. This will provide us with an ability to grow quickly and leverage our buying power,” Bergren said in an interview. “It’s hard to imagine another acquisition with more compelling similarities and benefits from day one.” He said it was too early to provide any details on staff changes.

On top of the expected cost savings through consolidations, the company expects to realize sales and gross margin opportunities. Bon-Ton will utilize Saks Inc.’s back-office transition services, revolving around information systems, finance, credit and distribution, at least initially, and will determine later whether to use Bon-Ton, Saks Inc. or another third party in the future for those services.

Bergren said there are no plans to close any stores or distribution centers and the stores in the northern group will retain their names.

Asked if the company could be eyeing other regional acquisitions, Bergren said: “There are others out there, but there is no one else we are looking at. We have a history of always growing through acquisitions. It’s a cheaper way to expand,” as compared with building stores. This [the northern group] is sizeable enough to keep us busy for a few years.”

One key project might be to renovate the Carson Pirie Scott flagship on State Street in Chicago, which has long been overshadowed by the Marshall Field’s flagship next door. “That’s one of things we have to consider.” He noted that the Carson’s flagship in Milwaukee was recently remodeled.

“Except for one or two stores, we are very excited about their appearance and the condition Saks has kept them in.”

While Bon-Ton units average 100,000 square feet, Carson’s vary quite a bit, but have an average footprint of about 120,000 square feet. Carson’s merchandising and marketing offices in Milwaukee will be maintained, Bergren said. He also said the company will cease buying private label merchandise from Federated Department Stores after summer deliveries next year, and will incorporate the Saks northern group’s private label program. Carson’s has a 16 to 17 percent penetration of private label, while Bon-Ton is around 14 or 15 percent. Bon-Ton sees Saks Inc.’s private labels starting to hit its stores in the fall of 2006.

Overall, the northern group tends to offer more updated merchandise and more items targeting ethnic audiences, while Bon-Ton tends to be more traditional. The northern group also has a trendier, upscale cosmetics offering, with such brands as Bobbi Brown, MAC and Origins, while Bon-Ton depends more on brands such as Estée Lauder and Clinique.

Saks estimates a pretax book gain ranging from $290 million to $310 million and an aftertax book gain ranging from $120 million to $130 million on the transaction. The company also estimates that the cash taxes on the gain will be approximately $75 million to $90 million.

— With contributions from Vicki M. Young and Meredith Derby