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Growing Neiman Marcus: New Owner May Be Near And Expansion a Priority

With Neiman Marcus Group drawing bids in the $100-a-share range, new owners will need to expand in order to profit off the investment.

NEW YORK — Expend, then expand.

With Neiman Marcus Group expected to be sold as early as next month for a minimum of $100 a share, or in the $5 billion range, concerns are mounting over what it will all mean for the luxury chain’s future and its ongoing expansion.

At the moment, it appears the bidding action has boiled down to two front-runners — Kohlberg, Kravis Roberts & Co. teaming with Bain Capital Partners, and Thomas H. Lee with The Blackstone Group. Other private equity firms apparently have taken a pass. According to a source close to one of them: “Final bids are due no later than April 29. Most likely there will be a decision by the second week of May.”

But whoever buys Neiman’s will be under enormous pressure to maintain and build on the significant growth the retailer has seen over the last few years. Higher revenues and earnings will be required to support the huge investment, and for a financial buyer seeking to flip the business for a profit, that means an accelerated expansion is practically a certainty.

Industry experts say Neiman’s could tap many more locations in the U.S., and begin opening stores overseas.

“Neiman Marcus is the sleeping giant of luxury,” said Steve Greenberg, president of the Greenberg Group retail real estate advisers. “They’re in so many markets, like Boston, where they have one store downtown and never went to the suburbs. In Chicago, there’s Neiman’s downtown and one in Northbrook. That’s not a lot of stores for one of the biggest markets in America. There are 25 major markets in America, and Neiman’s only has 35 stores.

“I don’t think we need one in Pittsburgh, but you can have second stores in a lot of major markets,” he continued. “And why can’t there be a small Neiman’s in La Jolla or Santa Barbara [Calif.] — smaller markets that are very, very affluent? Neiman’s already seems to be picking off some of the smaller markets, particularly in Texas where the brand is so strong.”

Speculation on expanding Neiman’s heated up this month when an executive from Vornado Realty, at one time said to be among the firms that could invest in the retailer, estimated at a recent investor luncheon that the chain could double its store count. Several hedge funds, who have done their own leveraged buyout models on Neiman’s, said the brand could support up to 60 or 70 stores, as reported. Based on their LBO models, doubling the store base would peg Neiman’s earnings before interest, taxes, depreciation and amortization at $1 billion, against the expected $500 million based on existing operations. For fiscal year 2004, total revenues were $3.55 billion compared with $3.1 billion in the prior year. Net earnings were $205 million, compared with $109 million for fiscal year 2003, which represents an increase of 87 percent.

However, others warn that any new owner of Neiman’s has to be cautious about expanding the retailer too fast just to increase its sales. They worry that, under a financial owner, Neiman’s, one of the best-run and focused retailers in the world, could become just another “numbers game” with an expansion program that waters down its message of exclusivity and enters markets lacking the proper “psychographics.”

“There could be a very big difference between what Burt Tansky [president and chief executive officer of Neiman Marcus Group] and friends have been doing and what a financial group would want to do with Neiman’s,” said Arie Kopelman, vice chairman of Chanel Inc. “They would want to get the numbers up in the medium term and sell the company, and that puts a lot of pressure on growing the business. Hopefully, they would try to do it intelligently, but in growing the business, you have to be very careful not to dilute what the company stands for. That could be tempting when you broaden the base and go into new markets.”

With the price tag on Neiman’s expected to top $5 billion, “any group making that kind of investment will obviously want to see a bigger return, which is already a good one,” said a former luxury retailer. “Certain financial people are talking about opening 30 more Neiman’s. That would be the beginning of the end of a quality retailer. In a merchandising business, there’s a great deal of expertise, details and knowledge about sizes, colors and styles required. Bankers never know that. Maintaining steady growth, good gross margins and a reasonable expense rate is a pretty good trick. To pump up the volume to justify the price is not the way to go.”

Marvin Traub, the former Bloomingdale’s chairman and a consultant working on expanding brands and retailers overseas, believes: “In the United States and Canada, there continues to be some emerging markets that Neiman’s can go in. They haven’t saturated the country.”

Traub said he sees another 10 or 15 full-sized Neiman’s. Beyond that, “you would have to build smaller stores, not something that’s 200,000 square feet.”

As for international markets, Traub said: “Trying to expand department stores overseas is very, very complicated. It would be best by licensing, the kind of thing that Saks is doing.” (Saks Fifth Avenue already opened stores in Riyadh, Saudi Arabia, and Dubai, United Arab Emirates.)

Still, “licensing is not hugely lucrative,” Traub added. “It’s difficult to make a major difference in earnings per share. The bigger advantage is the international exposure it provides.”

Neiman’s operating overseas is not far-fetched. It’s a well-known, world-class brand, and past managements of the retailer have examined foreign cities for possible Neiman’s and Bergdorf Goodman units. Asia, said retail sources, seems more likely for Neiman’s than Europe. One reason is that Taubman Centers is forming Taubman Asia to develop shopping centers in the Asia-Pacific region. Five of the 22 Taubman regional centers in the U.S. house Neiman’s units, and three have Neiman’s outlets, known as Last Call.

“To think about doubling the business in three to four years, it becomes a different game and a more fragile one,” said one Neiman’s supplier. The success of a big expansion depends on a lot of variables, including “the vagaries of taste, the health of the economy and the market penetration of other luxury goods  stores. There are just so many variables. It’s not a slam dunk. Vendors tend to take it one market, one door at a time. It’s not automatic that they go into each market.”

Bill Dreher, senior research analyst, broadlines, at Deutsche Bank Securities Inc., observed, “Neiman Marcus stores overseas could work. Tourists are a very important part of the customer base. The name is a world-class brand among the jet-setting community, and Neiman would play very well in the major Western capitals of the world.”

As far as doubling the store base, “we have a very difficult time imagining that,” Dreher continued. “Their very high-end customer has an income that starts at $250,000 annually. The average is higher, typically at $500,000 to $600,000 annually. Because those annual income levels are only in isolated pockets of the country.”

Dreher said Neiman’s Internet is one avenue where the company can reach consumers who are not near a store, but 10 new stores a year, as some financial players may be considering in their projections, is too optimistic. “We would not expect Neiman’s to grow [its square footage] to above 5 percent a year without jeopardizing its profitability. Even new formats, such as Saks and its smaller resort store, don’t always work. You have to weigh how much would one’s ability be to significantly improve sales and earnings.” The profitability, he noted, resides in the larger boxes.

To date, Neiman’s expansion has been disciplined and successful. Under Tansky’s management, about a store or two has been opening annually. Seven stores are planned through 2008 in San Antonio, and Boca Raton, Fla., this fall; Charlotte, N.C., in fall 2006; Austin, Tex., and Oyster Bay, N.Y., in spring ’07; Natick, Mass., in fall ’07, and Topanga in West Los Angeles in fall ’08.

Neiman’s is also expanding by increasing square footage at high-volume locations. For example, the 153,722-square-foot store in Lenox Square in Atlanta is getting a 52,000-square-foot addition, while units in North Park in Dallas and San Francisco also are being enlarged.

Whatever the strategy under a new owner, the focus should be on keeping Neiman’s special, Greenberg observed. “Neiman’s has these great touches that make the customers feel very special. It starts with the popover and the broth at lunch and goes all the way down to the way they sell. Their salespeople are so gentlemanly and helpful, and they dress so well. They write you a note after you buy something. They call you. They service the customer. Neiman’s pays to get the best help. It’s the tradition of Stanley Marcus.

“But if these banker types don’t leave the management alone and say, ‘We’ve got to look at the bottom line,’ I would be concerned that they forget about providing the service for the customer. I’ve seen a lot of venture capital companies buy retail companies and destroy them along the way.”