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Reading the Currents: Federated-May Merger Still Seen as Possible

Although merger talks between Federated Department Stores and May Department Stores have stalled, Wall Street remains bullish on the deal.

NEW YORK — Think stalled, not broken down.

The merger dance between Federated Department Stores and rival May Department Stores still has legs, according to sources. At least two leading retail analysts have pegged May with an acquisition value of $36 to $40 a share.

Despite published reports, the analysts and sources said there has been only a pause in the talks between Federated and May, not an irrevocable breakdown. The analysts believe the likelihood of a Federated takeover of May remains high in the end given the rush to acquire that seems to have taken hold in the retail world.

And Terry Lundgren, chairman, chief executive officer and president of Federated, has plenty of options to consider if he’s hunting for a company to buy. Federated reports sales and earnings Tuesday, and the company may reveal a balance sheet healthy enough to lure a mega-investment bank (or banks) into underwriting a Federated takeover of May — or another retailer, for that matter, from Neiman Marcus Group to Saks Inc.

The mergers and acquisitions market is red hot right now. Financial sources say Lundgren might take a lunge at Neiman Marcus Group, where he once worked. Neiman’s may be in play for a secondary stock offering or a sale of one of its subsidiaries. Sources in the financial community also say Neiman’s could make a bid for Saks Fifth Avenue.

As an acquisitions target, Neiman’s is attractive, although there are some strings attached. The luxury retailer is one of America’s best-performing properties. But the retailer is already operating in most major markets with affluent demographics to support the store. The retailer could develop new formats and more specialized or smaller versions of its core stores, however.

Earnings keep going up for Neiman’s and the stock price is high, hovering recently in the $70 range. This would mean that Neiman’s would command a premium price.

But the time could be ripe for a Neiman’s takeover, since its major shareholders, the Smith family, are said to be eyeing a sale of some or all of their stake, either to a single buyer or through a secondary offering. There has been a lot of buzz recently about the Dallas-based retailer and its ceo, Burt Tansky, who reportedly has been spending a lot of time in Boston, which is where the Smith family resides.

This story first appeared in the February 16, 2005 issue of WWD.  Subscribe Today.

There are also several regional operations that Federated could pursue, such as Dillard’s, though the Dillard family reportedly does not want to sell its majority stake. Other regionals worth considering include Bon-Ton and Boscov’s.

The other, ongoing murmur is that May would be broken up with Federated, Nordstrom, and J.C. Penney snatching up its real estate, which includes mall anchors in key markets. But the scenario most viable, from Wall Street’s perspective at least, is an outright bid for May by Federated.

However, as reported in WWD last week, the stumbling point in the negotiations between the two department store retailers has been price.

Still, Wayne Hood, an analyst at Prudential Equity Group, wrote in a research note Tuesday that he believes merger talks are “fluid,” and that his firm “continues to believe May could be acquired by Federated Department Stores and places the value at $40 per share based on a 50 percent debt and 50 percent equity deal structure and $200 million in synergy savings in year one.”

Shares of May closed Tuesday at $32.10, up 24 cents. May’s 52-week low is $23.04, and its high is $36.48. The last time shares of May traded in the $36 range was on Jan. 20, when 18 million shares changed hands. Shares of Federated gained 75 cents in trading on Tuesday to close at $58. Its 52-week low is $42.80, and the high is $59.91.

Hood said while May’s board is continuing its search for a new ceo to replace Gene Kahn, that option represents the “riskier one for the board when compared with a merger with Federated.” He explained that sales and margins have slipped over the past five years, and that there’s no guarantee a new chief executive will be able to restore growth.

Hood concluded, “Importantly, we don’t believe the board can wait another five years to see improved results. On the other hand, at the ‘right price,’ we believe that the board would vote in favor of a potential acquisition by Federated, which is what we believe is best for the company, shareholders, and the industry.”

The analyst wrote that even at $40 a share for May, the retailer would still be an attractive acquisition for a number of reasons. High on the list is May’s company-owned real estate, which Hood pegs at 62 percent of the total. While there’s also potential for a new management team to improve performance and raise depressed margins, another attraction is May’s growing bridal business, which has sales of over $600 million.

May’s bridal group includes 225 tuxedo stores, which is made up of 125 Gingiss Formalwear and Gary’s Tux Shop stores; 64 Desmond’s Formalwear stores, and 25 Modern Tuxedo stores, which were purchased in December 2003. Other nameplates operated in the Bridal group include 239 David’s Bridal stores, 449 After Hours Formalwear stores and 11 Priscilla of Boston stores. Hood estimates the bridal division can evolve into a $1 billion business over time.

Meanwhile, Citigroup Global Markets analyst Deborah Weinswig concluded in her research note Tuesday that the fair value for May in both acquisition and stand-alone scenarios is $36 a share. In her note, Weinswig said, “We estimate the probability of a deal happening is more likely than not based on the following: (1) timing is right; (2) synergies abound; (3) geographic fit, and (4) leveraging best practices.”

She estimates that the probability of a deal happening stands at 50 to 60 percent. Regarding the timing, she noted that the resignation of former May chairman and ceo Gene Kahn removes a “significant roadblock” to a potential Federated-May marriage.

With a price tag of $36 to $40 per share, Weinswig breaks down the value to $28 a share for the May department stores, $1.60 a share for the bridal group. Rounding out the $36 estimate is the contribution of May’s credit card portfolio, which she valued at $6.34 a share.

On the geographic front, Weinswig said the overlap is low, with 94 malls having an at least one May and one Federated banner.

— With contributions from David Moin and Arthur Zaczkiewicz