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The Future of Neiman’s: Maintain Luxury While Expanding Chain

The Neiman Marcus Group bidding entered its final chapter Sunday although the situation remained fluid.

NEW YORK — A deal for the acquisition of The Neiman Marcus Group appeared to have been concluded on Sunday, sources said. An announcement is expected today.

The Neiman’s board met over the weekend and sources familiar with the process said other final round bidders include Thomas H. Lee Partners with The Blackstone Group as well as the partnership of Kohlberg Kravis Roberts & Co. and Bain Capital Partners.

Spokesmen for the private equity firms either could not be reached for comment or declined comment at press time.

Final offers were submitted at noontime Friday, and speculation among financial professionals on Wall Street was that a decision could come as early as today.

Given the premium the new owner of Neiman Marcus is paying to purchase the company, expansion is a priority.

Several hedge funds and private institutional investors, who have done their own LBO 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. Neiman Marcus Group currently operates 35 Neiman’s stores and two Bergdorf Goodman units.

Meanwhile, the key question last week was how high the bidding went, with an expected price-per-share range of $110 to $113. That figure would include an estimated $500 million in cash from the sale of Neiman’s credit-card business, which financial sources believe ultimately will go to a financial buyer such as American Express or Citigroup. With about 50 million shares outstanding, the value of the credit-card business is estimated at $10 a share.

That sale would leave the core Neiman Marcus operation, which at press time was expected to fetch around $100 to $105 a share, or the previously reported price tag of $5 billion to $5.25 billion.

Nearly a month ago, the per-share bid for Neiman’s was estimated at around $100, but this was in the first round of bidding and included the credit-card business. Since then, a decision was made to sell the credit-card business separately. On Friday, sources close to the bidding said the per-share price would be at least $100, even excluding the credit-card operation.

Some fund investors on Thursday were spooked by speculation that perhaps the high-yield markets — a source of debt financing — were tightening and that bids for Neiman’s might not even go over $100. The high-yield market remains the main driver of leveraged buyouts, and if the loans in any deal have a hard time finding investors, that could crimp expectations about future LBO transactions. That scenario would leave the bankers involved in financing an LBO with huge exposure.

However, that initial concern might have been overplayed.

Financial analysts at investment firms on the buy side said Friday that, even if the high-yield market was tightening slightly, all that would mean is that the bankers will have to pay a slightly higher rate on the bond coupon. “A little bit extra won’t kill the return on the deal,” one analyst said.

Another buy-side analyst at a different fund said Neiman Marcus as a property is unique from other recent LBOs, more like the $6.6 billion transaction for Toys ‘R’ Us and less like the $11.3 billion LBO of U.S. data storage group SunGard, a technology deal with very little in assets.

Even if a retailer doesn’t have many company-owned stores, the existence of long-term leases, as with Neiman’s, represents assets that gives lenders a certain comfort factor, the analyst said.

Several buy-side analysts noted that, with Neiman Marcus, a property considered high profile and desirable, the key draw is top-line growth, which might dull the sting of paying a higher coupon rate on the debt.

Top-line growth is an important consideration in LBOs over the long haul because it impacts the rate of return on the investment. Typically, buyout firms have an exit strategy during the fifth to seventh year of an investment stake. In the case of Neiman Marcus, the challenges include how many stores would the chain need to operate and how quickly could the operation ramp up on the store count to generate sufficient top-line sales. A high rate of cash flow from sales after netting operating costs could help pay down the debt financing sooner, and therefore ultimately gain a higher rate of return on the investment.

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, there is concern in the retail and apparel industries that any new owner of Neiman’s, at that rate of store expansion, might be moving too fast just to increase its sales. They prefer a bit of caution, worrying 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.”

The high-end Neiman’s customer has an income that starts at $250,000 annually, with the average higher, typically at $500,000 to $600,000 annually. At those income levels, some say, there aren’t many locations in the U.S. that could support a Neiman’s store in its existing format.

Yet Neiman Marcus stores overseas could work because tourists are a very important part of the customer base. And the Neiman Marcus name could play very well in the major Western capitals of the world. In addition, Neiman’s could develop a different format to roll out, in the manner of Barneys New York’s Co-op stores, and could further expand its already successful e-tailing arm, neimanmarcus.com.