LBO Scenario Returns To Retail With Neiman’s Seen as First Candidate
As speculation continues over who will bid for Neiman's — with names ranging from Apollo to Texas Pacific Group — one hedge fund manager said a Neiman’s deal has the potential to be an LBO under which the financial structure would be...
NEW YORK — Leveraged buyouts could be back in vogue — with The Neiman Marcus Group the first in the latest fashion.
As speculation continues over who will bid for Neiman’s — with names ranging from Apollo to Texas Pacific Group — one hedge fund manager said a Neiman’s deal has the potential to be an LBO under which the financial structure would be $2 billion of equity and $3 billion of debt.
The fund manager said it would result in a 60 percent debt-to-capital ratio, which is considered “fairly conservative” when most LBOs have an average debt-to-capital ratio of 70 percent. In addition, a private equity buyer would still be able to pay down the debt within a decent time frame because a substantial portion of Neiman’s cash flow, which is about $450 million, would be available to do so.
Neiman’s is expected to name a buyer some time this month, financial sources said.
But there could be another wrinkle in the chase for Neiman’s. Real estate investment trusts that have Neiman’s stores in their mall portfolios, Simon Property Group and General Growth Properties, are said to be exploring the idea of joining forces with a private equity group so they can gain control over the value of the real estate, as well as possibly where Neiman’s might expand its store locations, according to financial and real estate sources. Several hedge fund managers said they think the Neiman Marcus business can support up to 70 stores. Neither executives at Simon nor General Growth could be reached for comment.
Neiman’s isn’t the only potential retail LBO on the horizon, though. J.C. Penney & Co. recently was said to be the target of an LBO led by Cerberus Capital Management and involving other financial partners, including the Carlyle Group. With J.C. Penney as a target and Cerberus as an LBO sponsor, a deal involving a consortium is possible, but it would take some work. And Cerberus would first have to line up some financing. One financial source said Cerberus had approached J.P. Morgan to underwrite a deal, but was turned down. The private equity firm is now said to be knocking on other financial doors to see if there’s any interest in the underwriting.Cerberus could not be reached for comment Wednesday. J.C. Penney said it does not comment on market rumors, and Carlyle said it had no comment regarding J.C. Penney.
As for other retailers making the “for sale” rounds, the names include the department store division of Saks Inc. and, most recently, Gottschalks.
Louis J. Bevilacqua, partner at the law firm Cadwalader, Wickersham & Taft, where he is chairman of the firm’s corporate/mergers and acquisitions department, noted that Saks Inc. will probably have a hard time selling its Saks Fifth Avenue division due to the risks involved concerning the potential liability arising from a Securities and Exchange Commission probe.
Saks disclosed last month that it is conducting an internal investigation involving “improper collections of vendor markdown allowances” and said it would pay back, or otherwise compensate, unnamed resources in an amount of up to $21.5 million. In addition it will restate earnings from fiscal 1999 to the third quarter of fiscal 2004 as a result of the repayments and accounting errors on leased departments.
One hedge fund, the Blackstone Group, has said it is not looking at either Saks Fifth Avenue or the Saks Department Store Group.
Meanwhile, there are plenty of other retailers that could get snapped up via a leveraged buyout, sources speculated. With $120 billion on the sidelines, which is tempered by a need to invest it cautiously, the tempo of LBOs may pick up as private equity players switch from targeting distressed companies to eyeing more pricy deals in a landscape scarce with suitable firms to acquire.
When a target company is found, everyone seems to want a piece of the action, which has resulted in a growing number of consortia prowling for deals. This is a departure from prior LBOs, when most of the deals involved just one or two buyers.
But why the sudden interest in retail?
“If you want to know why retail is the flavor of the month, look to Edward Lampert,” said Howard Davidowitz, chairman of Davidowitz & Associates Inc., a national retail consulting and investment banking firm. “The funds all see what he did with Kmart. It’s the herd mentality. That’s what they did a few years ago in the technology sector. Now [the intense focus is on] retail.”Lampert took Kmart Corp. out of bankruptcy two years ago and recently engineered its merger with Sears, Roebuck & Co. to form Sears Holdings.
An LBO is an acquisition where a large portion of the purchase price is borrowed against assets of the company being acquired. What makes LBOs an attractive option for a partnership or consortium of investors is that the participants are able to reduce the risks of their investment stake because it is shared between the consortia.
For the boards of a targeted company, an LBO is also a way to get out of the public market. That public status an be costly, due to the burdens of the Sarbanes-Oxley legislation requiring financial and accounting disclosure.
And although LBOs tend to result in a higher price tag for a deal, it’s better for the equity firms to pay a premium than sit on their cash, which seems to be growing daily. For instance, global private equity firm the Carlyle Group said on March 29 that it raised $10 billion of equity capital to fund new buyout investments in the U.S. and Europe. Investments in the U.S. will be funded through Carlyle Partners IV, which has $7.85 billion of commitments.
“Unfortunately, we were unable to accept all of the capital commitments made by our investors. We accepted a level of capital that we could prudently invest over the next five years,” said David M. Rubenstein, cofounder and managing director of Carlyle, in a statement.
As for why LBOs are the acquisition strategy du jour, Bevilacqua observed: “There’s a ton of money that needs to be put to use. The [private equity] funds are looking to buy in the most efficient way and an LBO transaction [fits that requirement].”
He said the increased mergers and acquisitions activity is a sign the economy is getting better. The same factors that lead to the general upside of the market cycle also point toward favorable exit strategies, particularly the initial public offering as the one favored following an LBO, the attorney said.
“Sarbanes-Oxley imposes substantial burdens on management and their boards. It can be a very expensive and somewhat invasive process. One can argue whether the benefit is worth the cost. At some point the answer is no. If it costs $15 million just to comply with Sarbanes, that’s a large cost of shareholder value. You’ll see more LBOs of some form as companies elect not to stay public,” the M&A expert predicted.In a classic LBO, such as the 1999 transaction involving St. John Knits International, capital is borrowed to take the firm private. Buyers, because they use debt to fund their purchases, expect the company’s operating cash flow to service that debt. Typically, the debt consists of the assets of the targeted firm, which generally is pledged as collateral for the borrowed funds.
Successful fashion LBOs in the past include Donnkenny, Chorus Line and Norton McNaughton. Norton McNaughton became McNaughton Apparel Group after it bought the Jeri-Jo and Miss Erica labels. McNaughton went public in 1994, and was acquired by Jones Apparel Group in 2001.
A more recent example is the 1998 LBO of Aerospostale by Bear Stearns Merchant Banking Group, which it successfully took public in May 2002.
Of course there’s no guarantee an LBO will result in an IPO five years down the road. Some unsuccessful LBOs — all done in 1986 — have left investors awash in red ink.
In that year, Edward Finkelstein, chairman of R.H. Macy & Co., the fifth-largest department store chain at the time, took the company private through an LBO valued at $3.6 billion; Ronald Perelman completed a $1.8 billion acquisition of Revlon via an LBO, and Linda Wachner, former chairman of Warnaco Group, completed her hostile LBO of that firm.
R.H. Macy eventually filed for bankruptcy, and was subsequently acquired by Federated Department Stores, itself a victim of a bungled LBO by Canadian real estate mogul Robert Campeau. Revlon went public in March 1996, after one failed attempt in 1992. Since the LBO, the company generally reported losses, even back in 1992. In the case of Warnaco, the company went public in 1991, but then, after a series of acquisitions, ran into cash-flow problems that eventually led it to file for bankruptcy. It exited bankruptcy proceedings in January 2004, and is now known as Warnaco Inc.
Even with today’s economic environment seemingly improving, the risks involved with an LBO are still present.
“As the economy continues to improve, more and more investments will get done. The really good deals will get done in the early stages. At the end [of the LBO cycle] is when you’ll see people buying stuff of no quality and overpaying for marginal properties,” Bevilacqua said.But with a lot of money chasing the same deals and driving prices up, the stakes could get stratospheric.
“What it really depends on is what happens in the next several years. In highly leveraged transactions, if the economy stays strong and interest rates stay low, it should be fine. If we have a hiccup, along with the high leverage, you might see some restructuring and bankruptcies,” Bevilacqua noted.
Davidowitz was more pessimistic about the future. He cautioned: “Who is celebrating all these consolidations? Wal-Mart, Target, Home Depot and Lowes. All the retailers who keep their eye on the ball focused on the customer and intelligently building their businesses. They’re dancing in the streets.
“If you’re Target and you see what Sears and Kmart are doing, you’re just laughing,” Davidowitz said. “How do you integrate your computer systems? Which buyers are going to buy what? The problem with the LBO is that the leverage takes away your flexibility.”
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