By and  on July 19, 2007

Private equity firm Kohlberg Kravis & Roberts wants to close on a deal for Macy's Inc., but turmoil in the debt financing markets might get in the way.

KKR is looking to acquire the retailer at $52 a share. Disclosure of the offer in WWD triggered a 7.6 percent surge in Macy's stock price on Wednesday. The volume of trading also jumped.

Sources said KKR met with Macy's Inc.'s chief executive officer, Terry Lundgren, about a month and a half ago regarding its interest. KKR is said to be looking to buy the department store chain for $24 billion.

Shares of Macy's, formerly known as Federated Department Stores Inc., soared 13.7 percent to $45.50 during morning trading on the New York Stock Exchange. Trading volume rose to more than 20 million shares in the morning. The stock pulled back to $43, up 7.5 percent, at noon. At the bell, shares gained 7.6 percent to $43.09 and trading volume was 38 million, compared with a three-month average volume of 7 million. Macy's market capitalization gained $1.4 billion to $19.8 billion.

The $43.09 close represents a 20.8 percent premium on the $52 offer price, which compares with the 30 percent premium to Tuesday's close of $40.03.

Neither KKR, Macy's nor Goldman Sachs issued any statements on Wednesday.

Sources said KKR was looking to do a deal with Goldman Sachs through its Principal Investment Area, the investment firm's private equity arm, and that the Goldman Sachs real estate group also was working on the deal. However, it was learned Wednesday that the real estate arm is not involved in any of the negotiations, although it may have some advisory role, as the plan is to bring the group in once a deal is completed to work on the disposition of Macy's real estate assets.

Sources last week and this week said KKR had hoped to do a deal sooner rather than later, but there's now a question of timing as the debt financing markets are in turmoil. There were rumblings early last week that the debt market might make it tougher to complete some deals, partly because of the lingering effects of the subprime mortgage debacle. This week's problem was due to Bear Stearns' comment that two of its hedge funds had "little value," sources said."It doesn't necessarily derail a deal, but it does make you go through the models and double check on price and make sure the numbers work," said one source.

"This couldn't be a worse time to try to get a deal done," said another source, referring to the financing markets.

Another source said the index for the credit default swaps had a big bear move up in just the last two days. He explained the problem this way: "If someone had a deal in mind and debt that they wanted to price, they would have found out Wednesday morning that the numbers they had in mind don't work anymore and the deal can't be done. The higher spread over treasuries would force them to now issue the debt at a higher rate, which means it would cost more to finance the deal."

There was also talk of KKR looking instead at the commercial mortgage-backed securities market, but sources Wednesday said that market also was showing signs of stress. And another financial source said that, if the mortgage markets were showing signs of stress, then that could have other ripple effects on the financing markets.

Wall Street analysts' reactions were mixed. A.G. Edwards analyst Robert Buchanan said he would not be surprised if a transaction took place.

"I think it's certainly a possibility," Buchanan said. "Macy's has a lot of things private equity looks for — established cash flow and substantial ownership of real estate."

Buchanan said a Macy's sale makes sense because the chain has limited physical growth opportunities and needs to focus on its existing retail space. At the same time, Buchanan said Macy's is bloated in cost structure and is inefficiently run.

"If Terry Lundgren is the right person to cut costs at Macy's — then so be it," Buchanan said. "If he's not, then the ultimate owner, public or private, needs to find someone who can."

Thomas Weisel analyst Liz Dunn, however, said the probability of a Macy's takeout is low as management previously has said it is "inappropriate to lever up to extreme levels." Dunn estimated Macy's has $9.5 billion in debt and cash of $500 million."Macy's predecessor company has experienced periods of insolvency in the past related to overleveraging the business," Dunn said in a research note. "We believe senior management, some of whom were around during that era, is hesitant to try the leveraged buyout route again."

But UBS fixed income analyst Marc Smith said a deal makes sense on a number of levels including lagging equity, which Smith notes that, prior to Wednesday, was underperforming the broader market and was down 11 percent from its March high.

"Macy's equity has lagged due to slower-than-expected benefits of the May acquisition, giving a potential acquirer a quick outlet for value creation," Smith said in a note, adding that he thinks "there is room for an increased offer if necessary."

Standard & Poor's analyst Jason Asaeda agreed with others on Wall Street that Macy's attraction lies in the retailer's cash generation, real estate and turnaround potential. But, Asaeda said: "We think management would prefer to remain independent, rather than subject Macy's to the risks of a leveraged buyout, but believe institutional investors would find $52 a share appealing."

According to Deborah Weinswig, analyst at Citigroup Global Markets, "Macy's is not so broken that management can't fix the business. As for home, everyone's home business is a mess."

She said the last retail merger and acquisition deal was Dollar General, also by KKR, and was at a 31 percent premium. Although, Weinswig thinks a deal for Macy's is plausible, and that management might be able to do more as a private company. She said there is still some question on whether management truly wants to do a deal.

Emanuel Weintraub, an industry consultant of the firm that bears his name, observed, "It's about money and control. If you get the money and keep control of the operations the way you want, you do the deal. But the money has to come first. Macy's operating team is top rate. They know how to execute. What executive wouldn't love to get these Wall Street analysts off their back?"

At least one investor doesn't believe that the disaster that arose following Campeau Corp.'s 1988 acquisition of Federated Department Stores should be a substantive issue in today's operating environment. That LBO resulted in too much debt, and it became necessary for Federated to file for Chapter 11 bankruptcy protection in 1990. It emerged in 1992 after restructuring more than $8 billion in debt, and it acquired R.H. Macy & Co. in 1994."It was a different company back then. It didn't have Macy's. Also, a bankruptcy shouldn't matter as long as shareholders get paid. That would be a private equity problem, and at $52 per share, shareholders would be paid out at a nice premium," said the investor.

"Rowland H. Macy opens R.H. Macy & Co. as a dry goods store in New York City; first-day sales totaled $11.06."

David May opens the first store of what was to become The May Department Stores Company in Leadville, Colo., a silver-mining boomtown.

Macy's moves to Herald Square in New York City.

David May moves the headquarters of his retail organization to St. Louis.

Macy's Herald Square location becomes the largest store in the world; 10,000 people watch Macy's first Thanksgiving Day parade.

Federated Department Stores Inc. is formed as a holding company by several family-owned department stores.

Campeau Corp. acquires Federated. Several Federated divisions, including Foley's and Filene's, are sold to other retailers.

Saddled by debt resulting from the Campeau takeover, Federated files for bankruptcy.

A new public company — Federated Department Stores Inc. — emerges in February with 220 department stores in 26 states and annual sales of approximately $7 billion.

Macy's files for protection under Chapter 11.

Federated acquires R.H. Macy & Co., creating the largest department store retailer in the nation.

Terry Lundgren becomes chairman, president and chief executive officer as James M. Zimmerman retires.

Federated begins operating nationwide under two national store nameplates — Macy's and Bloomingdale's — as all regional department store names are converted to the Macy's brand.

Federated acquires The May Department Stores Co.

More than 400 former May Co. stores convert to Macy's.

Federated divests Lord & Taylor, David's Bridal and Priscilla of Boston, which were acquired as part of The May Department Stores Co.2007
Shareholders vote on corporate name change from Federated Department Stores Inc. to Macy's Inc.

Macy's Stock Price
WWD reports KKR makes offer for Macy's. Stock gains 7.6% to $43.09.
Macy's posts steeper-than-anticipated drop in its June results and lowers its second-quarter guidance. Stock falls 2.9% to $39.25.
AXA Financial, the retailer's largest institutional holder, reports it has increased its stake in Macy's to 11.2 percent. According to Edgar, the firm held a 6 percent stake in March. Stock falls 3.7% to $40.13.
Wall Street mumurs that billionaire investor Edward Lampert, chairman of ESL Investments, which bailed Kmart Holding Corp. out of bankruptcy and then later engineered the merger of Kmart and Sears, Roebuck & Co., might have intentions to acquire the department store giant. Shares gain 5.6% to $41.99
Speculation of Macy’s as a takeover target stirs market. Stock gains 6.6% to $41.43.
Macy's Inc. posts larger-than-expected drop in May same-store sales. Stock falls 2.7% to $38.30.

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