By  on July 20, 2007

NEW YORK — With investors speculating about the ability of Kohlberg Kravis & Roberts to acquire Macy's Inc., trading leveled off as Citigroup put the largest U.S. department store operator on its list of companies with undervalued real estate — saying it sees a 25 percent upside to the current share price.

In a research note Thursday, Citigroup analyst Jonathan Litt valued Macy's at $25.57 billion, or $53.66 a share. The fi gure is a 26.6 percent premium over the stock's Thursday closing price of $42.40, and $1.66 more than the $52 a share, or $24 billion, which KKR is said to have offered.

WWD reported Thursday that KKR wants to close on a deal for Macy's, formerly known as Federated Department Stores Inc., but that turmoil in the debt fi nancing markets might get in the way. Neither KKR nor Macy's has commented.

In his report, Litt said that Macy's operations, independent of real estate asset sales, could be worth $20.5 billion. Asset sales might boost that fi gure to $43.75 billion. Subtracting debt and liabilities would leave the net asset value at $25.57 billion.

Litt noted that Macy's inclusion on the Citigroup list wasn't connected to recent speculation about the retailer's future.

He said Macy's could capture its real estate value three ways. First, it could execute a series of sale leasebacks, in which Macy's could sell its property and lease it back from the buyer for a fi xed amount of time. Second, it could split the company in two, with its operations and real estate as separate entities. Finally, Litt said Macy's could sell off its individual real estate assets one by one.

"We estimate there is $9.3 billion in real estate value for the owned stores and $2.6 billion in real estate value for the leased stores," Litt wrote. "There could be another $2 billion to $3 billion in value for the most valuable stores depending on their ownership or lease structures."

The analyst estimated that Macy's owns 54 percent of its stores, or 463 units; leases 32 percent, or 273 stores, and has ground leases on 14 percent, or 122 of its stores.Litt's estimates were based on assumed rent of 4.5 percent of sales, which he noted is "well below the level of in-line mall tenants of around 10 percent to 13 percent, but well above the levels department stores paid when they initially leased the space."

In another research note, Morgan Stanley analyst Michelle Clark valued Macy's owned real estate at $9.2 billion, $6.4 billion after debt, liabilities and other costs.

"If a leveraged buyout is not announced over the near-term, we see a downside risk to Macy's shares back to the $38 level — similar to previous price action following LBO speculation — as the focus shifts back to fundamentals," Clark wrote. "We continue to believe the issues at the converted May Co. locations are structural in nature and could take longer than two to three years to fix."

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