By  on April 25, 2005

NEW YORK — With final bids due today, it looks like Kohlberg Kravis Roberts & Co. and Bain Capital Partners are in prime position in the race for the Neiman Marcus Group.

The KKR/Bain Capital joint bid is competing against the partnership of Thomas H. Lee Partners and The Blackstone Group.

Sources at several financial firms, who spoke on condition of anonymity, predicted KKR/Bain Capital is likely to come in with the winning bid because the partners are willing to accept a lower rate of return on a premium-level investment.

This suggests the winning bid could come in higher than earlier anticipated for the 37-unit luxury retailer, which includes two sites in Manhattan operating under the Bergdorf Goodman nameplate as well as 35 Neiman Marcus stores.

As reported this month, a senior executive at Vornado Realty Trust told investors during a meeting that the price tag for Neiman’s could reach $115 a share, which would push the purchase price to more than $5.5 billion.

The rationale behind such a high premium — Neiman’s shares have been trading at around $93 to $95 on the New York Stock Exchange — is a valuation model that’s not based on current operations, but on expected opportunities with the brand. An offer of more than $5.5 billion, those familiar with the bidding process said, also means the new owners would possibly have to double the store base over time to get an adequate return on their investment when they look to resell Neiman’s.

Another source close to the bidding process said his firm did not pursue an acquisition because the price was getting too high, based on his company’s valuation analysis.

With the bidding on Neiman Marcus nearing its end, hedge funds, institutional investment firm analysts and investment bankers are speculating on other deals in the market.

Most sources agree that the Saks Department Store Group of Saks Inc., if it really is for sale as some speculate, could be problematic at this point because of an ongoing internal investigation of the retailer’s accounting matters as well as a Securities and Exchange Commission formal investigation of the issue.

Regarding J.C. Penney Co. Inc., chief executive officer Myron E. Ullman 3rd outlined the company’s strategic goals in a two-day analysts’ meeting last week. Ullman said the company is on a five-year strategic plan that centers on the moderate-income shopper. While Ullman didn’t address market rumblings regarding a leveraged buyout of his company, he said J.C. Penney will be among the first to capitalize on available real estate opportunities.However, prior to the J.C. Penney meeting, several analysts published research notes discussing the viability of LBOs in the retail sector, which included J.C. Penney.

According to a report by Citigroup Global Market retail analyst Deborah Weinswig, J.C. Penney could fetch a price of “over $18 billion” based on the company’s sales last year of $18.4 billion, current market capitalization and net debt levels.

While Weinswig said there could be some roadblocks to an LBO of J.C. Penney, she said the margin expansion opportunity on earnings before interest and taxes is in the 200 to 300 basis point range for the next five years. The hurdles to an LBO include a poison pill, inability of shareholders to call for a special meeting to vote on a buyout, and a board that has staggered elections, which would make gaining control of the board difficult.

“We assign a probability of over 50 percent that J.C. Penney is acquired and we believe that the likely vehicle would be through an LBO by an investment consortium of private equity firms. We believe that the private equity firms are looking for ways to deploy their cash and J.C. Penney is an attractive target given its high-quality operation, room for operating margin improvement and a strong cash position,” Weinswig wrote.

She speculated that if a consortium had the financing and could overcome the hurdles of the LBO, a hostile takeover could take place over the next six months.

Meanwhile, Goldman Sachs issued a report regarding LBO speculation in the market, which concluded that there is limited opportunity in the retail sector. The analysts at Goldman Sachs said J.C. Penney, assuming a $14 billion transaction size, would be too big for the high-yield market to absorb. Because the retailer owns only 20 percent of its real estate, and with limited margin opportunity, the Goldman Sachs analysts rated the probability as “low.”

In contrast, an industry bulletin on retail by Deutsche Bank Securities Inc., issued earlier this month, emphasized that the private equity market is creating a more favorable climate for LBOs.

From the perspective of the private equity funds, there’s a lot at stake — roughly $2 billion in fees they could lose if they don’t make investments. The private equity market is flush with $120 billion, and the typical management fee is around 2 percent. In some cases, if there is cash that remains unused for a long enough period, it must be returned to investors.The Deutsche Bank report concluded there is a “historic level of cash available for investment, and in record sizes as well as a historic degree of leverage that would be considered acceptable."

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