By  on July 5, 2005

NEW YORK — At Saks Fifth Avenue, there's irony, controversy and a future that's got everybody guessing.

SFA has many difficulties, but the brand image remains strong, and given the current mergers and acquisitions climate, the business is appealing as an acquisition target, particularly since Neiman Marcus Group and Barneys New York got sold earlier this year.

No movement to sell is apparent, but the Saks Inc. board is known to be weighing the future of its Saks Fifth Avenue division, even as federal probes continue into its chargeback and related accounting practices. Meanwhile, investor Helu Carlos Slim of Mexico is buying up stock and currently owns some 18 million shares, or about 8 percent of shares outstanding. The stock is depressed, but has crept up slightly, closing Friday up 0.42 percent to $19.05 on the New York Stock Exchange.

"I can tell you there has been a ton of discussions at the board level," said a real estate source. "Brad [Martin, Saks Inc. chairman and chief executive officer] is a financial animal. In his blood, he's not a merchant. The right financial deal might prove interesting."

Especially given all the legal entanglements at SFA — which resulted in Martin's bonus being cut or eliminated and the dismissal of his brother, Brian, a senior vice president — and Martin's other growing business activities outside Saks.

"It's clear that the price Neiman Marcus got must be appealing to Brad and the Saks people," said one executive in the deal-making field.

The $110 billion in private equity funds seeking acquisitions certainly makes the timing right for a sale of SFA.

"The environment for sellers has not been this strong in a long time, given the general economic conditions, the low interest rates, the availability of capital and the need on the part of strategic buyers to get bigger," observed William Susman, president and chief operating officer of Financo Inc.

According to one competitor to Saks, "The most likely scenario is that a private equity firm, or consortium of private equity firms, buys Saks Fifth Avenue. They have the appetite for retail. A private equity consortium bought the Neiman Marcus Group, as best of class. With Saks, the approach would be different. They could buy it on the cheap, and use capital to make a run of it. There is significant upside potential."Martin was not available for comment on whether putting SFA up for sale is imminent. But it appears not. A Saks Inc. spokeswoman said last week: "As noted in our April 29, 2005 press release, we stated that Saks Inc. would continue to operate Saks Fifth Avenue Enterprises. We are focused on closing the Belk transaction [scheduled this week] and exploring our alternatives for the northern stores and Club Libby Lu," a chain catering to girls.

Preliminary bids on the northern group, including department stores Carson Pirie Scott, Herberger's and Younkers, were due last week.

People close to Martin said he wants to fix Saks Fifth Avenue first and sell it later, after going to great lengths to stack it with high-powered talent, weed out weak locations, load up the flagship with designer and contemporary brands characteristic of the competition and cut the debt to create a cleaner balance sheet free of liquidity concerns.

Selling Saks now, these sources said, would amount to a defeat for Martin, considering that the year-old turnaround will require at least another 12 to 24 months to take hold, unless he pulls off a deal for a rich premium above the stock price. "He's in the first few innings of a nine-inning [turnaround] game," said the real estate executive.

"Saks is my second-largest customer, but I don't think you can turn around a company that size so quickly," said shoe designer Stuart Weitzman. "It will take a lot of rebuilding. They really want to improve their footwear business, but they have to redesign the presentation.

"There's been an extra $50 million in better-grade shoes sold in New York City over the last seven, eight years. It didn't come out of Saks," Weitzman added, citing Barneys and Bergdorf Goodman instead.

"Saks has enormous upside potential, and the management is quite good now," said investment banker Peter Solomon of Peter J. Solomon Co. "They're spending a lot of money, and the corporation might be better waiting to see if they can reap some of the capital and energies that they have sowed. Saks is a wonderful franchise. If the board thinks the turnaround is achievable, it would do well to wait."Another source said that the $2.7 billion Saks Fifth Avenue Enterprises could command a price tag as high as $4 billion or more, given its brand equity, the appeal of a growing luxury assortment and the fine physical condition of most of its 56 stores. Saks, over the years, has been diligent in maintaining its real estate.

"I do think there is a market for Saks Fifth Avenue, much more so than the northern group," said one former investment banker who was active in the retail sector. "The private equity community would have the strongest interest. But Brad would only sell if he doesn't think he could turn it around, or unless he has to. That would show the world he failed."

With Jones New York buying Barneys, it's not entirely unthinkable that Saks could be pursued by another big vendor, such as Liz Claiborne Inc. However, industry observers said private equity firms seem more likely, including Blackstone Group, KKR, Apollo, Cerberus, Leonard Green, Thomas Lee, Bain Capital, Freeman Spogli and Saunders Carp, which is part of Apex.

They would be chasing a retailer with a checkered history and some legal and accounting problems to clean up. Saks Fifth Avenue for the past two decades has been wracked by ownership and management changes, strategic shifts, an ill-planned expansion and, lately, business scandals. The company is being investigated by the Securities and Exchange Commission and the U.S. Attorney for improper collections of markdown money from vendors and for accounting irregularities, delaying the filing of its annual and quarterly reports that put the company at risk of violating loan covenants.

There are also a few vendor suits filed against Saks, though the legal problems and government probes "don't necessarily have the material effect on the intrinsic value of the underlying assets. Those are desirable," said Isaac Lagnado, president of the consulting firm.

Others disagreed somewhat. "With the investigations going on, one doesn't know what effect it will have on the value of the firm. That will be an overhanging issue," said Michael Appel, managing director of Quest Turnaround Advisors. "With these unresolved issues and uncertainty, it may not be a good time to sell the company. On the other hand, you can negotiate a deal with a contingency or escrow, based on the result of those investigations."Meanwhile, Saks is trying to jump-start its business with a battery of aggressive strategies aimed at modernizing its image and chipping at the market share of Neiman Marcus, retailing's luxury leader, which was sold in May to private equity firms Texas Pacific Group and Warburg Pincus for $5.1 billion.

The new team at SFA, led by chairman and ceo Fred Wilson, president Andrew Jennings and vice chairman and chief merchandising officer Ron Frasch, has been building a stable of luxury and designer brands, recently bringing in Graff diamonds, Marni, Luella Bartley, Valextra, Roger Vivier shoes and bags and John Varvatos, and has been installing new shops for Marc Jacobs, Dolce & Gabbana and Chloe, among other designers.

About two dozen luxury brands have been added to the Manhattan flagship in about a year's time, though sources from the financial and vendor communities say Saks needs more time to strengthen its store organization to sell the brands and educate shoppers about what's new in its stores. Sales have generally not been strong.

"It's clear that management has major plans and has taken steps already to reposition Saks Fifth Avenue, which will enhance the value of the brand. I think their goal is to be conceived as a more contemporary store, not just a luxury store," said Marvin Traub, president of Marvin Traub Associates.

"The big question is, what's the right position? To turn to luxury, or turn away and compete more directly with Nordstrom?" said the retail competitor. "There is not an obvious strategy. They tried to very quickly roll out or make a statement that the company was moving upscale and aggressively went after luxury product. They went ahead of themselves. They might be more conservative going forward."

The latest ads are anything but, with Saks running its edgiest in a long time. They balance humor with sophistication, and incorporate phrases like "Saks loves grace under pressure" or "Saks loves close encounters." It's about picturing actress Rosie De Palma in an ad, rather than a supermodel.

"Consumers may not recognize the person, but they do recognize a stylish individual with personality," said Terron Schaefer, senior vice president of marketing, in a recent interview. "It's about elegance. Sex, mystery and royalty — these are the things that sell product."In addition, the store barrages consumers with e-mails about its latest deliveries; the logo and catalogues have been redesigned into a perfect square, and events are splashier, like inviting U2's Bono for a party to launch Edun, the sportswear line he co-founded to help employment in developing countries, or Elizabeth Hurley to launch her beach line last spring.

This fall, Saks will stage the city's most comprehensive cashmere promotion, with a few goats on the selling floor to further the point.

A grand plan to renovate the flagship, spearheaded by architect Frank Gehry — who drew up plans to redesign and add selling floors — has been put on hold, however.

"We are still exploring the possibility of renovating the New York City flagship, but no plans have been finalized or announced," said the Saks Inc. spokeswoman.

Other renovations at "flagships" outside New York — for example, in Boca Raton, Fla., and Boston — are happening, to keep pace with Neiman's, which is moving into Boca this fall, and in San Francisco, where Neiman's is spending tens of millions on enhancements.

Despite some advances, running Saks Fifth Avenue "just isn't as much fun for Brad anymore," said one resource. There have been murmurings that he's spending more time with his family business interests under the umbrella of Brad Martin Enterprises, which includes holdings in restaurants, real estate and resorts. Saks Inc. vice chairman Steve Sadove, some industry sources believe, has assumed a greater role, though Fred Wilson, chairman and ceo of SFA, remains in charge of the day-to-day operations.

"Steve and Brad, as corporate executives, are more focused on strategies and initiatives for the corporation," said the Saks Inc. spokeswoman.

Within retail and fashion circles, the Saks executive team is perceived as rife with politics and factions, stemming from an overstacked management. According to one source familiar with the players, Wilson demanded free rein in running SFA, was granted great independence and originally reported directly to Martin, but reports more to Sadove lately.

"The culture is so strong at Saks that no matter who comes in, it never changes," said one former insider. "The same things go on. There are factions, pyramids and internal politics. That's the ghost of Saks Fifth Avenue."

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