NEW YORK — The new owners of Neiman Marcus have a tough act to follow.
The top U.S. luxury chain on Monday announced a definitive agreement to be sold to two private equity firms, Texas Pacific Group and Warburg Pincus LLC, for $100 a share in cash, or about $5.1 billion. The planned acquisition is triggering intense speculation about Neiman’s future, and about other potential retail deals in a merger and acquisitions market that is ravenous.
The Neiman Marcus Group Inc., which was officially put up for sale in March, has been controlled by the Smith family for 20 years. They have been supportive, without taking a heavy hand in running the company, allocating capital to renovate and expand stores and open new ones at a methodical pace, and enabling president and chief executive officer Burt Tansky and his team to sharpen the service, merchandising and luxury appeal.
But considering the high price tag, there will be pressure on TPG and Warburg Pincus to grow the business faster to service the debt load and get a sufficient return. Elevating same-store gains will be challenging, considering they are already at double-digit levels, so developing new formats for growth, such as store prototypes, could be on the horizon.
An executive close to the transaction said it would be structured with more of an equity component compared with the norm, which is generally in the 20 to 30 percent equity-to-debt range.
“There will be a healthy equity slug” when the capitalization is completed, the executive said. “It will provide the company with a lot of operating flexibility, with more of an equity component than what’s traditional. Burt will be reinvesting some of the equity he has, and the management team will have a whole incentive structure set up with options…relatively deep into the organization.”
The executive added that TPG and Warburg Pincus will be looking for low double-digit earnings growth rates, similar to what’s been seen at Neiman’s. “If the trend continues, that would be fantastic,” said the source, adding that, with some of the 40-plus investments in the TPG portfolio, TPG “absolutely looks to change things.” But with Neiman Marcus, “they’re not thinking there is much of a change in the strategy.”Investors on Monday didn’t appear pleased with the price per share, sending Neiman Marcus down $5.36 to close at $92.96 in New York Stock Exchange trading. A total of 6.3 million Neiman’s shares changed hands. The Smith family has 13 percent of the Class A and Class B shares outstanding, according to a proxy statement filed with the Securities and Exchange Commission. As of Monday, the number of Neiman’s shares outstanding totaled 48.9 million, which means at $100 a share, the Smiths’ payout would be at least $640 million.
The Dallas-based Neiman Marcus Group in fiscal 2004 generated $3.55 billion in revenue, compared with $3.1 billion in the previous year. Net earnings for the company were $205 million compared with $109 million for the 2003 fiscal year.
The company ratcheted up luxe and kept its focus even after the post-9/11 downturn. It comprises 35 Neiman Marcus units and two Bergdorf Goodman stores; the Direct Marketing segment including catalogues and online operations under the Neiman Marcus, Horchow and Bergdorf Goodman nameplates, and the Kate Spade and Laura Mercier operations. Seven Neiman Marcus stores are already planned: in San Antonio, Tex., and Boca Raton, Fla., this fall; Charlotte, N.C., in fall 2006; Austin, Tex., and Oyster Bay, N.Y., in spring 2007; Natick, Mass., in fall 2007, and Topanga in West Los Angeles in fall 2008.
Retail sources said the opportunities for growing Neiman’s are:
Continuing to expand the catalogue and online businesses, which are said to be the fastest-growing units.
Opening stores in the U.S. in key affluent metro areas where Neiman’s might have just one site, or none at all. Smaller boxes also might be considered, a change from the current model of operating large stores with major designer presentations.
Revisiting a new format, such as the Galleries at Neiman Marcus, which specialized in jewelry and gifts, operated a couple of locations, but failed. One consultant from an investment banking firm said Neiman’s picked the wrong locations to launch that business in the Nineties, but a reformulated Galleries concept could be formidable against Tiffany.
The company also may sell off its credit-card operation to cover some of the purchase price. It already is said to be up for sale, but the new owners wouldn’t comment.
Accelerating Kate Spade’s store count, though that “wouldn’t move the needle that much,” said one retailer. Neiman’s acquired a majority stake in Kate Spade in February 1999 for $34 million. There are only 14 locations, but 10 more stores are planned this year and the mix has broadened from handbags to home products and some apparel.
Expansion abroad, though it would be tough since the designers that Neiman’s sells are widely distributed abroad through their own boutiques, and suitable real estate is scarce. One way might be to buy another company. Overseas expansion for the Bergdorf Goodman division was considered years ago for a handful of European cities.
Another issue for TPG and Warburg Pincus, which outbid Thomas H. Lee Partners with the Blackstone Group and the partnership of Kohlberg Kravis & Roberts & Co. and Bain Capital Partners, is succession planning. Tansky will continue to run the business, but he is 67 years old. Karen Katz, ceo of the Neiman Marcus stores division, would appear to be the top inside candidate.
As far as what the sale means to the future of Neiman’s: “Nothing has changed,’’ Tansky said in an interview on Monday. “I’m here. Nothing has changed. We will continue to operate as we have, and we’ve been very successful.”
Addressing speculation that Neiman’s would expand abroad, Tansky said: “Overseas will not be part of the agenda.”
As far as other growth strategies, “we have number of ideas, but there’s nothing I can talk about,’’ Tansky said. “We’re 24 hours into this. I don’t want to lay out a strategy or talk about our plans. We do have a strategy and that strategy is very consistent with what you’ve seen us do. We have a formula and niche and we will protect it.”
Asked if he is considering retiring, Tansky replied: “I have not given that any thought. I’m too busy to think about those things.”Tansky said he couldn’t talk about the terms of the deal or his own equity stake.
Meanwhile, the Smiths have entered into a separate agreement to vote their shares in favor of the merger. The deal is subject to regulatory review and shareholder approval and is expected to close by Nov. 1.
“TPG and Warburg are smart buyers,” said a retailer familiar with the players. “You can bet they saw something in Neiman’s that others didn’t see. Why shouldn’t Kate Spade [56 percent owned by NMG] be an opportunity like Coach?”
Still, others say making Spade a bigger contributor to the bottom line is a tall order, and have concerns that a financial buyer might mess with a well-oiled retail gem. “A financial buyer does not know to manage retail. Nonretailers can’t run retail,” said a retailer. “TPG learned their lesson from J. Crew,” which floundered for five years under TPG ownership until Mickey Drexler, former Gap ceo, was recruited two years ago to fix things and set it in the direction of an initial public offering, possibly next year.
John Bucksbaum, ceo of General Growth Properties, the second-largest U.S. shopping center developer, said, “It would have been nice if Neiman’s was left alone. The management team there has done a tremendous job. But if anybody had to get it, I’m glad it’s Texas Pacific. This group is very competent. They understand retail.”
TPG has a reputation for seeking turnaround situations, which Neiman Marcus Group certainly isn’t, but the portfolio has of late been broadened to include “a little bit of everything.” TPG, founded in 1993 and based in Fort Worth, Tex., San Francisco and London, manages more than $15 billion in assets in a range of industries, including retailers such as Petco, J. Crew and Debenhams; consumer franchises such as Burger King, Del Monte, Ducati and Metro-Goldwyn-Mayer, and airlines such as Continental and America West.
As far as how TPG relates to Neiman’s management, the executive close to the transaction said: “TPG always tends to be very involved, but Neiman’s has a great management team, so hopefully TPG will think of itself as kind of an intellectual debater, to bring up new things, test new strategic ideas, but the team is running this company on its own.”There are plenty of cases of nonretailers buying stores and taking them nowhere. Investcorp had a tough time with Saks Fifth Avenue, but did well with Tiffany & Co., and R. Brad Martin, a businessman-politician but not a merchant, has had a difficult time with SFA. Aside from J. Crew, TPG also has had an uphill battle to turn around Bally.
Warburg Pincus, which has been in operation since 1971, manages about $13 billion in investments in information and communication technologies and financial services, among other industries.
“Neiman Marcus is a wonderful, well-operated business,’’ said Marvin Traub, president of Marvin Traub Associates. “Clearly, to make the investment pay, they will have to expand the retail business, and aggressively expand NM Direct.’’
Traub speculated that J. Crew’s Drexler might be part of the strategizing for the Neiman’s of the future. “I suspect they have confidence in Drexler,’’ he said.
Traub said that, with all the merger and acquisition activity and the premiums private equity firms are paying for retailers, “we’re in a fascinating period of retailing. The sale of Neiman Marcus will enhance the interest in other retail companies.”
Among them is Saks Fifth Avenue, a division of Saks Inc. Last week, Saks Inc. said it was selling its southern group of department stores, Proffitt’s and McRae’s, to Belk Inc. and wants to sell its northern group, including Carson Pirie Scott, Younkers, Herberger’s and Bergner’s. It is not commenting on whether Saks Fifth Avenue is up for sale. But sources close to the company believe that the major shareholders, which include Martin, are not interested in selling SFA at the moment and would be patient, hoping to improve the operations for a sale down the road.
However, SFA could be approached with an offer by an investor who sees much upside in the stock and greater value in a deal compared with the Neiman’s deal. Saks would be priced much less.
“Absolutely, this deal will continue to add fodder to the interest that private equity groups have in brands,” said William Smith, managing partner of Global Reach Capital.Plenty of retailers and big brands have considered the option of selling because of the extremely attractive M&A environment, Smith said.
“You can borrow more, put more leverage on companies and increase your returns,’’ he said. “This deal shows that very attractive properties continue to go at a premium. I think we will see more and more of that. Burt Tansky and his team built a phenomenal franchise. Because of that, the private equity guys are willing to pay a higher multiple of cash flow.”
However, another banking source said, “the market allowed Toys ‘R’ Us to happen.” He was referring to the company’s acquisition by Bain Capital, Vornado Realty and KKR. That was another expensive deal, but Toys ‘R’ Us has a questionable future competing against Wal-Mart. “Real estate was the backstop with Toys ‘R’ Us. It doesn’t make sense to buy it as an ongoing operation” because Wal-Mart dominates the toy market.
As of late last week, the expectation was that the purchase price for Neiman’s would be at least $100 a share, along with another $10 or so for the sale of the credit-card business. Investors were disappointed when they found out that the $5.1 billion purchase price included the credit-card business. An auction will still be held for that asset, but now investors are surmising that proceeds will go to the new owners, and not current shareholders. It was still unclear who was actually running the auction, Neiman’s or the soon-to-be owners.
Yet, as one private institutional investor observed: “The price, while shocking, reflects the debt markets and uncertainty regarding the financing of the deal.”
As reported last week, there were concerns about a tightening of the high-yield markets, a source of debt financing.
Another analyst at an institutional investment firm noted that, with the price for Neiman’s at less than some experts had speculated, there was now a greater chance that the deal would go through. He added that, because the purchase price is not necessarily aggressive in terms of leverage, the new owners won’t be pressured as much into pushing for more cash flow to pay down the debt sooner. In the end, he explained, there will be less pressure to expand the store count rapidly, and consequently, less risk to diluting the brand.Jim Fogarty, managing director at Alvarez and Marsal, a global management and advisory firm, said, “The price for Neiman Marcus [at $100 a share] was a fair one at nine times EBITDA on a cash flow basis. Since Neiman is not a broken company, the question is how do the new owners drive the value from here. Typically, retail deals go for around six times cash flow.
“The classic place to look is at the operational efficiencies and cost structure,’’ he said. “There’s probably opportunity there, but they’ll need to be careful to protect the front end of the business. Maybe they’ll see efficiencies on the back end. They have to remember that the strength of the Neiman franchise and brand is the customer experience.”
While there’s been concern over whether the luxury boom will continue, Fogarty expects that the trend is in favor of Neiman’s new owners.
“If you look at demographic trends, the Boomers are spending as they head into retirement,’’ Fogarty said. “There’s a lot of money concentrated in that space and there are also some wild luxury items that people will spend money on.”
Fogarty added that, in the early Nineties, when consumer spending slowed, shoppers didn’t leave the luxury sector entirely, but opted to spend less. “Besides, nobody buys a business thinking we’re going to have a recession in the first few years. I believe that the Boomer trend is there to propel them,” he said.
Analyst Stacy Turnof of Merrill Lynch wrote in a research note on Monday that, because Neiman is well run, her firm believes there is “limited opportunity to reduce costs. We believe that the motivation behind Texas Pacific and Warburg Pincus’ investment is that they could accelerate the company’s store growth [currently growing at about one store per year on a base of 37 department stores] and bring the company public again at a premium.”
“We are delighted to be partnering with Burt Tansky and the rest of the Neiman Marcus management team. Together, we hope to build on their exceptional track record of performance,” said Jonathan Coslet, partner at TPG.“We believe strongly in the continued growth of the company,” Warburg Pincus managing director Kewsong Lee said in a statement.
By the Numbers
Return on Assets
Return on Equity
Neiman Marcus Group
Source: Yahoo Finance. Ratios are for the trailing 12 months.
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