S&P Puts Saks on Credit Watch

Debt agency sees takeover of chain as likely and envisions the luxe retailer with a heavier debt load.

With multiple bidders emerging for Saks Inc., the focus has shifted to how much the luxe department store might fetch and what toll a buyout could take on the company’s balance sheet.

This story first appeared in the July 23, 2013 issue of WWD.  Subscribe Today.

Shares of Saks fell 6 percent to $14.94 Monday, retrenching after real estate player Starwood Capital’s reported interest in the retailer pushed its stock to a 52-week high of $17.51 Friday.

Standard & Poor’s said it is likely that Saks would ultimately be acquired, but put the retailer’s credit rating on its watch list Monday, anticipating that a new owner would weigh down the tony retailer with additional debt.

Just what Saks’ debt load would look like is only one of the open questions lingering around the sale process. Also up in the air is how much of a role, if any, the company’s major shareholders would play in a transaction and what would happen to chairman and chief executive officer Stephen I. Sadove if he were to close a deal.

By entering the fray, Starwood is providing a counterbalance to Hudson’s Bay Co., which has been looking at opportunities to bring its operations together with Saks. Other buyers are also believed to be considering a run at the retailer.

Some estimates have Saks worth as much as $19 a share, but others have balked at that price as much too high. The current stock price gives Saks a market capitalization of $2.17 billion and a total enterprise value, which includes debt, of $2.6 billion.

S&P analyst David Kuntz said, “The CreditWatch placement reflects our view that there is a high likelihood that the company could be acquired by either a financial or strategic sponsor. Such a transaction could add a substantial amount of debt to the company. As a result, the company’s credit metrics, which are currently commensurate with the company’s ‘intermediate’ financial risk profile, would weaken.”

S&P currently rates Saks’ debt at “BB,” a grade that indicates the issue faces “major ongoing uncertainties or exposure to adverse business, financial or economic conditions.”

Saks said in May that its funded debt — including the balance on the revolving credit facility, capitalized leases, senior notes and the debt and equity components of its convertible debenture — totaled $319.6 million.

Even though interest rates are creeping up, debt is still relatively cheap, a dynamic that could ease a takeover.

Goldman Sachs, which has been shopping Saks in recent months, set up a $2.25 billion term loan for the ailing J.C. Penney Co. Inc. in May, which surpassed initial expectations by $500 million and showed that investors are willing to lend money to retailers when they put their real estate up as collateral.

And Saks is real estate rich.

“The real estate on Fifth Avenue and other retail sites such as Beverly Hills at the very least provides downside protection,” said one hedge fund manager. “Think of it this way: If business gets worse or if it takes longer to turn around the business, the overall value of the acquisition can’t be lower than its real estate value.”

Another fund manger wasn’t quite sure if the valuations for Saks’ Fifth Avenue store should have any impact on the valuation of the retailer, given that the site can’t add much more to the bottom line because of limitations of future construction or improvements due to air rights and landmark status.

Deutsche Bank analyst Paul Trussell said a deal for Saks was plausible given the company’s valuable real estate, but also because it has room to improve its profitability and a concentrated shareholder base, with three investors holding about 40 percent of the company’s stock.

At last count, Mexican billionaire Carlos Slim Helú controlled 15.3 percent of the company, or 23.1 million shares; Tod’s chief Diego Della Valle owed 14.2 percent, or 22.7 million shares, and Southeastern Asset Management Inc. held 11.4 percent, or 17.4 million shares.

Saks owns 53 percent of its square footage, or 27 of its 42 department stores, Trussell said.

The Fifth Avenue flagship is clearly the company’s 660,000-square-foot crown jewel. The analyst said the store on its own is arguably worth more than $1 billion, pushing the value of all of the company real estate to nearly $2 billion.

“Our [leveraged buyout] model suggests a potential price range of $16 to $19,” Trussell said.

Maxim Group senior retail analyst Rick Snyder has a “buy” recommendation on Saks shares, with $18.50 as the price target — which he said was the minimum price for a deal. His reasoning was that Saks is in a “unique position to capitalize on the growing trend of omnichannel selling.”

At Saks’ annual meeting last month, Sadove spoke about the firm’s omnichannel culture.

The retailer recently extended the responsibilities of its top merchants to cover both saks.com and stores, and this fall Saks will launch off5th.com.

“We believe firmly that omnichannel and bricks-and-mortar linked to the digital is the longer-term winning strategy,” Sadove said. “The lines are blurring between channels, and it’s one of the reasons we don’t report the Internet sales anymore.”

Snyder said Saks has “a very specialized product, with a specialized clientele. Omnichannel gives them the reach into those pockets of attractive consumers that don’t necessarily support a Saks Fifth Avenue store.”

The Maxim analyst also noted that luxury brands put Saks in a unique competitive position. “While all department stores are ‘brand compilers,’ Saks is in a unique position of compiling luxury brands.…Luxury goods manufacturers are more likely to invest back into the business of what makes their brands special and exclusive [versus an investment in mass distribution directly to the end consumer]. Also, luxury goods manufacturers are typically more willing to allow Saks to act as a showroom for their brands rather than build them. It would be difficult or impossible to replace or rival the showroom that Saks operates for these manufacturers in its Fifth Avenue property.”

Mary Epner, a principal at Mary Epner Retail Analysis, said, “Saks has the Fifth Avenue location and a strong e-commerce business, but the downside is that it has many problems maintaining a strong branch business.”

According to Epner, who has a merchandising background and did two tours of duty at Saks, “When one leaves New York City and heads to [Walt Whitman Mall on Long Island] as an example, Saks’ assortment isn’t as good as its competitors, such as a freestanding Gucci or Tory Burch store. And there’s the nearby [Americana Manhasset], which has the better options for the high-end merchandise.”

Maxim’s Snyder said Saks could close another six to seven stores, adding too that if consumers are buying online, Saks’ merchandising issues with its branch stores become “less of a problem.”