Could Macy's Experience a Leveraged-Turnaround Miracle? - A $5.8 Billion Buyout Bid for Macy's
Arkhouse Management and Brigade Capital Management have submitted a $5.8 billion bid to acquire the Macy’s stock they don’t already own for $21 a share, a 32% premium over last Friday’s closing price of $17.39, the Wall Street Journal reported on Sunday, citing people familiar with the matter. After that report, Macy's Inc.'s stock soared 22% on Monday.
Tracing back the past few years, Macy's has travelled a rough road for nine years or so,as department stores got shouldered out of shoppers' budgets by Amazon and fast-fashion giants. In that time it has also fielded an activist campaign from Starboard Value and a takeover approach from Hudson’s Bay, neither of which were successful.
Similarly, one of the sponsors of the buyout bid, Arkhouse, is a private investor best known for its real estate. Its interest is reminiscent of Starboard's 2015 suggestion that Macy's spin out its real estate holdings or even do a sale-leaseback transaction for its flagship store.
So, could Macy's experience a leveraged-turnaround miracle?
Citi downgraded Macy's to sell from neutral after the buyout report, citing that they are skeptical that anything will materialize.
"Others have gone down this path before (Starboard, Hudson's Bay), we are unsure how advanced talks are, and in this interest rate environment and with the secular challenges Macy's faces, it may be difficult to finance.” Citi analyst Paul Lejuez wrote in a Tuesday report.
Citi notes that while Macy's has more real estate than other department stores, monetizing that is easier said than done,even for the company's flagship Herald Square store in Manhattan. “A non-strategic buyer may have a different view on monetizing certain locations than management such as selling an entire building, and not operating a retail store in locations like Chicago and Brooklyn,” wrote Lejuez. “Herald Square is the highest value property in its portfolio, though value is not necessarily maximized as a retail store.”
Prior to the COVID-19 pandemic, there were estimates that Macy’s Herald Square location could be worth $3 billion to $4 billion, according to Lejuez. “While it is tough to put a specific dollar value on the space currently, we believe it is worth less than it was pre-pandemic,” he added.
Macy’s has also been down this road before, according to the Citi analyst. “It is worth noting that in 2016 the company hired Doug Sesler, a Wall Street real estate financier, to head its real estate team with the specific goal to help maximize shareholder value through real estate monetization,” he wrote. “Sesler left the firm in 2021, which signaled to us that there wasn’t much else left they were willing to do.”
Moreover, UBS analyst Jay Sole also skeptical of the real estate story.
Sole argues that a $21-per-share price overvalues Macy's properties. And even if brick-and-mortar retail has already seen its meltdown, broader CRE markets aren't especially attractive after two years of steep Fed rate increases:
We're surprised a real estate focused investor would be interested in buying Macy given we haven't believed the NPV of Macy's real estate is worth $21 per share., especially given today's high interest rates. We also believe Macy is worth less than $21, due to ongoing share loss to off-price retailers and other competitors. However, what matters is the investor group sees value in Macy and/or its real estate. This likely boosts market sentiment around softline retail stocks. Plus, if the investor group's intent is to create value by selling Macy's real estate, it likely means major market share will become available to Macy's competitors, such as Kohl's and Nordstrom.
Despite that, Macy's current creditors may not mind a deal. According to CreditSights, around 80% of the retailer's outstanding bonds have change-of-control provisions (for all bonds issued after 2005). If we make a significant assumption that private buyers will not take a hard stance against the creditors, it means that they would be bought out at a price of 101.
And the maths do work out, CreditSights’ retail analysts write, partly because Macys' leverage of 2.3x EBITDA (including leases).
But the problem is, the maths looked workable for prior department-store LBOs as well:
Owing to relatively low starting leverage, the theoretical/on-paper math for a LBO works for Macy, as it does for many of its peers.The real-life experience of LBOs in the department store space has been much less fruitful, with post-LBO Neiman and Belk landing in bankruptcies,while other outside-influenced department stores have also met the same fate. Deals like a bid for Kohl’s as well as the Nordstrom family’s attempted MBO/LBO have ultimately failed to get off the ground on the realities of high funding costs.
With rising debt financing costs, average equity contributions to LBOs have also been on the rise — reportedly eclipsing the 50% mark, on average.In this exercise, we model a 40% equity check from sponsors, but show post-transaction metricsin a range of 30-50% sponsor equity. At these levels, and assuming a blended 9.5% borrowing rate on secured/unsecured transaction funding, we show Macy being able to modestly sustain positive FCF ($526milions) based on FY24e EBITDA expectations and recently forecasted capex spending, with some cushion for either poor execution or further weakening of macro conditions.
And about that real estate:
It seems possible that a near-simultaneous deal could be structured to monetize all or some of the company’s sizeable and unencumbered real estate holdings, which might reduce the size of the required equity check — but at the same time, weigh on Macy’s EBITDA generation ability, assuming a leaseback of the properties. If not, the real estate would likely form the basis of primary security for deal financing.
Mooers, what are your thoughts on the buyout bid for Macy's？Where will Macy's go in the future?
Source: Financial Times, MarketWatch, Wall Street Journal
Disclaimer: Moomoo Technologies Inc. is providing this content for information and educational use only.
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