Saks Accepts $16 - Is That Enough?

Saks (NYSE:SKS) announced July 29 that it was accepting the Hudson's Bay Company's (TSE:C.HBC) $2.9 billion dollar acquisition offer. Bringing Saks under the same roof as Hudson's Bay and Lord & Taylor, the trio will have annual revenues of $7.3 billion making it a formidable department store chain in both Canada and the U.S.

HBC is paying $16 per share. Is this enough? Could the price go higher? I'll have a look.

Go Shop
Saks has 40 days to find a better deal. The company says it's unlikely to find such a beast. However, Barron's featured a guest column July 30 from Maxim Group, a New York-based investment bank, that puts the value of its stock at $18.50 per share. Maxim gets to this number by projecting EBITDA all the way out to 2017 ($443 million) and then applying a multiple of seven times those earnings to arrive at an enterprise value (less $600 million for flagship real estate) of $3.28 billion, $375 million higher than the current deal.

And here's where it gets interesting.

Some experts value the Fifth Avenue location at $1 billion or more. In early 2012, I recommended Saks' stock when it was trading around $9. In that article I reminded investors that the flagship store on Fifth Avenue generates 22% of its overall annual revenue or approximately $700 million. It's a business unto itself. If you substitute Maxim's $600 million valuation on its flagship store for the billion-dollar figure being thrown around, its enterprise value jumps to $3.68 billion and a per share value of $21.33, 33% higher than Hudson's Bay's existing offer of $16 per share.

Who Might Bid
Well, if the news is to be believed, there weren't too many interested parties in the first place. Now that an offer is on the table, it does seem unlikely that someone new would put in a bid, but maybe they should. Perry Caicco, an analyst with CIBC World Markets told clients that the REIT Hudson's Bay is considering for some of its real estate as well as Saks' Fifth Avenue and Beverly Hills stores is absolutely essential to the financing of the deal. Currently, it has total debt that is 2.7 times EBITDA; buying Sakes takes this to 5.7 times EBITDA. In Caicco's words: "That's a big stretch for any retailer, especially one that has now hitched its future to the fickle U.S. luxury department store market and, as such, the U.S. economy." Despite this skepticism, Caicco has a price target of $20 for HBC.

SEE: Understanding Leverage Ratios

The problem that I see with Hudson's Bay buying Saks is that they both have a number of terrible locations mixed in with some very valuable retail properties. In Saks case, it really only has two that carry substantial value. HBC has 56 properties that it owns out of a total of 207, but even then many of the locations both in the U.S. and Canada don't carry as much value as HBC would like to think they do. Canaccord Genuity analyst Derek Dley puts the value of HBC real estate in a REIT at $13 per share. Add in another $8 per share for Saks' real estate and the company would reap $2.56 billion from the spin-off. If that were to come true, HBC's pro forma debt would be reduced to $640 million according to Caicco. I see the number a little higher at $1 billion. I'm skeptical that it can hit $2.56 billion but Richard Baker's pulled rabbits out of his hat before.

The most obvious choice to put in a last minute bid would be Dillard's (NYSE:DDS), who originally were interested in the company back in 1990 when British American Tobacco (NYSEMKT:BTI) put the luxury retailer up for sale. It ultimately was sold for $1.5 billion to Investcorp, a holding company located in Bahrain. It would be a stretch for the Arkansas-based, family-run, department store chain. But even if paid $18.50 and financed most of the purchase, its debt-to-EBITDA would still be less than HBC's on a pro forma basis. It's a long shot though. The Dillard family seem happy with the status quo.

As for private equity, unless there's a lot of growth on the table, most investment firms are steering clear of the big names. Saks has a name but its growth is limited. Otherwise, KKR (NYSE:KKR) would have bought it and merged it with Neiman Marcus.

Bottom Line
While I think Saks is worth more than $16, I just don't see another company stepping to the plate. Richard Baker will either become the King of North American retail or he'll fail in a less spectacular fashion than Robert Campeau, who bought Allied Stores in 1986 and then Federated Department Stores two years later, only to lose both to bankruptcy. Whatever happens, it sure will be interesting to watch.