Stock Picking - Macy's (M.NYSE) Robert Swift – Head of Global Equity - 16 February 2017 -
Macy’s, the US department store retailer, is a relatively recent purchase for the High Conviction Strategy. Traditional bricks and mortar retailers have found it tough going against big online retailers like Amazon. As a result, Macy’s valuation has been hit hard. In under two years the shares have more than halved from over US$ 70 a share in July 2015 to the low US$ 30 area recently.
Macy’s recently announced a plan to shed underperforming stores and reduce corporate staff numbers by 6000. The company also owns a significant proportion of its store portfolio which is potentially value that can be unlocked in a sale and lease back agreement.
So the low valuation, the self-help policies put in place by the management and the potential of further value to be unlocked in the company is what attracted us to the business. Since our purchase there was a disappointing trading statement which pushed the share price even lower. We re-evaluated the position and decided to add more at the lower prices.
In the last week the CEO has intimated that the company would be open to offers for the business. Since then Hudson Bay, a Canadian retailer, barely a fifth of Macy’s size has expressed interest in acquiring Macy’s. It may sound bizarre for a much smaller company to gobble up a far bigger rival but it can be done if Hudson Bay can raise the finances to do the deal. The current market value of Macy’s is around $10bn. Pencil in a suitable bid premium and let’s say it gets taken out at $13bn. It is estimated that the property of Macy’s could be worth anything up to $20bn. But let’s be conservative and assume they’re worth only $10bn. So that leaves only $3bn of additional financing – yet Macy’s has substantial cash flow to support additional debt. It’s Earnings before Interest and Tax (EBIT) is around $1.3bn, take off rent now due to the sale and leaseback of $600m, but add in cost savings of $300m from redundancies (the original management plan). This would give you further earnings of around $1bn to finance a $3bn funding loan! Even at a high yield of, say, 6% this would mean annual funding costs of $180m. This would leave a fully funded deal with pre-tax profit of $800m! So the idea of Hudson Bay being able to do this deal and for them to finance it directly from Macy’s own resources is very doable.
It may be that the Hudson Bay approach to Macy’s simply flushes out other potential bidders for Macy’s. We shall have to wait and see. But what it clearly does highlight is the potential appetite for financial engineering with plenty of liquidity to do deals and low interest rates. If companies are struggling to grow organically – which many are right now – they will be under pressure from the market and shareholders to contemplate such deals.
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