Macy's May Be Acquired, But It Begs For Greater Logic
A rumor has recently surfaced regarding the possibility, not the probability, but the possibility of Macy’s (M) selling itself. The story has come to the media and investors from the New York Post. The Post doesn’t name its sources other than to assign the typical media quote being “sources close to the matter”. Below is an extrapolation from the Post’s article.
Lundgren, who had not planned to cap his tenure with a sale, has recently become open to offers from potential friendly buyers as a proactive measure to head off any attempt to mess with the board, sources familiar with the situation said.
A partner at a private equity firm told The Post that he’d been contacted about a Macy’s sale by a real estate investor — while other industry sources close to the situation say they, too, have had similar discussions.
This article aims to analyze not only the Post story but to draw out the likelihood of a sale of Macy’s. What is strange about the Post article is that it assumes or offers the catalyst for the sale to have come from Jeffery Smith of Starboard Value. I offer this to be strange because for as long as Starboard has pushed for the monetization of Macy’s real estate assets, the company has acquiesced to the demands of Starboard and even aligned its Board of Directors for this operation. So why the additional demand or stimulus now, besides the continued deterioration of the core business? If anything, Starboard should be aligning Macy’s to more appropriately adjust its core business to exhibit the underlying value of the real estate assets from its retail operations. This has been the core issue with Starboard’s investment thesis to begin with.
Starboard believed Macy’s was undervalued back in 2015 when they first invested heavily into the company and when the stock was in the high $50s. The firm then ran a multi-media campaign whereby they put forth into publication their investment thesis that was heavily levered to Macy’s real estate value. It gave minimal consideration to the core retail business. The issue Macy’s and other retailers of scale, like Target (TGT), have long since understood is that the real estate is only of value for the situational purpose of big-box retail operations. And for such an operation there is a curtailment of demand in the marketplace. To repurpose these assets for other commercial business usage devalues the properties in the eyes of a potential buyer. Starboard valued Macy’s real estate to be worth just over $21bn in their 2016 publication.
The investment thesis was clearly outlined and offered with great detail shy of real operations surrounding the monetization of Macy’s real estate. Additionally, the Starboard presentation didn’t allow for the true valuation of the Macy’s business post any monetization of real estate assets which would certainly curtail their revenues from the lost real estate space and absent lease back agreements. I wouldn’t propose lease back agreements would be any more beneficial to Macy’s than it was when they would have previously owned the retail space, as the core business would be unaffected in such a transaction. A leaseback agreement wouldn’t fix same-store-sales.
Moreover, the $21bn valuation put forth by Starboard in January of 2016 was unrealistic and notwithstanding the reality of a negotiated price for each asset sold inclusive of transactional fees and taxes. But that’s of little relevance to the present rumors and state of business affairs surrounding Macy’s.
The reality is “who would buy a business in great decline and with no fix in sight”, a brick and mortar retail business at that, with huge real estate assets or what might also be viewed as liabilities given the state of the brick and mortar retail business. Who would pay a premium for this business, again, in great decline for consecutive years and offering no real fix to turn the core business around? For all Macy’s has offered in the way of restructuring and core operating initiatives, nothing has proven incremental to sales and earnings. In fact, on a YOY basis, the situation has only worsened for Macy’s. They are running an antiquated business model with a core client demographic that is aging and more finite in quantity than ever before. That’s just not an attractive proposition for any would-be acquirer. For that consideration, it doesn’t matter what major retailer you consider today, they have all been trying for several years to improve sales beyond opening new stores only to find disappointment and lesser sales to some degree. But to dig a little deeper…
The current market cap of Macy’s rests at $9.4bn, which couldn’t be the acquisition price. Investors of scale would demand a premium, possibly pushing the market cap up to $12-$13bn or above $40 per share. The company’s debt stands at 7.5bn that would have to be assumed by an acquirer. Now I get that a potential acquirer would look at free cash flow and let’s face it, most mass market, big-box retailers have strong free cash flow. But in the case of Macy’s, they’ve leveraged nearly half of their free cash flow and as such greatly void the benefit of that free cash flow. That’s not something that can be easily remedied either, especially as Macy’s is experiencing cash flow drains. Now if we circle back to Starboard’s valuing of Macy’s real estate at roughly $21bn and account for a premium to the market cap and assumed corporate debt, what is there really to profit from if you are Starboard forcing or stimulating a sale at this time? They may only be able to squeeze a couple of billion in profits and assuming they get the full $21bn out of a total re-sale. It’s the only way they can make a reasonable profit, shy of allowing a sale to go through with a side agreement that allows Starboard to carry warrants tied to the real estate. Good luck getting the rest of the shareholder base to go along with that agreement though.
$13bn + $7bn = $20bn worth of investments from any would-be acquirer, at least. Because remember, post the retail sales the acquirer is still left running whatever is left with regards to Macy’s retail outlets. How much further will that core business decline and possibly exhibit losses in the future? For a shrinking core business and across all metrics and the hopefulness of activating and executing on all real estate assets to their assumed valuation…that’s a risk profile not usually found in great demand. The worst part of a $20bn buyout is that it assumes a premium to Wal-Mart’s price to sales. The logic just isn’t there and as such it is hard to rationalize why Starboard would be pushing for a sale or even a member of Macy’s itself. Also, I’m using a baseline for the acquisition price, as it would likely be forcibly higher.
In the end, how does Macy’s get regulatory approval for such a deal that would leave many shareholders with significant losses? How does Macy’s make the claim that a sale of the company below $40 a share is inline with their fiduciary duty? The company could make the claim that their core business is “a going concern”. Such verbiage could actually be accurate and easily validated given the retailers credit rating and likelihood of further credit rating downgrades given its YOY results, restructuring and state of the business. On those grounds, Macy’s certainly could achieve their desired outcome of a sale to a potential acquirer, admittedly.
Despite what many investors have believed over the last 2-year period, Macy’s is a going concern and the business expresses this quite plainly. The company aims to close another 68 stores and potentially lose another half billion in revenues. Never mind the restructuring of the business model has found with it pitfalls to date, but history has laid the foundation of how these stories play out longer term. The initiatives that Macy’s has put forth are too few and of little ability to incrementally adjust to the changing retail landscape. Furthermore, nothing Macy’s is doing in the way of adjusting its retail operations is unique to its peers. So is there logic to Macy’s selling itself, yes and it is largely needs based? Is there logic for an entity to acquire Macy’s given the probable profit from re-selling assets and operating portions of the business, well…it’s definitely found wanting for logic. Having said that, where optimism meets ignorance, a great deal of capital and willing buyers can be found. If a buyer surfaces for Macy’s and a deal is struck, I’m of the opinion that no profit on that investment will be achieved long-term. I said the same thing when Jab Holding Group acquired Keurig Green Mountain for nearly 3X sales and as Keurig fell into a 3rd consecutive year of declining sales and profits. There is always a “least common denominator acquirer” to be found.
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