Macy's: In the Buyout Bin?

Shares jumped Wednesday on a report that KKR could be looking to take the retailer private

Nostalgia for the 1980s is fine as far as music and fashion go, but could takeover artists be ready to take Macy's (M) -- the subject of one of the most spectacular LBO flops of that decade -- back to the future for a 2007-style buyout?

The department-store operator is reportedly in the crosshairs of Kohlberg Kravis Roberts for a leveraged buyout worth $24 billion, Women's Wear Daily said on July 18. An agreement in principle could be secured within days.

The actual value of the potential transaction is hard to calculate, as it isn't clear whether the $24 billion would include debt or not, the retailing trade publication said. The offer price equates to $52 per share, a 30% premium to the stock's closing price of $40.03 on July 17. Macy's had $9.425 billion in long-term at the end of June.

Macy's stock was trading 9.0% higher on July 18.

The deal would put a gloss on shares KKR plans to sell through an initial public offering later this year, WWD said. KKR is partnering with Goldman Sachs (GS) to finance the buyout, sources told WWD.

The department store chain is certainly natural prey for private equity, which looks for opportunities to slash costs, tweak the business model and boost profit margins in the companies it acquires. Macy's has a bloated cost structure that has squeezed its profit margins and made it difficult to offer the competitive prices needed to attract bargain-hunting shoppers. The retailer has seven buying offices around the country for dealing with merchants, versus one each for its more efficient rivals, Kohl's Corp. (KSS) and Target Corp. (TGT).

Cost-conscious consumers have cut back on spending amid sustained spikes in energy and food prices, while the increased difficulty of refinancing mortgages has put an added crimp in people's purses.

Last week, the Cincinnati-based retailer posted a larger-than-expected 2.7% drop in same-store sales for June from a year ago, warned of flat to lower sales for July and cut its profit forecast for the second quarter by 33% to 20 to 30 cents a share, excluding merger expenses.

Nearly two years after its $17 billion acquisition of the May Department Store Co., Macy's is still struggling to integrate the new stores and wrestling with how to retain customers of such upscale chains as Marshall Fields even as it overhauls its merchandise strategy to target lower-end consumers.

Macy's management isn't likely to be keen to surrender the company's independence through an LBO, as many people hold painful memories of its bankruptcy filing in 1990, Bear, Stearns & Co. analyst Christine Augustine said in a June 24 research note.

Federated Department Stores, as the company was called until June 1, 2007, filed for chapter 11 protection just a couple years after being a takeover by debt-laden Campeau.

But the extended time spent on turning the company around following the May acquisition could make the chance to complete the integration out of the public spotlight more tempting now, she conceded.

If that's true, however, an offer from KKR wouldn't be that enticing, given the firm's timetable for going public.

From KKR's vantage point, $52 a share looks like a pretty fair price, nothwithstanding the 30% premium to stock price on July 17. The value of the deal, at 9.7 times Macy's earnings before interest, taxes, depreciation and amortization for the past four quarters - including debt and minus cash - is below the average of 11.1 times trailing EBITDA for 39 M&A deals involving large retailers that have been completed since 2000 or are pending, equities analyst Robert Buchanan said in an A.G. Edwards & Sons (AGE) research note on July 18.

Macy's appears to be a suitable candidate for an LBO due to abundant cash generation - an estimated $2.3 billion, or $5.20 a share this year - and 68% ownership of the square footage its stores occupy, the A.G. Edwards note said.

A.G. Edwards has received non-investment banking compensation from Macy's within the past 12 months. Bear, Stearns or one of its affiliates holds a significant financial interest in Macy's corporate debt.

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