The $2.9bln takeover of Saks (NYSE: SKS) by Hudson’s Bay Company (TSX: HBC) that was announced yesterday was well received by the market as both stocks closed higher on the news.
The transaction creates a North American retailer that serves consumers in 3 different segments of the retail market: the luxury, mid-tier, and outlet segments.
Furthermore, Saks has a very attractive real estate portfolio, and HBC management plans to create a REIT to monetize some of that value. This would be highly lucrative, as experts are estimating that the value of just the Manhattan and Beverly Hills Saks real estate could be at least US$1bln. Analysts estimate that a $1.5bln REIT could be created out of the entire portfolio of assets.
Not all roses
Now let’s look at some of the not so attractive aspects of this deal.
First of all, the deal will be financed with $1 billion in new equity and $1.9 billion in debt. Ontario Teachers’ Pension Plan has committed to purchase $500 million worth of shares at $17.00 and West Face Capital has committed to purchase $250 million at $17.00. HBC will raise the remaining $250 million from the public markets. This will lead to earnings dilution, that is, earnings per share will decrease as the number shares increases at a faster rate than earnings.
Also, this transaction will put a real strain on HBC’s balance sheet. According to Hudson Bay management, after the transaction the Debt/Earnings before interest, taxes and depreciation (EBITDA) ratio will hit the sky high, dangerous level of 5.7 times. This ratio should improve after the realization of the $100mln in synergies, but it would still be high, at over 4x.
Furthermore, while Saks may be a good real estate investment, however, operationally the company has been struggling in recent years. In its latest fiscal year, net income decreased 16% and sales were only marginally higher. Saks offered deep discounts during the recession and the brand has not been able to recover from that. On top of this, luxury retailer Nordstrom will soon be entering the Canadian market and it remains to be seen whether the market can support 3 luxury retailers (Holt Renfrew, Saks, Nordstrom).
Finally, to quickly reduce leverage, HBC plans to cut the quarterly dividend to $0.05/share from over $0.09/share. A cut in the dividend is never really a good thing.
Bottom Line
The negative aspects of this deal seem to have been shrugged off by the market yesterday, as the focus was mostly on the potential creation of a REIT. However, even plans to create a REIT has some uncertainty associated with it. The market for REITs is not as strong as it was months ago and we don’t know how it will look when HBC is ready to act. The world of retail, and especially Canadian retail, is undergoing some seismic shifts, and to face these shifts with a balance sheet loaded with debt could end poorly.
A dividend cut to better handle debt is a sign of a company that probably should not be paying a dividend in the first place. The Motley Fool’s special FREE report “13 High Yielding Stocks to Buy Today” profiles a collection of companies that are unlikely to ever face this dilemma. You can download this report right now at no charge by simply clicking here. It’s free!
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Fool contributor Karen Thomas doesn’t own any of the stocks mentioned at this time. The Motley Fool doesn’t own shares of any of the companies mentioned at this time.