The $7 billion hurdle: Could Macy's debt prevent an acquisition?

Posted at 9:00 AM, Feb 07, 2017
and last updated 2017-02-07 11:26:25-05

CINCINNATI - Macy’s Inc. shares rose 5 percent Friday because of media reports that the company is entertaining sale offers.

The Wall Street Journal named Hudson’s Bay Company as a potential buyer. Cowen & Co. analyst Oliver Chen opined that a Macy’s acquisition could also make sense for the Japanese parent company of Uniqlo, which operates mostly online in the U.S., and tech giants Amazon, Google, eBay or Facebook.

“This would be a revolutionary combination of establishment retail meets new media,” Chen wrote.

Deutsche Bank analyst Paul Trussell said Macy’s could fetch up to $16 billion, or $53 per share, if acquired. That’s 60 percent higher than Friday’s closing price of $32.69.

But lost in all that speculation is the $7 billion hurdle any acquirer must clear: Macy’s has a lot of debt.

“I’d be thinking about that long and hard,” said Jim Hagerty, an investment advisor at Bartlett, one of the region’s oldest money-management firms. “By historical standards, interest rates are still friendly but they are higher. You’d have to think about that an awful lot.”

Macy's acquired: What would it mean?

Hagerty said Cincinnati’s status as a corporate headquarters would immediately be threatened if a rival retailer bought Macy’s. But any potential buyer would cut more jobs and close more stores than Macy’s has to date. Macy’s is in the process of closing about 100 stores and last month announced it would eliminate 10,000 jobs as holiday retail sales came in.

“For private equity investors, who would be taking on a lot of debt to make the transaction happen, job one becomes maximizing cash flow and cutting costs,” Hagerty said. “You’d see an even more aggressive approach to reducing head count, closing under-performing stores and, if they could, monetizing some of their real estate.”

Macy’s already has too much debt to satisfy Moody’s Investors Service, which has been threatening to reduce the retailer’s debt rating since May. Macy’s debt is now 3.5 times EBITDA (earnings before interest, taxes, depreciation and amortization).

“We could downgrade the company’s Baa2 rating if debt/EBITDA remains above 3.0x,” Moody’s Vice President Christina Boni wrote in a Jan. 5 note. “Our negative outlook reflects leverage above our target for a Baa2 rating and continued business weakness. We expect that the company will need to redeploy excess capital in order to reduce and maintain leverage.”

Moody’s has an even lower rating on Hudson’s Bay debt, which makes some observers think the Canadian retailer isn’t capable of acquiring Macy’s.

“There is very limited capacity for HBC to undertake additional debt while maintaining its B1 rating and stable outlook,” Boni wrote in August.

Hudson’s Bay could get around the debt problem by issuing stock or partnering with a real estate investor that has a stronger balance sheet, said John Meyer, securities analyst and portfolio manager for Meyer Capital Management in Anderson Township.

“I don’t think the debt is a deal breaker but it’s going to be a stretch, especially for somebody like Hudson’s Bay,” Meyer said. For other buyers, “It depends on how much cash they bring to the table.”

Meyer figures there is a 50-50 chance of a Macy’s acquisition.

Macy’s investor Ron Kardon thinks Hudson’s Bay could team up with Simon Properties to pull off a Macy’s acquisition, then use its real estate to secure new loans of at least $11 billion. Macy’s “has zero mortgages on their real estate,” said Kardon, who lives on Long Island and owns Macy’s because of its real estate value.

“I think a deal makes a lot of sense,” he said. “I am sure there are many that would love a chance at Macy's. Hudson management is very shrewd.”

Cowen analyst Oliver Chen puts the odds of a deal at less than 25 percent, but not because of debt. He thinks Macy’s has yet to figure out how to grow revenue in a post-Amazon world.

“Macy’s vendor and buying model and supply chain lead times are too long,” he wrote.  “Lack of buying agility and speed has added markdown risk, weather risk and inventory overages leading to too much unhealthy promotions on a multi-year period. Additionally, we believe shoppers are transitioning away from shop-in-shop brand models – there’s no more loyalty - towards curated assortments, which does not bode well for the similarity of all Macy’s stores.”