NEW YORK ( The Deal) -- Once it acquires luxury department store chain Saks ( SKS) in a deal valued at $2.9 billion, Hudson's Bay Co., plans to place all of the newly combined company's real estate into a publicly held real estate investment trust, or REIT, according to a source. The cash generated by selling shares in the new public company would be a way to pay down the debt financing the deal, the source said. Cutting into long-term profitability, however, will be all the rent Hudson's Bay would then have to pay once it starts leasing the store locations both it and Saks currently own. Hudson's Bay declined to comment on its post-acquisition plans. Hudson's Bay's stores sit on some of the most expensive real estate in the world, including Lord & Taylor's Fifth Avenue location in New York City and Toronto locations. Now, it would be adding another top-of-the-line locale: Saks' own Fifth Avenue flagship location. In a REIT structure, the owned real estate is separated from the operating company, and then leased back to the operating company, pays rent at market rates. The rent the REIT collects is how it makes its money, and how it pays not only shareholders, but also affords to pay the property taxes, which are no longer on the operating company's books. Still, making it a more reasonable deal economically is the fact that retailers these days also tend to be landlords. At the Fifth Avenue location, for example, Saks can sublet space to high-end boutiques such as Louis Vuitton. Or alternatively, the high-end boutique would rent from the REIT, so that Saks would not have to lease the entire department store space. It would then be those high-end boutiques that would have the headaches of managing and moving inventory, not Saks or Hudson's Bay, the source suggested. The $2.9 billion Hudson's Bay is paying for luxury department store chain Saks Inc. is nearly 11.2 times its estimated $260 million in forward EBITDA for fiscal 2014, ending Jan. 31, 2014. The purchase price is also about 10.7 times the $271 million in trailing EBITDA it generated in fiscal 2013 ended Feb. 2.
As Saks' EBITDA drops, an acquisition by a strategic rather than a non-strategic acquirer also gives the luxury department store chain new flexibility, allowing it to plug in Lord & Taylor into Saks' locations that were slated for closing, or to put Saks' stores into certain Hudson's Bay locations in need of an upgrade, for example, an industry source said. Justifying the multiple Hudson's Bay is paying is Saks' real estate portfolio, which not only includes its Fifth Avenue location but also a Beverly Hills location, said to be worth up to $1.5 billion, according to Deborah Weinswig, a Citigroup analyst. When trying to consider comparable deals in the sector, it is notable that multiples for retail have been all over the map with little relationship to whether they are for companies in the luxury or mid-market brackets. The Hudson's Bay-Saks multiple is less than that for the $1.1 billion deal private equity firm Apax Partners struck in May to take Rue21 ( RUE) private, valuing the fast fashion retailer at nearly 10.9 times the $101 million in EBITDA it generated for the last 12 months as of Feb. 2, according to data provided by Bloomberg. The take private deal for Rue21 followed earlier transactions this year for Hot Topic, which was acquired by Sycamore Partners for $600 million, and True Religion Apparel, acquired by TowerBrook Capital for $835 million. The multiple paid for Saks compares to the nearly 8.6 times Sycamore paid for Hot Topic as a multiple of the $64 million in EBITDA it generated over the last 12 months as of Feb. 2. That includes the nearly $50 million in cash on Hot Topic's balance sheet, giving it an enterprise value closer to $550 million. It also exceeds the 7 times EBITDA TowerBrook paid for True Religion, making the designer denim brand look like a basement bargain in comparison. Dutch, the parent of brands Joie, Current/Elliott and Equipment, sold a stake in the business to private equity firm TA Associates on Jan.10. The deal valued the target at between $500 million to $600 million, or around 10 times to 12 times EBITDA. EBITDA was roughly in the vicinity of $50 million, according to sources.
The multiple paid for Dutch is closer to that of Rue21 and Saks, but Dutch has three growth brands considered to have a great deal of growth potential, whereas Rue21 and Saks are considered to be mature retailers. Not only can Hudson's Bay squeeze value out of Saks' real estate, but the acquirer also said it could find ways to save the newly combined company money. To finance the deal Hudson's Bay has lined up a $500 million cash investment from Ontario Teachers' Pension Plan and a $250 million equity check from West Face Capital. In exchange, Hudson's Bay will issue Ontario Teacher's 1.5 million share purchase warrants and an additional 3.5 million share purchase warrants to it upon the closing of the transaction. West Face will get 1.75 million share purchase warrants when the deal closes. The subscription price of the common shares and the exercise price of the warrants will be C$17 ($16.57) per share. Hudson's Bay also plans to combine $1 billion in new equity with $1.9 billion in senior secured loans and $400 million of senior unsecured notes and available cash on hand to help finance the deal. As of May 4, Hudson's Bay had $27 million in cash. The new debt would not only finance the acquisition of Saks, but would also help to refinance at least a portion of the nearly $1.1 billion in debt Hudson's Bay currently has on its balance sheet. Hudson's Bay closed up 6.55% to $17.57 per share Monday, while Saks' closed up 4.18% to $15.95. Written by Richard Collings.