Macy’s Dismisses $5.8B Buyout Offer From Arkhouse and Brigade

Updated Jan. 22 5:22 p.m.

The pressure is on at Macy’s Inc.

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On Sunday, the department store nixed a $5.8 billion buyout offer from Arkhouse Management and Brigade Capital Management, citing questions surrounding the financing behind the proposal and its “lack of compelling value.”

But that’s not the end of things.

Few expected Macy’s to embrace the offer, which was widely seen as too low. But the back and forth shines a bright light on the department store just as president Tony Spring prepares to step up as chief executive officer next month.

Investors traded shares of Macy’s up 3.6 percent to $18.26 — not far off the $21 per share offered by Arkhouse and Brigade — signaling that the market is still waiting to see what happens.

“Macy’s does not want to sell because I think the board thinks they can really make Macy’s a $30 to $35 stock with its new management coming in,” said a source familiar with the company.

Oliver Chen, a stock analyst at Cowen, estimated that the takeover has a less than 40 percent chance of happening, although more clarity around financing or another bidder could make a deal more possible.

Fundamentally, there’s a disconnect between the purchase price and the value of Macy’s real estate, which Chen pegged as between $7.5 billion and $11.6 billion. Then again, that same disconnect exists between the value of Macy’s stock and the value of the real estate.

“We believe Macy’s stock is inexpensive, in part due to negative near-term sales trends, credit card income exposure, and a need to engage younger customers,” Chen said.

And even though Arkhouse is known for its real estate savvy, turning brick-and-mortar into cash isn’t always easy.

“Unlocking real estate value may or may not be realistic depending on time horizon, usage and restrictions, and developer appetite,” Chen said.

Gavriel Kahane and Jonathon Blackwell, Arkhouse managing partners, said in a statement that they “are highly motivated to consummate an acquisition of Macy’s and are prepared to pursue all necessary steps, including direct engagement with stockholders, to achieve this goal.”

That raises at least the possibility of a showdown at the retailer’s annual meeting, which is usually held in May and gives shareholders an opportunity to vote directors in or out via proxy ballots. Proxy battles to try to install new directors are expensive, but can lead to big changes in a company’s direction.

However, Arkhouse and the distressed specialist Brigade are looking for more than a tweak here or there that would boost the company’s stock price.

“We have conviction in the long-term success of Macy’s but believe that its potential will only be realized as a private company,” Arkhouse’s Kahane and Blackwell wrote.

The investor group has asked to get a peek at Macy’s books to do more due diligence and, perhaps, raise their offer, but Macy’s has rebuffed the advance.

In a letter to the group, Jeff Gennette, the outgoing chairman and CEO of Macy’s, expressed “serious reservations about your ability to finance your nonbinding proposal” and said the price of the offer lacked “compelling value.”

One source who works in the activist investing space, said: “What [Macy’s] said in their letter was pretty devastating” and suggested the retailer might not need to do more in the way of defense.

“This is an investor who really wants the real estate and is trying to put a proposal forward that they’ve never done before and, honestly, they would much prefer to just buy the real estate,” the source said. “If it’s a real hostile acquirer, they come with fully committed financing, it’s just a different level of seriousness.”

But the source speculated that the investor group could try to get some other parties involved to prompt some changes at Macy’s now that the process is out in the open.

“Putting the bid off at this time is the right tactic at this stage of the game. Anytime you have new management coming in and dislocation at the head office, a company is a little bit vulnerable, but at the same time, Macy’s may not be really ready to entertain an offer,” because of all of its internal changes, which included last week’s disclosure of seven store closings and 2,300 layoffs mostly at the corporate level, said Craig Johnson, president of Customer Growth Partners.

“The Macy’s board will resist for the time being, but at some point, if the bidders raise the offer, Macy’s will consider it,” Johnson said.

Johnson also said that because Macy’s is already involved in cost reductions that outsiders coming into the business would likely initiate, including closing stores and reducing the headcount, it’s correct and proper for the retailer to resist the offer. “Macy’s has historically been overstaffed at its headquarters, is already on the path of cutting and has a new round of store closings though that’s fractional [to the entire fleet],” Johnson said.

The combination of unrealized real estate value and low stock prices has long put retail on the radar of activists in the sector. HanesBrands Inc. and VF Corp. are both contending with vocal activists pushing for change — a pressure that Kohl’s Corp. and others are familiar with.

A tally by Barclays’ investment banking shareholder advisory group found 159 corporate activist campaigns through the third quarter of last year, an 8 percent year-over-year increase.

Nearly three-quarters of the campaigns targeted four sectors: technology, industrials, consumer and health care. Barclays also found that half of all activist campaigns were driven by merger and acquisition-focused demands.

Activist campaigns — even if they’re not ultimately successful — always throw a company and its management’s strategy in stark relief.

“Any activist target needs to have a compelling case to take to shareholders,” said consultant Greg Portell, a partner and global markets lead at Kearney. “And what an activist is looking at is a gap between what the company thinks it can do and what the forecasts are.

“In Macy’s case, if they can’t articulate how they’re going to close the earnings gap then the story from the activists starts to take more space in the press,” Portell said. “The defense that Macy’s and others have used around, ‘Oh, [the activists] just don’t have a plan,’ only works up to the point that management has a plan.”

Mark Cohen, adjunct professor of business and director of retail studies at Columbia Business School, said the retailer’s incoming management needs to formulate a new strategy. The existing strategy, Cohen said, “doesn’t move the needle much if at all.”

“The Macy’s board has placed its trust in its new CEO, but it takes several years to turn a retailer around,” Cohen said. “Tony gets tremendous credit for having success at Bloomingdale’s. Whether he is capable of transformational leadership, I don’t know. Time is not on his side. Whatever he brings to the table is going to take a long time to gestate and reveal itself as successful. This takes a couple of years at best. In the meantime, the vultures circle.”

If Arkhouse Management and Brigade Capital Management chose to up their offer and can demonstrate financial viability, Cohen added, “the Macy’s board can’t blow that off.” Moreover, a richer bid, Cohen said, opens up the possibility of alternative bids emerging.

“There are not a lot of logical buyers that would come into this,” Cohen said.

While Macy’s extensive real estate holdings could be attractive to any bidder for the business, “It’s not so easy to monetize these assets,” Cohen said. City centers, where Macy’s operates its biggest volume stores and where a lion’s share of store upgrades have happened, are rife with problems from homelessness and crime to unoccupied offices, Cohen pointed out. “The real estate pathway is a red herring.”

Macy’s management clearly feels that it is best positioned to come up with the fix.

Neil Saunders, managing director of GlobalData, said in an analysis: “At heart, Macy’s management don’t really seem to want a deal. They likely see the real-estate focused approach of Arkhouse as wrong for the business — and, they have a point. Monetizing real estate with no focus on revitalizing the retailer and bolstering trading would produce short-term gains but severely weaken long-term prospects.

“The problem for Macy’s management is that they have also been incredibly poor at adding value,” Saunders said. “Years of neglect of stores and the fundamentals of retailing has reduced Macy’s market share and relevance in retail. The company is now in a weaker position and is scrambling to engineer profit gains as sales fall.”

Next month, Spring will get his chance to work some new magic at Macy’s — that is, if he isn’t fending off Arkhouse and Brigade and their efforts to shape the company’s future.

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