Reading the Tea Leaves: As Saks Inc. Nears Deal, SFA Speculation Swirls

NEW YORK — The fate of Saks Fifth Avenue is still in limbo.

As its parent, Saks Inc., inches closer to shedding its northern department store group — most likely to Bon-Ton — and Club Libby Lu division, speculation continues to swirl over the future ownership of its crown jewel, SFA.

And there's a new wrinkle to the plot: Banking sources said that, if Saks Inc. sells both the northern stores and SFA, chairman R. Brad Martin would still hold onto the reins of the 41-store Parisian chain.

Parisian officially is not for sale and recently has become a stronger property. Sources close to the division said its profitability has been on the rise, and noted that it has new management in place and is doing well in some locations in the Midwest, where it recently expanded beyond its southern roots.

Wall Street's close attention to the goings-on at Saks Inc. was illustrated Monday when a U.K. financial newsletter reported a deal for SFA already had been completed. While sources dismissed the report, it sent skittishness through Wall Street. Shares of Saks closed up 3.45 percent to $21.29. Trading volume was 1.6 million, below the average, three-month volume of 1.9 million. The stock's 52-week high is $24.64, the low is $11.61.

Nevertheless, some sources suggested SFA, with its international reputation, great real estate and upside potential, has garnered much interest, primarily from private equity firms, but also some strategic players. Sale efforts, they said, could resume next month, after the long-delayed second-quarter financials get issued. Accounting irregularities caused a delay in filing certain financial data and the annual report, which was recently released.

"Neiman's left a lot of people at the altar," said one retail source, referring to the recent sale of the Neiman Marcus Group to Texas Pacific Group and Warburg Pincus. While both of those firms also have checked out SFA, they are not believed to be serious players. Others still mooted as possible bidders include Galen Weston, owner of Selfridges in London and Holt Renfrew in Canada; Bain Capital; Blackstone Partners, and Apax. LVMH Moët Hennessy also has been mentioned, but a purchase of SFA is not seen as fitting its modus operandi.

The complication is that the board evidently still isn't certain it wants to sell SFA. A source close to Saks' bankers said that, as of last Friday, the board still hadn't decided one way or another. The board was supposed to have a meeting shortly after Labor Day to decide what to do, but they haven't met yet, according to the source close to the retailer's bankers.

The general view among some buy- and sell-side analysts is that firms could still bid for SFA even though it is not officially on the auction block. One sell-side analyst said bids might be coming in low for SFA because not all the financial information about the operation is available.

As reported, Saks had to restate certain financial information because of improper markdowns at its SFA operation, which spawned investigations by the U.S. Attorney's Office in Manhattan as well as the Securities and Exchange Commission. After a delay due to the investigation, Saks filed its annual report, or Form 10-K, with the SEC on Sept. 1. The retailer said in the report that it is "fully cooperating" with investigators.

The financial restatements necessitated by the improper markdowns are for the fiscal years 2001 through 2004. According to the annual report, adjustments were made to balance sheet and income statement items. On the income statement, sales for the restated periods remained unchanged, while net income adjustments varied.

In fiscal year 2004, net income was restated downward by 12.6 percent to $72.4 million. For fiscal year 2003, net income was restated to $12.1 million, down 50.1 percent from the previously stated results. For the year 2002, the restatement had no "meaningful" impact on net income, while the fiscal year 2001 showed a 2.1 percent gain in restated net income to $76.8 million.

Saks reiterated that vendor allowances of "approximately $34.1 million had been improperly collected from vendors in periods from fiscal 1996 through 2003," and that the amounts are "attributable to overcollections that resulted from falsification by merchants in one [SFA] merchandising division of information delivered to vendors."

Saks said it will pay interest of 7.25 percent a year to affected vendors, which will total $14 million. "In aggregate, the company expects to repay vendors a total of approximately $48.1 million during fiscal 2005," it said in the filing.

Filing the annual report has given Saks and its SFA operation some breathing room. Financial sources, such as factors, said they were awaiting the statements to determine whether or not to approve orders for the upcoming holiday shopping season. Factors are companies that handle a supplier's accounts receivables for a fee. A critical part of the factoring process is assessing the creditworthiness of retailers. As of last month, approvals were granted for orders through September, meaning that at least fall merchandise is being shipped to the stores.

Still, one sell-side analyst said on Monday the results have been "less than stellar," and that the turnaround still seems to need much work. As a result, the company may get less for SFA than it had previously hoped.

Saks, sources said, had expected to get a premium for its luxury flagship business, which includes the SFA stores and its Off 5th operation, especially after seeing Neiman's sold for $5.1 billion.

The perception in the market is that Neiman's is a top performer, well beyond reach of SFA. The numbers back up the claim. In its most recent quarter, Neiman's said net income grew by 66.8 percent on a revenue gain of 8.5 percent, while same-store sales jumped 9.6 percent. Revenues at the Neiman Marcus nameplates increased 7 percent, while those at Bergdorf Goodman gained 14.5 percent.

SFA, meanwhile, has posted inconsistent results over the past four months. In May, June and July, same-store sales showed gains of 0.8, 7 and 4.1 percent, respectively. In August, same-store sales rose 5.3 percent.

Meanwhile, financial sources said Saks is getting close to finalizing a deal with Bon-Ton Stores for the sale of its northern department store group, which consists of the Carson Pirie Scott, Bergner's, Younker's and Boston Store nameplates. Sources said that, after Cerberus Capital Management bowed out of a possible run at Saks with Bon-Ton as a partner, the retailer searched for and found another, unnamed private equity player to team up with.

Now it is looking like the bid price for the northern department store group will be less than the $1.5 billion that was the prior asking price for the operation, as reported by WWD.

Saks is also said to be weighing bids for its Club Libby Lu preteen business. Los Angeles-based Forever 21, the girls' specialty retailer, was in talks with Saks for the chain, but has since elected to drop out of the process, according to a financial source.

Lawrence Meyer, senior vice president at Forever 21, declined comment. A spokeswoman for Saks Inc. declined comment.

Forever 21 was considered by several financial bankers as an ideal candidate to buy the girls' chain because it would fit snugly into its business. Earlier this year, Forever 21 purchased the Gadzooks chain.

Other names that have been mentioned as possible buyers of Club Libby Lu are Too Inc., Claire's and Build-A-Bear.

Saks Inc. at a Glance

Nameplates (Number of Stores):

• Saks Fifth Avenue (56)
• Parisian (41)
• Younkers (47)
• Carson Pirie Scott (30)
• Herberger's (41)
• Bergners (14)
• Boston Stores (10)
• Off 5th (50)
• Club Libby Lu (51)

Key Executives:

• R. Brad Martin: chairman, chief executive officer
• Stephen I. Sadove: vice chairman, chief operating officer
• James A. Coggin: president, chief administrative officer
• Douglas E. Coltharp: executive vice president, chief financial officer
• Kevin Wills: executive vice president of finance,chief accounting officer
• George L. Jones: president, ceo of Saks Department Store Group, but resigning Sept. 30
• Frederick W. Wilson: chairman, ceo of Saks Fifth Avenue Enterprises

Saks Inc. Key Profit Ratios 2002 2003 2004 Gross margin 36.74 37.86 37.93 Operating margin 3.94 3.80 3.02 Pretax margin 1.86 1.81 1.31 Source: Company reports. Calculations by Edgar Online Editor's note: These are three text breakout boxes for the Saks story.