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Acquisitions Driven by a Weak Market

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In 2005, TPG and Waburg Partners picked up retailer Neiman Marcus for $5.1 billion. Yesterday, they sold the business to Ares Management and the Canada Pension Plan Investment Board for $6 billion. The purchase is the second big-name department store to be picked up by Canada in 2013. Earlier in the year, Saks (UNKNOWN: SKS.DL2  ) was acquired by the Hudson's Bay Company. The buyout also adds to the midyear run of acquisitions that the retail space has seen. Saks, Neiman Marcus, True Religion, and Billabong have all already exchanged hands or moved onto the sale table.

The more you buy, the more you save
All of this selling highlights a few key undercurrents in the retail space. First, weaker retailers are having a tough time, while high-end retailers are having a better run. The companies that have moved this year can be split into two groups: winners and losers. As it turns out, the winners are the companies that have been focusing on the quality at the high end, while the losers have been chasing trends.

Saks and Neiman Marcus both had solid comparable-store sales growth in their last quarters. Saks was up 4% compared to the previous year, while Neiman Marcus rose 3.6%. Past that point, things diverge for the chains, and the reasons for their sales become clear, but we'll get to that in a second. On the lower end, True Religion saw comparable-sales growth of only 0.7% in its last reported quarter, and Billabong -- which relies less on its own stores -- was forced to write its brand value down to $0.

The reason for the division between the two groups is the second issue driving this year's acquisition push -- the middle class is feeling the squeeze. A combination of unemployment, payroll growth, and taxes is giving consumers pause. The result is that weaker retail companies are suffering, especially if they focus on the middle.

Using Target (NYSE: TGT  ) as a gauge of middle class demand, it's easy to see why companies are having issues. The company only managed to grow comparable-store sales by 1.2% over last year in its most recent quarter. That brought it to year-to-date comparable-sales growth to just 0.3%. The main drain on Target has been a fall in the number of transactions, which have declined 1.6% year to date.

There are still winners
With that difficulty, it's easier to see why funds are interested in picking up the higher-end brands. While Saks was suffering further down the balance sheet, as noted above, much of that suffering was imposed by the company's weaker locations. Those stores in failing malls have been too expensive to shut down, so they've simply been a drag on margins. Hudson's Bay owns the Lord & Taylor brand, which can potentially switch into some of those weak locations. In short, the synergy between the two companies made it a great buy.

Neiman is more straightforward. The business has been growing nicely, and the current owners will make about $1 billion on the sale. Growth in retail continues to be weighted toward the high end. While acquisitions have been in the spotlight, I would also be on the lookout for new entrants to the market. Handbag designer Tory Burch, in particular, is rumored to be eyeing an IPO and the timing could hardly be better. Look for that move in the next six months.

Even though the middle class is having a hard time of it right now, that doesn't mean we have to just sit back and take it. Investors focused on the high end have driven prices up for luxury and put the focus squarely on top. The Motley Fool's new free report highlights three less-than-luxurious stocks the 1% may be overlooking. Just click here to read it now.

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