Nordstrom (NYSE:JWN) has been a public company for nearly half a century. Yet the founding family has remained intimately involved throughout that period. Indeed, the upscale retailer is headed today by three great-grandsons of founder John W. Nordstrom.
On Thursday, the company announced that the Nordstrom family is thinking about taking it private again. Nordstrom stock soared as much as 18% on this news, ending the day up more than 10%. There's no guarantee that a formal buyout offer will ever materialize -- but this news could still reignite interest in the stock.
Nordstrom stock has been struggling
In the past two years, Nordstrom stock has been caught up in a broader retail sector rout. To be sure, Nordstrom has seen its sales growth slow since mid-2015. Furthermore, the company's profit margin has declined significantly in the past five years or so.
However, much of the earnings pressure that Nordstrom faces comes from the company's own growth initiatives. Thus, the bigger issue that has been holding back Nordstrom stock is that investors have lost patience with management's long-term focus. This is what makes the idea of a management buyout particularly appealing.
Nordstrom is massively undervalued
Prior to the news of the potential buyout, Nordstrom stock was trading for a little more than $40 per share. That's about 14 times the company's 2017 earnings guidance.
This may seem like a generous valuation compared to other department store operators' single-digit earnings multiples. However, Nordstrom's earnings -- and especially its free cash flow -- have been artificially depressed in recent years by the company's big growth investments.
In 2017, Nordstrom expects a combined profit drag of $85 million from its investments in its off-price e-commerce business, its Canadian operations, and its Trunk Club personal stylist program. It also expects to incur $30 million of pre-opening expenses for its Manhattan flagship store. In total, these costs will reduce earnings per share by $0.40-$0.45 this year.
Over the next few years, Nordstrom plans to ramp down its investments. It will open several new and relocated full-line stores between now and 2019, but full-line store openings will be few and far between thereafter. Additionally, nearly half of the company's off-price Nordstrom Rack stores have opened in the last five years. As the Rack store base matures over the next few years, profitability should improve in that part of the business.
There's even more upside in terms of free cash flow. Nordstrom has spent nearly $1 billion a year on capex for the past three years. By contrast, it plans to reduce capex to $800 million this year and an average of about $650 million annually for the following four years.
Meanwhile, the various growth initiatives that Nordstrom has been investing in will start to pay off in the coming years, driving further increases in cash flow. As a result, Nordstrom stock is probably worth substantially more than its current valuation.
Good news for shareholders?
Members of the Nordstrom family already own more than 30% of the company's stock. As a result, they might not need to put any more equity into the company to finance a leveraged buyout. At $50 per share, they would only need to raise about $5.7 billion of financing; at $60 per share, they would need $6.9 billion. Either number would probably be manageable, in light of Nordstrom's strong cash flow prospects.
One of the biggest risks for Nordstrom shareholders now is that the independent directors could agree to sell the company for a price that's too low in light of its substantial growth opportunities. (Long-term Best Buy shareholders are very happy that company founder Richard Schulze failed to line up financing a few years ago to take that company private for about $25 a share.)
The good news is that any buyout would presumably value Nordstrom stock well above its current price. And at the moment, there are plenty of other bargain stocks to be found in the retail industry.