Shares of Nordstrom (NYSE:JWN) jumped nearly 7% on Friday, following reports that the founding family could be close to submitting a bid to take the upscale retailer private. The Nordstrom family, which already owns more than 31% of the company, had suspended an earlier bid last fall, after potential lenders demanded interest rates as high as 13%.
Lenders may be more willing to play ball this time around, after retailers, including department stores, posted solid sales results during the holiday season. That said, finding a price that can get shareholder approval while remaining palatable to the Nordstrom family will be very tricky.
Nordstrom is on firm ground
Last fall, widespread fears about the future of retail made lenders reluctant to support a retail leveraged buyout. The high-profile bankruptcy of Toys "R" Us and severe financial distress at Neiman Marcus clearly contributed to this skittishness. Both companies took on far too much debt as part of earlier leveraged buyouts.
The sky isn't falling, though. Last month, Nordstrom reported that comp sales rose 1.2% year over year in the November-December period. Total sales increased by 2.5%, as the company continued to gradually open more stores. Nordstrom also boosted its full-year earnings guidance modestly at this time.
Furthermore, Nordstrom will get a big profit boost from the tax reform bill that went into effect at the beginning of 2018. The reduction of the corporate tax rate from 35% to 21% should increase Nordstrom's after-tax income by a little more than 20%, all else equal. There are additional cash flow benefits for companies that make significant capital investments during the next five years.
Thanks to the solid holiday-season performance and expected tax benefits, Nordstrom stock was trading near a 52-week high even before its big move higher on Friday. Thus, shareholders aren't likely to accept a lowball offer from the Nordstrom family.
Pros and cons of trying a buyout in 2018
Strengthening sales trends at Nordstrom -- and among retailers more broadly -- should encourage lenders to back off of the onerous demands they were making last fall. But unless the interest rates come down to single-digit territory, it could be hard for the Nordstrom family to strike a deal to take the company private.
First, as noted, the company's fair value has risen, particularly because of tax reform. Second, the tax reform bill imposed new restrictions on the deductibility of interest expense. The practical result is that by going private, Nordstrom would surrender some of the tax savings it would otherwise get from tax reform.
The impact of the new limits on interest deductibility will depend greatly on the interest rates prospective lenders offer. (The higher the interest rates, the greater the amount of non-deductible interest expense.) The trajectory of Nordstrom's operating income is also critical. With higher underlying earnings, Nordstrom would be able to deduct more interest.
A delicate balancing act
The Nordstrom family hopes to submit a formal bid for the company next month, according to Reuters. But for the moment, it's hard to evaluate how realistic the go-private plan is.
The company's Q4 earnings report, scheduled for this Thursday, could provide more insight. Nordstrom needs a solid earnings report and -- perhaps more importantly -- good guidance for 2018 to avoid spooking lenders again. (While the Nordstrom family's talks with prospective lenders appear to have progressed further than they did last fall, the financing isn't locked in yet.) However, if the outlook is too rosy, shareholders' asking price could rise beyond what the family can afford.
I remain skeptical that the Nordstrom family will be able to thread this needle. As a shareholder, I would be willing to support a buyout at a fair price -- but that could be something like $70 per share, depending on Nordstrom's Q4 results and 2018 outlook.
Given that Nordstrom stock traded below $40 as recently as November, the founding family may be hoping for a considerably lower buyout price than that. Investors will have to wait until a binding offer materializes to determine whether selling out to the Nordstrom family makes sense.