Back in June, Hudson's Bay (OTC:HBAYF) Chairman Richard Baker and several strategic partners offered to buy the rest of the department store conglomerate for $9.45 Canadian ($7.12) per share. (The partners already own more than half of the company.) However, a special committee of Hudson's Bay's independent directors flatly rejected this offer two months later. The committee said the proposed price undervalued the company.
Initially, Baker's group seemed unwilling to budge on its offer. However, on Monday, Hudson's Bay announced that the company had accepted a go-private deal at a revised price of CA$10.30 ($7.87) per share.
Hudson's Bay makes a deal
The revised buyout price for Hudson's Bay is only 9% higher than the value that the directors had rejected out of hand in August. It is also near the low end of the CA$10 ($7.64) to CA$12.25 ($9.35) range given by TD Securities, which was hired to prepare a formal valuation of the company's shares. Despite these factors, the directors decided to accept the revised offer for three main reasons.
First, the deal provides certainty to minority shareholders, providing a 62% premium over the company's early June stock price. That is definitely worth something in light of the headwinds faced by department stores and the reality that Hudson's Bay's remains a major turnaround project.
Second, while Hudson's Bay just received a CA$1.5 billion ($1.1 billion) windfall from selling its European joint venture stakes to partner SIGNA Holding, much of that will be needed to cover restructuring costs and "dead rent" for stores that have closed. The rest is needed for debt reduction, nixing shareholders' hope that some of the proceeds would be returned through dividends or share buybacks.
Specifically, it will cost about CA$300 million ($229 million) to wind down Hudson's Bay's Netherlands operations. Dead rent for closed Saks Off 5th and Home Outfitters stores -- and for Lord & Taylor stores that are being sold to Le Tote under a bizarre arrangement where Hudson's Bay will continue paying the rent for three years -- totals another CA$430 million ($329 million). Finally, Hudson's Bay anticipates CA$95 million ($73 million) of restructuring and other costs.
Third, the company's real estate advisors believe that the net value of Hudson's Bay's real estate -- after deducing the company's debt -- is less than the proposed buyout price. By contrast, just two years ago, the company was arguing that its real estate was worth more than CA$30 ($22.92) per share. That was a big reason several activist investment funds had believed that the stock was deeply undervalued.
Where did all that real estate value go?
In explaining the massive reduction to the estimated value of its real estate, Hudson's Bay noted that the retail apocalypse has hurt the value of retail real estate. This reduces the potential gains from redeveloping the company's department stores for other tenants. While redevelopment for non-retail uses is still a possibility, such projects take years to execute, are extremely expensive, and can be highly risky. Thus, they can't necessarily create much value for shareholders.
However, the really big -- and truly shocking -- change to Hudson's Bay's assumptions related to the Saks Fifth Avenue flagship store in Manhattan. Five years ago, the company had the building appraised for a mortgage, and the value came back at a stunning $3.7 billion. Now it says the building is worth "only" CA$2.08 billion ($1.6 billion), barely more than the $1.25 billion mortgage it carries.
In describing the valuation of the Saks flagship, Hudson's Bay notes that redevelopment potential is limited by the building's historical landmark designation and the lack of air rights that would be needed to build up. Neither of those factors is new, though. Instead, it appears that the value of the Saks flagship was inflated a few years ago by a bubble in luxury retail (and the highest-quality retail real estate) in New York. That bubble has since deflated, sweeping away more than $2 billion of real estate value.
Another case of horrible mismanagement
The plunge in Hudson's Bay stock's value over the past few years has a lot in common with the even steeper decline at Sears Holdings over the same period. Both companies were run by financiers with no retail experience. In both cases, management neglected the core business while focusing on too-clever financial engineering tactics and various pet projects. The result was massive destruction of shareholder value.
Of course, the carnage at Hudson's Bay wasn't nearly as bad as at Sears, which was forced to file for bankruptcy protection a year ago. That's not saying much, though. If Hudson's Bay had been more aggressive about fixing the Lord & Taylor business, moved faster to capitalize on its real estate value, and avoided its costly and indefensible Netherlands adventure, the stock could have been worth at least twice as much as the buyout price the board has accepted.
Hudson's Bay shareholders may not like the idea of rewarding Baker for his mismanagement by enabling him to buy the rest of the company at a low price and potentially benefit from a future turnaround or a recovery in its real estate value. However, in light of the risk that the company's turnaround effort will fail, the go-private deal may be the best option left for investors.