Few of Saks' (NYSE:SKS) customers are deadbeats. But interestingly enough, one of its investors thinks the company is. According to a Wall Street Journal story, Highbridge Fund has sent Saks a nasty default notice.
Last week, credit agencies Standard & Poor's and Moody's downgraded their ratings for Saks. Moreover, the company announced it will delay its earnings report because of a Securities and Exchange Commission inquiry.
That last misfortune likely triggered Highbridge's default notice. Saks' indenture included a (fairly common) covenant triggering a default if Saks delayed filing. Apparently, Highbridge owns more than 25% of Saks' convertible notes, due in 2024. Getting payback on those notes could reap Highbridge a tidy profit.
Given the hedge fund world's problems -- especially for those that play convertibles -- it's hardly surprising that Highbridge is getting rough. Convertible strategies are based on complex mathematical models that attempt to make profits based on discrepancies between the pricing of a convertible note and a company's underlying stock. But these models have been backfiring lately, largely because of the big surprise of the GM credit downgrades. Besides, there appears to be too money chasing these convertible notes, thus eliminating much of the profit potential.
In fact, Saks quickly agreed to repurchase $1.22 billion in outstanding debt. With its existing credit lines, cash in the bank, and proceeds from its sale of Belk, Saks should be able to handle this redemption. It's still a risky move, though, since the company's recent sales have been somewhat stagnant.
In light of Saks' troubles, the stock price should tank, right? Ironically, continued weakness has made the stock more attractive as a buyout candidate. The retail industry is in the midst of consolidation -- witness the purchase of Toys "R" Us (NYSE:TOY) or the merger between Kmart and Sears (NASDAQ:SHLD). Much of the consolidation has involved the middle to lower-end retail marketplace. However, Saks' customers, with their plentiful purchasing power, are a valuable demographic. (The rich are getting richer and need to find more places to spend their money.) If Saks does want to sell -- or find itself the subject of an offer -- it will certainly try to get a premium.
But for individual investors, buying a stock like Saks is probably too risky. The SEC investigation is still in the early stages, Saks' core business has seen recent weakness, and there are no current filings (nor may it be a good idea to rely on the old filings). This is probably an investment play for sophisticated firms such as Highbridge. After all, the fund has avoided Saks' equity; it seems to consider buying the company's debt a much better alternative.
We've tagged more Saks takes:
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Fool contributor Tom Taulli does not own shares in the companies mentioned in this article.
