Value Investing

NEIMAN MARCUS DEBT – CONTRARIAN LUX RETAIL PLAY

By By Caleb Gibbons, CFA, FRM,– Originally at IBankCoin.

There are few things held in more deplore than retail at the moment. The list of retail equities that have blown up year to date is long, with Ralph Loren being only the latest to banzai skydive, and miss the chute. Luxury retail has not been immune, despite overall robust consumer spending.

While ibankcoin’s readership is largely focused on equity investment/speculation, hopefully my blogs posts have opened a few eyes to the bond opportunities that occasionally arise and merit both your attention and deep due diligence.

Enter the venerable luxury department franchise, privately held, Neiman Marcus (NMG), rated B3/B-. The speculative grade (Caa2/CCC) cash pay (I’ll explain shortly) NMG 8% 10/15/2021 (cusip 570254AA0) got rocked to trade < $60.00 last week for the first time. The bonds are currently wrapped around $61.00 for a yield to maturity (a quarter shy of 5 years) of > 21%.

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The capital structure is complex and the 8’s 21? are as you might expect, rank near the bottom with a couple of classes of debt ranking ahead on them in terms of priority of payments. In the event of a tap out, the recovery rate would be expected to be low.

New York based independent credit research firm CreditSights moved to a buy from hold rating on the unsecured debt of NMG on 1-Feb-2017 on some “early signs of stabilization in the luxury good market, the benefit of a runway clear of maturities until 2020, and a decent prospect for neutral free cash flow generation over the next  year. While we view the prospects for recovery in the bonds as limited – given the significant contractual subordination to the ABL (Asset-based Loan) and large term loan – yield opportunities of approx. 20% offer an enticing return while the company attempts to get the story moving back in the right direction during 2017.”

The October 2020 term loan maturity is a big one at $2.9bln. There is $1.56bln of unsecured debt maturing 10/15/2021, including $960,000,000 of the cash pay 8’s 21? and $600,000,000 of 8.75% 21? PIK (Payment in Kind) notes.

Beyond poor operating results in terms of comps, margins and outlook, the market is reacting to the fact that NMG pulled plans for an IPO (filed August 2015, delayed and most recently pulled). The history of NMG is long, complex and storied. Founded in 1907 with a head office in Dallas, Texas, NMG has has varied ownership over the years. The first store outside of the Dallas/Fort Worth area was opened in 1957. NMG was publicly traded from June 1987 until May of 2005 when it was taken private via leveraged buy out (LBO) by Texas Pacific Group (TPG) and Warburg Pincus for $5bln. The exit was prolonged, but in October 2013 NMG was sold for $6bln to Canada Pension Plan Investment Board (CPPIB) and Ares Management, netting TPG and Warburg Pincus a $1bln gain versus purchase price. CPPIB & Ares went 50/50 on the venture contributing $1.6bln in equity ($2bln was “expected”) with the rest of the deal financed via the debt markets.

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Note: Trump’s signature. He is signing these executive orders Neiman Marcus? More recent renditions are even more similar.

 

Fast forward to today and approx. $900,000,000 of shareholders equity remains. The degree of leverage imparted in NMG on acquisition would make even Trump blush, and it has only intensified over the last 18 months. On the positive side, NMG is closely held by very savvy institutional investors that are used to taking the long view (CPPIB much longer in terms of liability matching). The next NMG IPO filing must be a successful one and beyond a century + long track record as a competent luxury retail operator, the elephant in the room is the immense debt burden approaching $5bln. NMG is well within their rights to suspend interest payments on the $600mm 8.75% 21? PIK notes, a move that would save $52,500,000 per annum going forward. The signaling effect of such an election on the PIK notes would likely not be viewed as favorable though, and would likely take a potential IPO take-out off the table for the foreseeable future.

Owners with deep pockets is certainly a positive attribute. CPP and Ares have been equal partners to date, but there is nothing to dictate this has to be the case going forward. Ares would likely be somewhat reticent to add to a trade that has moved so far offside since late 2013. CPPIB, for their part, might look to creative ways to decrease leverage while operational efficiencies are given time to work through (cost cutting, reduced capex, further build-out of successful online offering “mytheresa”, etc.).

The current yield on the NMG 8% 10/15/2021 is 13.1%, if the bonds can be purchased for indicated $61.00 (+ accrued interest). The yield to maturity, as noted, is in excess of 20%. A plausible outcome would be for the current owners CPPIB/Ares to tender for the cash pay bonds, leaving the PIK bonds outstanding for debt servicing flexibility. Pure conjecture to estimate what percentage of the $960,000,000 of cash pay note holders might respond to a $70.00 tender offer, but given the prospects for a near term recovery from the dregs, I would expect at least a 50% take up rate would result. Deploying another $336,000,000 of equity under such a scenario would have the effect of extinguishing $480,000,000 par value of public debt, greatly improve the gearing numbers at NMG.

While not a pure “Red, White & Blue” lux retail play, given the Canadian connection, it merits further study for certain. Not for the widows and orphans due to outsized potential for losses , but in a measured dose Neiman Marcus debt may be worth a look.

Follow me on twitter; Caleb Gibbons @firehorsecaper

Disclosure; Not yet long, but vetting a 2.5-3.0% allocation to NMG 8’s 21? in clips of 100k par value.