Is A Neiman Marcus, Saks Merger Inevitable?

For years rumors have abounded that various forces were trying to lead North America’s two leading luxury department stores to the alter. And I can neither confirm nor deny that I may have been involved in analyzing such a marriage on more than one occasion. Now, such an outcome may become a fait accompli.

Before it became increasingly obvious that Neiman Marcus could never grow its way out of an ill-conceived 2013 leveraged buyout by Ares and the Canadian Pension Plan Investment Board, earlier speculation centered on the company’s prior private equity owners (TPG and Warburg Pincus) desire to gain greater efficiencies and consolidate the competition prior to a hoped for highly profitable exit. Subsequently, it’s become well known that Richard Baker, Chairman of Hudson Bay Co. (the owner of Saks) has been eyeing Neiman’s for quite some time, though his hands have been pretty full with HBC’s own struggles.

As I highlighted in a Forbes piece last week, the pandemic has accelerated a reckoning for Neiman’s that has been looming given the brand’s maturity and its ludicrously leveraged balance sheet. What the current COVID-19 has amplified is that, the United States does not need two luxury department stores with nearly identical value propositions and many overlapping locations. The strategic rationale is therefore now far stronger than it’s ever been for a consolidation. Neiman’s bankruptcy filing seems to increase the odds that it can finally happen.

It’s been reported that Murdick Capital Management, one of Neiman’s creditors, is aggressively pushing for a merger, citing their own analysis that significant incremental value can be unlocked through closing a substantial number of Neiman Marcus locations and realizing major cost synergies. Directionally their analysis seems correct and lines up with my knowledge of the business derived from having been on the senior leadership team previously and from my work as an industry consultant and analyst more recently. But I will highlight a few issues that require a more nuanced view.

The overlapping store analysis is flawed. Murdick suggests a lot of Neiman Marcus Group stores can be closed because 22 are located within 15 miles of a Saks store and that 7 more could potentially be shuttered—which would be almost 3/4 of the Neiman’s full-line store count—that are more than 15 miles away, but in the same metropolitan area. The economic rationale for this presumably is not about cutting rent costs, since Neiman Marcus hardly pays any, but the ability for the remaining Saks location to pick up the vast majority of the exited location’s volume, thereby greatly leveraging its fixed cost base.

In most cases, it’s probably a slam dunk to close stores that are quite clearly in the same exact trade area. By my count, 6 other stores are not in the same mall, but are in easy walking distance of each other: San Francisco, Beverly Hills, Chicago, Palm Beach and Midtown Manhattan (Bergdorf Goodman). Closing one of the locations in Palm Beach seems like a lay up, but closing BG would be insane. And my guess is Related will do cartwheels to keep Neiman’s at Hudson Yards. For the others, including those more than 15 miles away, the analysis needs to be far more detailed, particularly it relates to core customer’s willingness to travel given traffic patterns and the like, as well as the ready availability of convenient alternatives, including shopping online where the competitive set is far broader.

An inconvenient truth. Aside from the massive volume Saks Fifth Avenue store flagship in Manhattan, in most cases the “branch” Neiman Marcus store in most markets is the better store, both in terms of cash flow and physical plant. So while it seems straightforward enough to close a bunch of Neiman’s stores by taking advantage of a Chapter 11 filing, that’s not always going to deliver the best long-term result. In places where there are shared landlords—like Las Vegas where the Neiman’s location is clearly the better one—I imagine some sort of deal that suits all the parties could be worked out. But it’s an added complication and likely a major one.

In cities like San Antonio, the Neiman’s location is far superior, but the competing locations are miles apart (though Brookfield operates both malls). Neiman’s is also dominant throughout Texas. Philadelphia is a similar story, without a shared landlord.

The key point is that there are reasons, often subtle, that help explain why many Neiman’s locations in the exact same location as Saks are dramatically more productive and profitable. The easy thing is not always the smart thing.

What’s the brand strategy? While it’s fun to play with Excel spreadsheets to generate theoretical estimates of shareholder value creation, there is the real issue of how a combined entity would manage the two brands. The most obvious concern is which brand name get kept in which markets—and please dear God, do not even consider a Ruth’s Chris Steakhouse-type strategy—and the degree to which the respective brand positionings get homogenized. While it’s easy to see Neiman Marcus and Saks as virtually identical, there are some important differences and relative brand strength (and resultant customer loyalty) based upon geography.

What the operating strategy? Clearly the best thing to do to maximize cost synergies is to push for more blending of operations than not. That is not necessarily the most effective. Even though Saks is the smaller brand, if they are the acquiring company they would dictate how and where things get consolidated. And presumably all roads lead to New York. But if we are honest, Saks has historically struggled to get their overall fleet to be terribly productive. Getting this integration right—and realizing that most of the volume in a post-merger world will come from trade areas (both physical and virtual) that are well outside the New York City metro area—is critical.

The underlying economic rationale for a merger, accelerated greatly by the forces of the pandemic, are undeniable. Whether the vagaries of the bankruptcy process, along with all the conflicting interests (and egos) of the various parties will allow it to happen is above my pay grade. Either way, time is clearly of the essence given the probable slow rebound of the North American luxury market. Ultimately consumers in quite a few markets will have to adjust to seeing yet another iconic name disappear for their set of choices—at least in its brick & mortar incarnation.

From an investor standpoint we should hope that efficiency is not the only thing that carries the day and that the new leadership team is highly sensitive to both the emotional components of what makes a brand remarkable and is reminded that, as a great man once said, “culture eats strategy for breakfast.”

This post first appeared on Forbes.com. To see the original, click here.