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Moody's is comfortable with Hudson's Bay Co.'s planned acquisition of Saks Inc. from a business standpoint. But corporate debt is Moody's main concern – and from that perspective, the deal makes the credit-rating giant a little uneasy.
Moody's placed the debt ratings of both Saks and Lord & Taylor Holdings LLC – Hudson's Bay Co.'s U.S. retailing unit – under review for downgrade, after Hudson's Bay announced a deal to buy Saks for $2.9-billion (U.S.), including the assumption of about $500-million of debt. (As of the time of this writing, Moody's had yet to publish its views on the rating impact on Hudson's Bay itself.)
In doing so, Moody's was quick to list the many things it likes about the deal: "It will combine three well-regarded retail nameplates in North America, result in a sizable owned real estate portfolio, and create the opportunity for potential synergies. In addition, the acquisition will provide Saks with a growth platform in Canada," it said.
But Hudson's Bay Co. is financing the purchase in large part through $2.3-billion of new debt – "weakening both Saks's and Hudson's Bay's credit profiles," Moody's said. The proposed transaction will nearly triple Hudson's Bay's total debt, to $3.2-billion; its debt-to-EBITDA ratio would be about 5.7 times, said CIBC World Markets analyst Perry Caicco.
"That's a big stretch for any retailer, especially one that has now hitched its future to the fickle U.S. luxury department store market and, as such, the U.S. economy," he said in a research note.
Complicating matters is exactly where the debt will reside within Hudson's Bay's more complex post-deal financial structure. Lord & Taylor, which joined the Hudson's Bay fold in early 2012, remains a separate debt-issuing entity in its own right, with its own credit rating. So does Saks. It's unclear at this point, Moody's said, whether Hudson's Bay will take advantage of that access to the U.S. market to raise the funds in the transaction via either of these U.S. entities – and how much backing the parent company will put behind those debt issues.
The high likelihood that Hudson's Bay will spin off its real estate portfolio into a real estate investment trust (REIT) – seen by many as not only a means to cash in on the ample high-value real estate it would acquire in the Saks deal, but also a source of funds to reduce the debt burden – is also, paradoxically, a dilemma for Moody's.
"A key underpinning of Lord & Taylor's existing B1 [corporate family rating] has been the sizable value of its real estate portfolio, which is well above it's current level of debt," it said. The same could be said of Saks, whose real estate is valued at about $1.5-billion. If Hudson's Bay essentially sells off a big chunk of the combined HBC/L&T/Saks portfolio, it won't be able to lean as heavily on this real estate to backstop its debt.
Still, the REIT looks like the key to solving Hudson's Bay's debt puzzle. Mr. Caicco estimates that Hudson's Bay could hand nearly $1.6-billion of its debt over to the REIT, along with the assets associated with it. There, the debt would be supported by nearly $3.8-billion in properties across Hudson's Bay, Saks and Lord & Taylor's holdings.
This is why the market needs to hear the REIT plan. Without it, an awful lot of debt questions remain unanswered.
David Parkinson is a contributor to ROB Insight, the business commentary service available to Globe Unlimited subscribers. Click here for more of his Insights, and follow him on Twitter at @parkinsonglobe .