Famous U.S. luxury retailer Neiman Marcus, which is held by Ares Management Corp. (ARES, Financial) and the Canada Pension Plan Investment Board (CPPIB), is preparing to file for bankruptcy after missing a $72 million interest payment on bonds owed in 2024, according to sources among the company’s lenders. The company could file as early as Sunday.
After the missed interest payment, the company’s bond holders also have the right to file a lawsuit to force bankruptcy.
This would mark the first declaration of bankruptcy from a major U.S. retailer since Covid-19 became a clear threat to public health and sent the economy into a tailspin. The reason is not entirely because Neiman Marcus lost the most money or has the most debt. One other contributing factor is that it is a bit difficult to plan the liquidation of assets when store locations are closed under government orders.
Financial distress in the cards
Neiman Marcus owns 42 of its namesake stores across the U.S., all of which have been temporarily closed due to quarantine measures as the Covid-19 pandemic continues. The company had previously announced that it would permanently shutter all 24 of its Last Call discount stores, ostensibly to focus more on its luxury niche.
However, shuttering the lower-margin discount stores would also be a good move if the company found itself facing financial pressures. Indeed, according to lenders, bankruptcy has been a possibility on their minds since 2018, when the company’s two asset holders, Ares and CPPIB, transferred a valuable asset, the MyTheresa website (worth approximately $1 billion), from Neiman Marcus to another entity. This left the company with no sustainable assets, which went against the interests of bond holders.
The legality of this move was called into question by Marble Ridge Capital LP, a distressed debt fund and one of Neiman Marcus’s bond holders. In a lawsuit filed in 2018 that is still ongoing, the fund alleged the following:
"These assets were stripped from its insolvent subsidiary Neiman Marcus Group LTD LLC (the 'Company') to benefit the private equity firms Ares Management L.P. ('Ares') and the Canada Pension Plan Investment Board ('CPPIB'), which are the beneficial owners of Neiman Marcus Group, Inc. The transfer was orchestrated in a two-step self-enrichment scheme orchestrated by Neiman Marcus Group, Inc. and the LBO Sponsors to loot the Company of a crown-jewel asset in order to hinder, delay and defraud the creditors of the Company.”
Regardless of any other potential backstory behind the asset transfer, it cannot be denied that it was a red flag for Neiman Marcus. The transfer means that the company’s creditors would not be able to sell the asset to pay off debts in case of bankruptcy, meaning that Ares and CPPIB determined that bankruptcy was a distinct likelihood for Neiman Marcus as far back as 2018.
Potential buyers
The investing public has tossed around the idea that Hudson's Bay Co. (TSX:HBC, Financial), the company that owns Saks Fifth Avenue, might acquire Neiman Marcus once it filed for long-expected bankruptcy and rid itself of some of its debt.
However, this kind of deal has become harder to strike, finance and assess given the temporary halt in cash flow to retailers. With gross domestic product expected to decline in the short term and millions of Americans unemployed, consumers are especially reluctant to buy luxury items.
In the meantime, Neiman Marcus will have to deal with the above-mentioned lawsuit from Marble Ridge Capital. Many of the store’s landlords will find themselves with an empty space and potential demands for rent reductions from other tenants, as Neiman Marcus has historically been a big draw for customers. Its absence could easily reduce the price that other tenants are willing to pay.
How will Ares fare?
Ares Management is a global asset manager with approximately $149 billion in assets under management. Investments are diversified through three main asset classes: credit, private equity and real estate.
On April 24, Ares Management’s shares traded around $33.69 apiece for a market cap of $8.33 billion. Shares are down 8% year to date compared to the S&P 500’s 12% loss.
Ares and CPPIB acquired Neiman Marcus in 2013 for $6 billion, so while the loss will be felt, it probably won't be catastrophic for the asset management company on its own.
However, as per the chart below, Ares has produced negative operating cash flow since 2015, and both diluted earnings per share and owner earnings per share have declined over the same time frame.
GuruFocus gives Ares a profitability rating of 6 out of 10 and a financial strength rating of 3 out of 10. While the return on capital is 497.32%, it comes at the cost of high leverage. The cash-debt ratio of 0.09 is lower than 88.64% of competitors, while the Altman Z-Score of 0.78 indicates that it could be in danger of bankruptcy, with or without Neiman Marcus in its portfolio.
One thing Ares potentially has going for it is that approximately two-thirds of its operations are in the credit industry, while the final third consists of roughly two-thirds private equity and one-third real estate, according to the SEC filing for the fourth quarter of 2019. Private equity will come under pressure as long as markets are depressed, while credit could achieve superior returns as companies increasingly need to tap credit facilities.
However, Ares’ debt is mostly high risk, high reward, meaning that default rates will inevitably be higher. This means that the results are unpredictable at best, and it is possible that higher numbers of clients will not be able to pay back their loans. Given this, the price-earnings ratio of 31.49 seems overly optimistic, even if it is in line with the company’s median historical valuation according to the Peter Lynch chart.
Disclosure: Author owns no shares in any of the stocks mentioned. The mention of stocks in this article does not at any point constitute an investment recommendation. Investors should always conduct their own careful research or consult registered investment advisors before taking action in the stock market.
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