When Texas Pacific Group and Warburg Pincus LLC came up with the winning bid of $100 a share to buy Neiman Marcus Group Inc., Dallas, industry insiders and investors wondered privately whether the glitzy deal would make headlines but not much profit.
Neiman shares are trading below that, with the stock closing at $94.50 on May 12. Now, industry professionals and investors are concerned that the deal leaves little room to generate returns, let alone upscale private equity returns. They say the only apparent ways to reap profit is by taking the firm public, which places a huge bet on the vibrancy of the initial public offering market; refinancing the company, using its real estate as leverage; or selling the real estate.
"In order to increase revenue and returns, TPG and Warburg Pincus are likely to need to open many new stores, something that may begin to impact the ‘exclusive' reputation of Neiman Marcus and impact operating margins, and also something that could be capital-intensive," said Kelly DePonte, partner at Probitas Partners, a San Francisco-based private equity placement agent.
"Too rapid an expansion could impact their core advantage, leading people to wonder not so much how TPG and Warburg will exit, but how they will build value on the road to that exit."
But Mr. DePonte acknowledged that TPG, which successfully invested in Petco Animal Supplies Inc. and European retailer Debenhams PLC, has retail experience. "They may have spotted something that conventional wisdom has missed, but these are the risk points." (Warburg Pincus has little experience in retail other than an interest in a retail real estate investment trust).
The Neiman Marcus deal also leaves other buyout fund managers that specialize in retail wondering how the two private equity firms will exit when the investment periods of their funds end. TPG is using cash from two funds: the $4.5 billion TPG III and the $5.8 billion TPG IV. Warburg Pincus executives have not decided what fund they will draw from, said Jennifer Powers, spokeswoman.
Investors in TPG III include the $126.9 billion California State Teachers' Retirement System, Sacramento, and the Oregon Investment CounOregon Public Employees Retirement Fundlion Oregon Public Employees Retirement Fund, Salem. Investors in TPG IV include the $181.9 billion California Public Employees' Retirement System, Sacramento, and the $80 billion New York State Teachers' Retirement SysNew York State Teachers' Retirement Systemion New York State Teachers' Retirement System, Albany.
One popular way private equity firms have been taking money out of a deal while retaining ownership has been refinancing, a strategy TPG used in the October 2003 Debenhams deal. Traditionally, however, retail companies have been viewed as riskier and more expensive than other types of buyout deals because they come with higher debt costs, said David Mussafer, managing director of leveraged buyout firm Advent International, Boston. Mr. Mussafer specializes in retail deals.
Recently, debt costs have been more favorable for retailers because more debt is available, Mr. Mussafer said. However, TPG and Warburg Pincus are betting that this trend continues when they are ready to pull cash out of the deal, he said.
Another strategy, also used by TPG to acquire Debenhams, is to sell the firm to a "strategic buyer," a company in the same business. But with the stock market down and revenues stagnant, overall merger and acquisition activity has been slowed.
So far, the only competitors for these big-company purchases have been private equity and hedge fund managers. In the case of Neiman Marcus, TPG and Warburg Pincus outbid a consortium of big players.