Friday, December 01, 2006

BJ's Land a Buyout Lure

BJ's Land a Buyout Lure
By Nicholas Yulico Staff Reporter

11/30/2006 7:04 AM EST


Imagine buying a retail stock and getting $750 million of real estate value for free. That's essentially the deal that investors are getting at BJ's Wholesale Club (BJ) -- and it is one reason why buyout firms may be circling. With the recent departure of the company's chief executive, talk of a possible leveraged buyout for BJ's is heating up. Much of the interest has to do with "hidden real estate value," a retailing play made famous by Ed Lampert's successful merger of Kmart and Sears in 2004, which resulted in the giant now known as Sears Holding (SHLD) . BJ's has long been tossed around as a buyout candidate because it has the qualities that private equity loves. The company owns more than a third of its properties, has just $11 million of long-term debt, and should post $300 million of annual earnings before interest, taxes, depreciation and amortization (EBITDA) next year.
Moreover, BJ's real estate alone is worth at least $750 million, according to an estimate calculated by The abrupt departure of BJ's CEO Mike Wedge last Wednesday, just 48 hours before Black Friday, was "too odd to ignore," wrote JP Morgan analyst Charles Grom in a research note last week. The stock bounced 10% on the news that Wedge was leaving. The departure "leads us to believe that the company's Board of Directors may be beginning to think strategically, including a potential sale of the company or other recapitalization alternatives, including real estate divestitures," Grom wrote.
BJ's stock, currently at around $32, has an enterprise value of $2.1 billion, which is 7.4 times trailing twelve-month EBITDA. Costco (COST) , the largest U.S. wholesale club operator, has a $53 stock that trades at 9.6 times trailing EBITDA. BJ's deserves to trade at some sort of discount to Costco because it has posted slower earnings growth in recent years and faces more challenges as the country's third-largest wholesale club operator. Sam's Club, which is owned by Wal-Mart (WMT) , is the second-largest discount club. However, even if you apply a slight discount to the Costco multiple and add to that a bottoms-up analysis of the real estate, you get a big number for BJ's stock value, says one large investor in the stock who spoke on the condition of anonymity. "This makes for the perfect going-private transaction," the investor says. Another large owner of the stock believes that BJ's is worth at least $38 in an LBO and estimates the real estate is worth about $1 billion.

Real Estate Value Unrealized

According to the company's annual report, BJ's had 165 warehouse club locations as of January, of which 48 are owned and 11 locations are ground leases (where the company owns the building, but leases the underlying land). The remaining stores are leased. BJ's doesn't specify which specific locations are owned, and a company spokeswoman declined to provide this information. The Natick, Mass.-based company's stores are spread across the Eastern seaboard, with a little more than half in New York, Florida, Massachusetts and New Jersey -- all desirable locations from a retail and real estate perspective Strong buyer demand for such properties has driven down cap rates, or initial rates of return, boosting real estate values to all-time-high levels. The demand is coming from real estate investment trusts, 1031 tax-exchange buyers, and high-net-worth individuals looking for tax shelters, industry experts says. CB Richard Ellis, a leading commercial real estate firm, is currently marketing for sale a rather typical BJ's Wholesale Club in Cutler Bay, Fla., just south of Miami. The seller is a private real estate investment trust. The cap rate is 6.75%, with initial rents of $8.40 per square foot per year. The 108,000 square foot property is being sold for $13.4 million. Jeffrey Thomas, the CB Richard Ellis broker who is marketing this listing, believes a 7% cap rate is a conservative number to apply to BJ's national portfolio of 48 owned stores. In fact, the true cap rate could be closer to 6.5%, he says. For the 11 sites where BJ's has a ground lease but owns the building, a higher cap rate of 8.25% to 8.5% should be used, he says. Using these cap rates and CB Richard Ellis data, came up with a value of about $750 million for the 59 stores that BJ's owns -- and that's likely a conservative estimate. This analysis uses a relatively low annual rent of $8.50 per square foot. CB Richard Ellis broker Greg Dalton says rents for new warehouse clubs typically range in the $10 to $15 per-square-foot range, per year. Old stores might see rents in the $7 to $9 range, he says. Higher rents would result in higher property valuations. BJ's balance sheet lists the value of its land and buildings at $584 million before accumulated depreciation. (The company doesn't specifically break out the depreciation charges for the land and buildings, so it's hard to decipher the book value of these assets, which would be lower). The company's stock isn't reflecting the true value of the company's real estate. On a sum-of-the-parts analysis, the company's adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) estimate for next year would be $245 million after the sale of all real estate. That estimate subtracts additional annual rental expenses. Over the past eight years, companies paid an average 10 times EBITDA on the 32 large merger and LBO transactions among retail stocks, according to A.G. Edwards. Applying a seven-times multiple to that adjusted EBITDA stream (roughly where the stock is currently trading now) and adding back the approximate $750 million of real estate, the stock is worth at least $37.

Value-Creating Moves Needed

There are several ways the company can realize this real estate value. BJ's could sell the entire real estate portfolio in a sale-leaseback transaction and then distribute the profits to shareholders in the form of a special dividend or share buybacks. The company also could recapitalize itself by keeping the real estate, then levering up the balance sheet to buy back shares -- a method that CBRL Group (CBRL) , owner of the Cracker Barrel stores, pursued last year. Cathy Maloney, a BJ's spokeswoman, declined to comment on these potential scenarios or a possible company buyout. She says the company's board had previously looked at doing a sale-leaseback, but they "have a bias against doing that." "They want to maintain an investment grade rating. We wouldn't want to put that into risk by taking on more lease obligations," Maloney says. BJ's has about $130 million of minimum lease payments due next year, excluding the 10 new stores expected to open this year. It's questionable whether doing a sale-leaseback would hurt the company's expansion efforts, as Maloney suggests. "Companies like Best Buy (BBY) and CVS (CVS) own virtually no real estate assets and have great credit ratings," says Christopher Volk, CEO of Spirit Finance (SFC) , a REIT that specializes in sale-leasebacks. A better case can be made that the real estate the company owns is going to waste right now, since it has absolutely no value in the stock market. Unless the company wakes up to this fact, the quickest and easiest way for shareholder value to be restored looks to be an outright sale of the company. And a buyout of at least $37 sure could be reasonable.


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