CPPIB emerges with a jewel from the Neiman Marcus bankruptcy

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Normally, stockholders in a bankrupt company get wiped out. But the Canada Pension Plan Investment Board and its partners in U.S. department store Neiman Marcus Group LLC have emerged from the retailer’s hard-fought bankruptcy process with a possible jewel.

After a series of legal manoeuvres and a bruising battle with creditors, CPPIB and investor Ares Management LLC are now the owners of Mytheresa, the Neiman Marcus-owned online luxury retailer that’s worth hundreds of millions of dollars. The struggle to retain ownership of Mytheresa has allowed Canadians to salvage something from CPPIB’s ownership of Neiman Marcus, one of the pension plan’s more notorious investment missteps.

CPPIB and Los-Angeles-based Ares bought Neiman Marcus in October, 2013. They together put in US$1.55-billion in cash and then used debt, placed on Neiman Marcus’s balance sheet, for most of the rest of the US$6.2-billion purchase price. The two split economic ownership of the company equally. (CPPIB and Ares declined to comment for this story, while Neiman Marcus did not reply to an e-mailed request for an interview.)

CPPIB, then led by chief executive Mark Wiseman and André Bourbonnais, its head of private investments, saw a rare opportunity to stake a position in luxury retail, as shoppers seemed to head to either high-end goods or the bargain basement, squeezing the middle.

According to a report in the Dallas Morning News, Mr. Bourbonnais told a crowd at a breakfast meeting in Neiman Marcus’s headquarters that when people congratulated him about Neiman Marcus, he would reply: “We’re really happy about the deal, but call me in five years when we’ve tripled our investment."

It was not to be. Neiman Marcus spent much of the time under CPPIB’s co-ownership trying to figure out how to pay its debts and negotiating with creditors, ultimately filing for bankruptcy in May, 2020.

However, a seemingly small decision six years earlier paved the way for today’s payoff: After Neiman Marcus paid US$253-million for German luxury goods retailer Mytheresa in 2014, it designated the company an “unrestricted subsidiary” under the terms of some of the company’s borrowings.

That legal designation gave Neiman Marcus far more flexibility with Mytheresa than if it was a typical subsidiary. It was also part of a larger trend in which borrowers have increasing power over creditors, sometimes flipping the bankruptcy script.

An increasing number of lenders have been willing to provide riskier debt financing because of the higher returns. The competition means that savvy borrowers can increasingly insist on better deal terms. That includes the ability to carve out some assets into separate companies, sheltering them from creditors in the case of a loan default or even bankruptcy. That defies the traditional pattern where equity holders are wiped out and lenders walk away with all the assets.

Neiman Marcus would prove to be no exception, and Mytheresa – a seller of luxury clothing, bags, shoes and accessories for women, men and children – would become a flashpoint in a looming bankruptcy.

In September, 2018, as Neiman Marcus continued to struggle with its debts, it moved to transfer ownership of the Mytheresa business, paid as a Neiman Marcus dividend to CPPIB and Ares. “Neiman Marcus' debt agreements expressly permitted the distribution of ownership interests in unrestricted subsidiaries without limit,” Neiman Marcus said in bankruptcy documents.

However, Neiman Marcus’s debtholders immediately balked, with some demanding that the Canadian pension plan and Ares return Mytheresa to Neiman Marcus and remove the unrestricted designation, and others demanding Neiman Marcus use Mytheresa’s stock to backstop its borrowings.

In anticipation of a bankruptcy filing, Neiman Marcus says, it added “disinterested" members to its boards and gave them the power to determine if there were conflicts of interest in the Chapter 11 case. An investigation by Scott Vogel, one of those disinterested board members, later determined that creditors could likely make a “fraudulent conveyance” claim against Neiman Marcus because there was a strong possibility it was insolvent at the time it distributed Mytheresa to CPPIB and Ares, for no consideration in return.

Ultimately, in a settlement to resolve the legal battle, Neiman Marcus issued a series of special shares and guarantees that promised the first US$500-million in proceeds from an eventual sale of Mytheresa would go to the unsecured creditors, not CPPIB and Ares. Neiman Marcus entered bankruptcy in May of this year and emerged in September, with CPPIB and Ares losing their equity investment in the company.

The two still have Mytheresa, however. With the passage of time, it’s entirely possible the owners can realize a value for the company that settles matters with the creditors and still leaves some return for themselves, albeit likely less than what they put into Neiman Marcus in 2013.

Neiman Marcus says in its bankruptcy documents that it tried to sell Mytheresa in May, 2019. It was able to tout sales growth of 28.5 per cent over two years and a profit margin of 5 per cent to 7 per cent, as measured by EBITDA, or earnings before interest, depreciation and amortization. Free cash flow – generally understood to be cash from operations before capital expenditures – was break-even to negative in the period, however.

The sale was abandoned, Neiman Marcus says, when the best offer received “was only for approximately US$525-million” – double what it had paid for it five years before.

In February of this year, Mytheresa was considering an initial public offering on the New York Stock Exchange, according to Reuters, with a potential US$500-million valuation.

Since then, apparel retail has dealt with two competing phenomena in the COVID-19 era: People aren’t going to the office or big social gatherings, so they have less need to dress up. But when they do shop, they increasingly do so online – which has helped the shares of many online-focused retailers explode in 2020.

Shares of three Mytheresa peers who list their shares on European stock exchanges – Zalando SE, Global Fashion Group SA and ASOS PLC – have increased between 80 per cent and 104 per cent since the end of July, 2019, when Mytheresa suspended its sales process.

Shares of Farfetch Ltd. and RealReal Inc., which listed in the United States, have risen by 34 per cent and fallen by 42 per cent, respectively, over that same time, according to S&P Global Market Intelligence. (Shares of RealReal, a luxury goods consigner, have more closely tracked the COVID-19 struggles of the broader market than the other retailers.)

Michael Kliger, CEO of Mytheresa, told Women’s Wear Daily in a September interview that his company’s revenue and profit has grown during the pandemic. In the year that ended June 30, sales rose nearly 20 per cent year-over-year and there was a “significant” increase in profit. During the pandemic, Mr. Kliger told the publication, Mytheresa saw “many more first-time customers, and possibly even customers who had never shopped online, anywhere before.”

Investors in publicly traded online retailers are clearly betting that some of those gains will stick. And to the extent Mytheresa has increased in value since that 2019 assessment, CPPIB – and Canadians – will collect its share of those gains, giving it a lot more than a postbankruptcy goose egg.

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