Speculators Hold the Key to Federated’s Fate

Stock speculators could play a decisive role in determining who ends up owning Federated Department Stores, Wall Street observers said Monday.

Major pensions funds and other big institutions, as well as arbitragers--who often buy shares in takeover targets in the hope of making big profits--now hold an estimated 50% or more of Federated shares.

As a result, they could swing a victory for either of the two bidders for Federated: Toronto developer Campeau Corp. or R. H. Macy & Co.

On Wall Street on Monday, the arbs--as arbitragers are nicknamed--were agitating for a Campeau victory, citing the higher cash value of the Campeau offer. And, in a filing with the Securities and Exchange Commission today, Macy’s is expected to provide details of its offer that it hopes will prove enticing as well to the speculators.

“Whoever appeals to the arbs is going to win,” said one speculator in Federated shares who asked that he not be named. “Right now, it looks as if Campeau has the inside track.”

Macy’s is offering $74.50 a share, or $5.25 billion, for 80% of Federated’s outstanding shares. The rest of Federated’s shares would be swapped for stock in the merged company, Macy’s/Federated Inc. Analysts value the offer at $69 to $71 a share. If Macy’s tender offer begins today, as expected, it would expire April 4.

Campeau, on the other hand, would pay $75 per share in cash for 80% of the shares and $44 a share for the rest after a merger. It values the offer, scheduled to expire March 15, at $68 a share.

Under a tender offer, shareholders are asked to tender, or sell, their shares to a purchaser seeking to gain control of the company. The offers run for a prescribed period but can be extended.

“Assuming Campeau’s offer expires before Macy’s, you’ve got to tender,” said another arb. “You can’t take the risk of tendering for $44 a share on the back end.” In other words, he said, those who sell their shares in the first stage of the deal would get substantially more for their shares, while those who hesitate would risk a much smaller return.

One piece of the puzzle could fall into place today, when Macy’s and Federated are expected to file the SEC documents. Reuters news service reported Monday that Macy’s will report plans to sell off $2.5 billion in assets and claim in the documents that it can double profit margins at Federated stores.

The documents are expected to show that Federated’s operating margins for the year ended Jan. 31 were just under 6% on sales of roughly $11 billion, Wall Street sources told Reuters, but that margin would increase in the next two years to about 11.5% to 12.5% on sales of roughly $12.5 billion to $13 billion.

“The arbs are looking at how fast they can get their money out of the deal,” said Michelle Y. Davis, a retail analyst at Oppenheimer & Co., a New York investment firm. “They’re not as interested in the perhaps more esoteric things that an analyst might look at, such as maintaining ownership in the United States and the long-term realization that one might get” from a merger of Macy’s and Federated.

“The real investors of the world will start buying once they understand what it is they’re going to start buying,” said one Wall Street source close to Macy’s.

But he acknowledged that speculators and institutions hold “well north of 50%” of Federated stock and that “the institutions will act much like arbs.”

“There are some who are better capitalized than others,” he said. “They’re in a position to sit there and make an investment decision. Some of the less capitalized ones are more likely to be sellers.”

For right now, he added, “everybody’s just waiting for the information.”

Ironically, when Wall Street observers are asked about previous instances when arbs and institutions held such clout, most respond: “Allied Stores, of course.”

Campeau succeeded in buying Allied after a two-month battle similar to the one it is waging for Federated. In that situation, Campeau withdrew a tender offer and then made what was called a “street sweep,” buying 48% of the retailer’s shares on the open market in one day, much of it from arbs.

The tactic was first used in 1985 by Hanson Trust. The British industrial company ended a tender offer, then bought a quarter of SCM Corp.’s stock from some willing speculators that gave Hanson control.

Allied’s subsequent claim that Campeau’s move was illegal was shot down by a federal judge in New York. One arb stopped short of suggesting that Campeau might try the same strategy with Federated, but he noted: “Things change.”

Many Wall Street analysts are taking a longer-term view of what a Macy’s purchase of Federated would mean.

“The management is empowered here by the shareholders . . . to do what’s in the best interest of shareholders, employees and consumers,” said Thomas H. Tashjian, vice president of retailing at Seidler Amdec Securities in Los Angeles. “The arbs are looking for short-term payments. Unfortunately for the arbs, management is likely to take a long-term view of things.”

Many institutional holders are waiting to see what develops. Farmers Group, a Los Angeles-based insurance holding company, has a holding in Federated of about 600,000 shares. As for which tender offer the company would choose, Tom Welch, director of corporate investments, said: “I haven’t a clue.” But, he added, “very clearly we are long-term thinkers, buy and hold investors.”

Investment personnel at the University of California System did not mess around waiting to see who would win a potentially bruising battle. The system sold its 2.8 million shares during February as the stock price rose. “We made a little over $100 million,” said Patricia Small, associate treasurer.

“We’re true investors,” she said. “Federated is an old holding for us. In terms of earnings growth, it has not been stellar. We viewed it as an opportunity to sell into strength, with the thought that the deal could have fallen through.

“We made our money and moved on.”