Expect Richard Baker to raise his Hudson’s Bay bid

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Here are two fearless predictions on the Hudson’s Bay Co. takeover battle: Richard Baker and his allies will increase their $1-billion offer for the department store chain, and they will do it with other people’s money.

Mr. Baker, governor and executive chairman of HBC, knows his group’s current $9.45-a-share bid is “dead on arrival,” to quote one of the retailer’s largest shareholders, Land & Buildings Investment Management LLC. Independent HBC directors were only slightly less dismissive when they called the offer “inadequate” earlier this month, even while they awaited a formal valuation of the chain’s real estate. Private equity fund Catalyst Capital Group Inc. is also snapping up shares, announcing on Monday that it has bought a 10 per cent stake in HBC for $10.11 a share. Catalyst is among the investors opposed to Mr. Baker’s plan.

It is hard to imagine Mr. Baker giving up. The second-generation real estate mogul has consistently said he has a strategy to stanch the bleeding from HBC’s retail operations - the chain lost $837-million last year - while coining money in the future from renovating some of its landmark properties. The 53-year-old executive’s credibility is on the line. Land & Buildings is pushing to have Mr. Baker tossed off the HBC board if the bid doesn’t go forward. Moreover, the chain’s managers have pointed to the value of the prize, as HBC chief executive Helena Foulkes estimated at a conference last September that the company’s real estate is worth $28 a share.

If Mr. Baker and his group do up the offer, the question will be where they get extra money, and how much they need to get a deal done.

Assume for a moment a worst-case scenario, with no more cash available to Mr. Baker and his partners, Rhone Capital LLC, WeWork Property Advisors, Hanover Investments (Luxembourg) SA and Abrams Capital Management LP, a consortium that already owns 57 per cent of HBC. In this unlikely situation, Mr. Baker can simply tap his relationships with some of the deepest pockets in the real estate industry.

Several years ago, HBC struck a joint venture on 42 U.S. properties with mall owner Simon Property Group LP and other institutions, including Ivanhoé Cambridge, an arm of the Caisse de dépôt et placement du Québec. In Canada, HBC co-owns 12 properties with RioCan Real Estate Investment Trust, a list that includes prime locations in Vancouver, Calgary, Winnipeg, Toronto and Montreal.

If Mr. Baker were playing poker, HBC’s joint ventures would be his extra chips. Unlike illiquid real estate, HBC can quickly convert partnerships into cash by simply selling a portion of its stakes. HBC currently owns 63 per cent of its U.S. joint venture and 87 per cent of the Canadian partnership. Mr. Baker’s group can increase its offer for HBC by borrowing from the likes of Simon, Ivanhoé Cambridge and RioCan, knowing that once the company is private, it would have the means to repay them.

For a sense of just how much money can be made from renovating supposedly out-of-fashion retail properties, look no further than a recent project RioCan highlighted for analysts at a presentation in June. The company spent $221-million to turn a midtown Toronto street corner occupied by a bank branch into a 466-unit condominium, and came away with a property worth $327-million, booking a $120-million profit. Mr. Baker’s group sees similar opportunities throughout the HBC portfolio.

How much will it take for Mr. Baker’s group to win over HBC’s independent directors and strike a friendly deal to take the company private? That dance will play out in September, after HBC’s investment bankers at TD Securities Inc. turn in a formal valuation.

However, analyst Mark Petrie at CIBC World Markets says when he takes into account the significant challenges facing department stores, along with the underlying value of the real estate, he calculates HBC is worth $10.25 to $11.25 a share. An offer in the midpoint of that range would cost Mr. Baker and his allies about $150-million more than they are currently offering, cash they could easily raise from HBC’s real estate partners. That may be enough to take HBC private for the second time in the storied company’s 350-year history.

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