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The guardian of Canada's massive $183.3-billion taxpayers' pension fund has developed an taste for luxury retail. It may find this isn't the easiest sector to swallow.
The Canada Pension Plan Investment Board (CPPIB), along with its private-equity partner Ares Management LLC, announced a deal Monday to buy a majority stake in U.S. luxury chain store Neiman Marcus Group. The price is $6-billion (U.S.); Ares and CPPIB are splitting the cost.
In doing so, it's making its first significant investment into a segment of the retail sector that is considerably riskier than is often assumed, at a time when assets look distinctly overvalued. Analysts at Merrill Lynch recently identified the consumer discretionary sector as the most overpriced sector in the S&P 500, with an implied price downside of a whopping 39 per cent based on price-to-book-value valuations. Within that, the luxury-goods segment is showing 44-per-cent price downside. The sector is near a record-high value relative to the rest of the S&P 500; typically, that's an indicator of a sector at the peak of its cycle.
And Neiman Marcus's current owners, private-equity firms Warburg Pincus and TPG Capital, haven't exactly had a great time as owners of this luxury gem themselves. The selling price of $6-billion represents an 18-per-cent premium over what Warburg and TPG paid when they bought Neiman Marcus in 2005 – an average of just 2.2 per cent a year on their initial $5.1-billion investment.
CPPIB isn't the only Canadian pension plan to have recently satisfied a hankering for a slice of the U.S. luxury market. Earlier this summer, the Ontario Teachers' Pension Plan plunked $500-million into Hudson's Bay Co. to help finance the Canadian retailer's $2.4-billion purchase of Saks Inc. – which, like Neiman Marcus, is a famed U.S. luxury brand that is still trying to find its footing in the wake of the Great Recession.
The official logic for buying seems to be that luxury retail is a high-margin business that is resilient to economic downturns, since the rich can still afford to be rich even when the economy goes sour. But there's not a lot of evidence to support that notion. The S&P Global Luxury Index, which tracks the biggest luxury-related companies in the world, lost two-thirds of its value during the Great Recession – suffering even deeper losses than the broader stock indexes such as the S&P 500 and the MSCI World Index.
Saks's stock fell from a high of more than $22 a share to a low of $1.55. Neiman Marcus's sales fell nearly 25 per cent from 2008 to 2009; they are still below their pre-recession level. According to Bloomberg data, the company's book value is less than half of what it was when Warburg Pincus and TPG bought it in 2005.
So why buy? The pension funds can trot out logic, but the simple truth is that they have a lot of money to invest, and limited quality assets to buy. And they need to generate returns in a low-yield environment.
One colleague in the newsroom aptly described CPPIB as a "great blue whale" – a huge fund basically swimming around the world with its mouth open, inhaling any investment that looks even moderately edible. Its private investing portfolio is a veritable grab-bag of businesses, and the addition of luxury retail adds something new to the mix. But this particular morsel may prove less profitable, and more risky, than it looks.
David Parkinson is a contributor to ROB Insight, the business commentary service available to Globe Unlimited subscribers. Click here for more of his Insights, and follow him on Twitter at @parkinsonglobe .