Does a Hudson Bay/Saks REIT Make Sense?

Tickers in this article: SKS SPG
NEW YORK (TheStreet) - Canada's Hudson Bay Company, which announced on Monday that it is buying Saks Inc. for $2.4 billion, has indicated that it will spin off the real estate holdings of the combined company into a real estate investment trust. The question is whether that move would be good for the company or for investors.

A REIT conversion would be good for Hudson Bay's balance sheet. If the Saks' deal with Hudson Bay closes, the combined company would be taking on considerable debt. The best way for Hudson Bay to reduce the debt is to monetize its real estate portfolio.

With a REIT structure, the company could recognize a lower cost of equity via the higher trading multiples associated with REIT securities. Hudson Bay could list shares as a REIT and monetize its real estate to support its retail operations.

The real estate holdings of the combined company would be vast and valuable. Hudson Bay operates 90 Hudson Bay department stores in Canada and 48 Lord & Taylor department stores in the U.S. Saks has 41 Saks Fifth Avenue stores, including its iconic flagship store in midtown Manhattan, and it has 67 OFF Fifth stores. Hudson Bay plans to bring Saks into Canada and other countries.

The real estate and retail operations are inextricably related; the success of a REIT model would depend on the success of the stores. Although reducing debt can help store-level profitability, retail operations are unique.

In that context, think Bergdorf's. It owns valuable real estate in Manhattan, but without its successful high-end retailing business, it would fail.

Meanwhile, I don't see the advantages of a REIT conversion for investors. A Hudson Bay/Saks REIT would offer little in the form of tenant diversification, and Hudson Bay's core competency is operations, not real estate.

It may be better for Hudson Bay to sell its real estate to an existing REIT like Simon Property Group , a giant REIT with a $81.5 billion market cap, with eight stores leased to Saks, according to SNL Financial.

Hudson Bay and Saks are good at selling stuff, and if a retailer isn't good at that, there's nothing a REIT can do to save it.

At the time of publication the author had no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.