Saks sale: As pricey as its designer shoes

(Fortune) -- Saks, known for selling high-priced handbags and designer apparel to wealthy shoppers, may find its richly valued stock price a hindrance to its biggest sale yet: that of the company to a pair of foreign investors.

Late Monday, the Baugur Group of Iceland, which owns British retailers House of Fraser and Karen Millen, disclosed in a regulatory filing that it was interested in making a joint proposal for Saks (Charts) along with the Landmark Group, a Dubai-based company that is controlled by the Indian retail magnate Micky Jagtiani.

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Baugur, which owns 8.5 percent of Saks, making it the company's second largest shareholder behind Mexican billionaire Carlos Slim Helu, said it expects to seek discussions with Saks management and the board of directors, although it cautioned that there is no guarantee that an acquisition will happen.

One hurdle to a potential deal is Saks' valuation, which has soared over the past two weeks on speculation that Baugur could be lining up a bid. The stock is up 11 percent through Monday, adding some $2.8 billion in market capitalization. On Tuesday, shares shot up another 5 percent.

"There is a limit to what someone would be willing to pay," said a Wall Street executive familiar with the company.

Its lofty valuation aside, Saks is an attractive acquisition target for many reasons, as Fortune.com recently reported. After years of infighting among top management, Saks' executive suite has unified around a strategy that includes store refurbishments and merchandise that better caters to local tastes. The changes are starting to pay off in the form of fatter sales and profit margins.

At the same time, Saks is building a footprint abroad. In addition to its 103 U.S. stores, Saks now operates in Saudi Arabia and the United Arab Emirates. Other locations are planned for Mexico City and Shanghai.

What's more, despite recent market jitters, luxury retailers are commanding premium valuations these days. That's partly because the market for high-end goods is considered insulated from the broader consumer slowdown linked to the housing downturn.

Warburg Pincus and the Texas Pacific Group, for instance, snapped up Neiman Marcus in 2005 for $5 billion. Earlier this year, Istithmar, a Dubai-based investment firm, bought Barneys New York for $942 million. Both companies commanded eye-popping valuations. Bear Stearns estimates that Barneys sold for an enterprise value (equity + debt - cash) of nearly 15 times cash flow, compared with an average multiple of nine times for other recent department store deals.

In the case of Saks, the company is likely to garner a scarcity premium: It's one of the last American luxury retailers on the block.

Even by those standards, however, Saks shares already look rich. Daniel Scalzi of Matrix USA estimates that Saks' enterprise value is currently 17 times earnings before interest, taxes, depreciation, amortization and operating leases -- a widely-used measure in the retail industry known, in Wall Street jargon, as EBITDAR.

That makes Saks the most expensive stock in a group of 16 retailers tracked by Matrix. Nordstrom (Charts, Fortune 500), which resembles Saks in terms of its luxury bent but has higher operating margins, has an enterprise value of just eight times EBITDAR, according to Scalzi.

An "already lofty" valuation for Saks shares is one reason why Morgan Stanley's Michelle Clark wrote in a recent report that the stock could trade lower if a deal is not announced soon -- perhaps as soon as November 20th, when the company is scheduled to release third-quarter earnings.

Yet with the looming holiday shopping season likely to sideline deal talks, it's possible that Saks shares, like any unsold merchandise, could wind up in the markdown bin.