(Reuters) - Canada's Hudson's Bay Co HBC.TO has hired a debt restructuring adviser to review potential options for combining its business with debt-laden U.S. department store operator Neiman Marcus Group, according to people familiar with the matter.

A man exits a Hudson's Bay department store in Toronto, Ontario, Canada June 6, 2016. REUTERS/Chris Helgren/File Photo

The move is the clearest indication yet that Neiman Marcus’ $4.7 billion debt pile poses significant challenges to a merger between Hudson’s Bay, owner of the Lord & Taylor and Saks Fifth Avenue retail chains, and private equity-owned Neiman Marcus.

Hudson's Bay Executive Chairman Richard Baker set his sights on Neiman Marcus, operator of 42 eponymous stores across the United States and two Bergdorf Goodman stores in Manhattan, two months ago, after larger U.S. peer Macy's Inc M.N spurned his acquisition overtures.

Since then, deal talks between Hudson’s Bay and Neiman Marcus have made little progress, the sources said.

Hudson's Bay has now tapped investment bank Evercore Partners Inc EVR.N, and has asked it to come up with ways that the two companies can combine without Hudson's Bay assuming the full burden of Neiman Marcus' debt, the sources said, asking not to be identified because the matter is confidential.

Hudson’s Bay and Neiman Marcus did not respond to requests for comment. Evercore declined to comment. Hudson’s Bay shares rose as much as 3.1 percent on Monday in Toronto and ended trading up 1.1 percent at C$11.43.

Neiman Marcus’ $2.8 billion loan and $1.6 billion in bonds are trading at deep discounts to their face value, indicating that creditors do not expect to get paid in full, as the company grapples with consumers’ changing spending habits, weak mall traffic, and the increased price transparency brought about by the rise of internet shopping.

An acquisition of Neiman Marcus would normally require its acquirer to assume its debt at its face value. Hudson’s Bay, which already carries about $2.4 billion in debt on a market capitalization of $1.5 billion, would essentially triple its debt load by doing so.

As a result, Hudson’s Bay does not want to repay Neiman Marcus’ creditors in full, the sources said. While the terms of Neiman Marcus’ bonds allow their transfer to a publicly listed acquirer, Hudson’s Bay is reluctant to take them on at full value, the sources added.

Any acquisition offer that would be accompanied by a debt haircut would pit Hudson’s Bay against several hedge funds and investment firms that have acquired Neiman Marcus’ debt and are poised to drive a hard bargain.

These include Oaktree Capital Group LLC OAK.N, Canyon Partners LLC and Capital Group Companies, which have acquired Neiman Marcus bonds, and H/2 Capital Partners, Eaton Vance Management, and GSO Capital Partners, which have invested in Neiman Marcus' loan, the sources said.

Oaktree, GSO, and Capital Group declined to comment. Canyon, H/2 and Eaton Vance did not return requests for comment.

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PAYING NEIMAN MARCUS OWNERS

Adding to the challenges of a deal are Neiman Marcus' owners, Ares Management LP ARES.N and the Canada Pension Plan Investment Board (CPPIB). They acquired Neiman Marcus in 2013 for $6 billion, including debt, and expect to be paid for selling the company, according to the sources, even though the debt markets currently assign little value to their equity.

Neiman Marcus does not face any significant debt maturities until 2020, when its loan comes due, so Ares and CPPIB still have three more years to try to turn the business around.

To convince Ares and CPPIB to let go of any hope of recovering the value of their equity on their own, Hudson’s Bay will have to offer them some kind of payment, the sources said. This puts Hudson’s Bay in a bind, because Neiman Marcus’ creditors will be less inclined to accept a haircut if they see Ares and CPPIB receive such a payment, the sources said.

Complicating negotiations further is a confidentiality agreement between Neiman Marcus’ owners and Hudson’s Bay that has so far prevented the latter from communicating directly with Neiman Marcus’ creditors over a potential haircut, the sources said.

Ares and CPPIB declined to comment.

COMPLEX DEAL

Another possibility that Hudson’s Bay is contemplating is not crossing the 50-percent ownership threshold at Neiman Marcus in any deal, be it through an equity stake investment or a joint venture, the sources said.

This would remove any obligation for Hudson’s Bay to assume Neiman Marcus’ debt, according to the sources. Yet such a deal would make Hudson’s Bay an investor in Neiman Marcus, rather than its acquirer, restricting its ability to achieve the full benefits and cost synergies that typically arise from a shared capital structure and integrated organization, the sources said.

It would also require Hudson’s Bay to pay for a minority stake in a company whose equity is on paper close to being wiped out, the sources added.

Given these challenges, Hudson’s Bay has not yet settled on a way forward, and it is possible that its negotiations with Neiman Marcus end without any deal, the sources said.

With its shares hovering near five-year lows, Hudson’s Bay is keen for any deal that will revitalize its earnings and relieve the burden of paying rent to the real estate properties it carved out into joint ventures. It is now considering an initial public offering of its real estate.

Neiman Marcus has been working on debt restructuring initiatives of its own. Earlier this year, it made changes to subsidiaries holding real estate in Texas and Virginia, as well as its online brand MyTheresa, potentially allowing it to issue new debt to buy back its bonds at a discount.