Department stores have been under threat for some time now as shoppers shift to discount stores, fast-fashion retailers, and buying directly from brands that have opened their own retail stores or newly launched websites. Several household names are struggling including Kohl’s, JC Penney, Saks Fifth Avenue, and Neiman Marcus, among others. But it is Macy’s that recently made the headlines.
Investors are Circling Macy’s and Its Assets
Macy’s (and Bloomingdales which it owns) may be the next major department store to disappear as two investor groups, Arkhouse Management and Brigade Capital Management, submitted a buyout proposal of approximately $5.8 billion or $21 per share, a 32% premium at the time of the offer. It isn’t clear what the investment groups, if successful, intend to do with the company i.e., keep it as a going concern or sell off all or some of the real estate assets. The question is meaningful as Macy’s remains among the world’s largest department-store chains with more than 94,000 employees and countless suppliers—all of whom would be impacted by store closures. With 783 stores, the malls that house these stores would also be affected by any major change to its operations.
But with “years of chronic underperformance,” according to one industry insider, Macy’s real estate may be worth more than its retail business. Net sales for the first nine months of 2023 declined by approximately 8% compared to the same period in 2019 (pre-pandemic) and profit has declined by 22%. To state the obvious, this is not good and directionally not where the retailer wants to be going.
The Crown Jewel is the Real Estate Portfolio
Many national retail chains rent—and don’t own—the stores where they operate. Macy’s, on the other hand, owns more than 300 of its locations and investors believe the stores are as valuable as the retail business and perhaps even more so.
Certain estimates put the real estate portfolio at $6 billion with the managing director of the research firm, GlobalData, saying its “real estate is the jewel.” But real estate values like these where the end-user occupant is also the owner are never easy to underwrite. Typically an end user pays a premium above and beyond what a traditional investor would pay who looks at value based solely on the current or potential income. It is also worth noting that capitalization rates—the standard metric for valuing income producing properties—have increased substantially since the Fed began increasing rates but are expected to decline as the Fed begins cutting rates in 2024. Lower capitalization rates mean high asset values. That said, this may arguably be the ideal time to acquire Macy’s for its real estate portfolio.
Things are never so simple, however. Each Macy’s-owned property requires thorough due diligence as certain locations have deed restrictions that could hinder the development or re-purposing of these assets. Zoning issues as well could impact value. Another critical issue is understanding the value of Macy’s flagship New York store in Herald Square which is estimated to account for about a fifth of the value of the total real-estate portfolio, or $1.2 billion. Do you sell off all the other assets and keep the flagship store or do the opposite?
In short, Macy’s real estate assets are unquestionably quite valuable but how much specifically requires a deep dive by attorneys and other specialists to ascertain the impact of deed restrictions and zoning issues. No doubt something Arkhouse Management and Brigade Capital Management took into account.
Past Acquisitions by Activist Investors Didn’t Bode Well for the Targets
A quick revisit of similar transactions from the past should worry Macy’s executives and equity investors may want to make use of the few remaining lifeboats and get out with the recent increase in the stock price in case the deal ultimately sours along with the stock price.
One approach the prospective Macy’s investors may pursue is a sale-leaseback where they sell off the real estate but keep Macy’s as the tenant. A higher rent paid by Macy’s would be good for the sale of the real estate but more burdensome for the retail business. Private-equity firms that bought Mervyn’s, a now defunct department-store chain, split the business into an operating company and a property company and pursued a sale-leaseback structure. The economy teetered into recession and the company went out of business in 2008.
The hedge-fund manager Eddie Lampert bought Sears and sold off its real estate and invested very little into the retail operations. Today, Sears is a shell of its former self with just a handful of stores, down from thousands at its peak.
Is it the End of Macy’s
The fate of Macy’s is still up in the air but its demise would be disheartening especially if the perennial Thanksgiving Day Parade disappears. The first parade took place in 1924 (this year would mark the 100th anniversary) and it was first televised on NBC in 1953 and my mother was in attendance. But perhaps like a good Nick Cave murder ballad, “all beauty must die.”
Website Source: Kapner, S. (2023, December 12). Macy’s $5.8 Billion Question: What’s More Valuable, Real Estate or the Business? WSJ. https://www.wsj.com/business/retail/macys-billion-dollar-question-whats-more-valuable-real-estate-or-the-business-e6477c8e?mod=hp_listb_pos1
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