Bankruptcy court has emerged as a shopping mecca of sorts for Sparc Group, which, after successfully bidding on a series of retailers in Chapter 11, is now the "operating partner" for Aeropostale, Forever 21, Lucky Brand and Brooks Brothers, and is a rumored suitor of J.C. Penney. The venture says it supports "over $2.7 billion in global retail sales annually."
"Sparc Group" isn't a typical retail enterprise, but, rather, half mall developer Simon Property Group, half brand conglomerate Authentic Brands Group — an entity designed to, as Simon CEO David Simon told analysts earlier this month, capitalize "on various value-creating opportunities." He downplayed the venture as requiring minimal investment with several advantages (including acquiring inventory "at or below cost," and assets like intellectual property "at attractive values"), such that Sparc expects any acquisition to reap dividends within a year. Simon also described the activity as taking advantage of each partner's particular strengths.
"[I]t's not like we want a huge portfolio of this. But listen, ABG, Authentic Brands Group, is a fantastic intellectual property group, does business throughout the world and has a ton of brands ... and they provide a lot of value on sourcing, marketing, international operations, et cetera," he said. "They're very, very good about understanding where there is value in the brand because they know how they can monetize that intellectual property. Obviously, we have a point of view because we know what the consumer likes. So, you put the two of us together in a room and that's how we do it."
Simon made it sound easy, but running a mall real estate investment trust and running a retailer are "two totally different businesses," according to James Angel, professor of finance at Georgetown University's McDonough School of Business.
"This is a very different change in direction, you have to wonder what's in it for Simon Group," Angel said in an interview. "It's highly unusual for a landlord to get into the retail business, but we're in very unusual times."
The sticking points
There are a number of reasons why landlord ownership of retailers is less than ideal for mall tenants, whether or not they're the ones owned by the mall.
The retail tenants not owned by the mall may look askance at the ones that are, especially if they're competitors, notes Angel. "Now I'm starting to view my landlord as my competitor, so there's definitely a channel conflict there," he said. "Will they scare away other tenants? That's the big strategic question."
Further, some leases that Sparc is taking over in bankruptcy are with other malls. As Simon noted to analysts, the agreement gives Sparc wide latitude in closing any Brooks Brothers or Lucky Brand stores, but that begs the question of whether negotiations with non-Sparc malls would be in the retailer's best interest, or in Simon's, Angel noted.
"Now I'm starting to view my landlord as my competitor, so there's definitely a channel conflict there. Will they scare away other tenants? That's the big strategic question."
Professor of Finance, Georgetown University's McDonough School of Business.
Other conflicts range from disparate fiduciary obligations to more complex financial, tax and other considerations, according to retail analyst Nick Egelanian, who calls the arrangement "full of holes and the equivalent of the proverbial house of cards." That's in part due to the unique requirements of a REIT, which include having to derive its funds from operations, or FFO, from a minimum threshold of rent, mortgage interest or real estate sales.
"Simon is buying bankrupt companies that without restructuring cannot pay rent to his REIT," Egelanian, president of retail development firm SiteWorks, said in an email. "Yes they have other problems, but presumably, if they had real value as ongoing concerns, a whole host of potential buyers would be lining up to [buy] them."
ABG clearly sees enough brand equity left at these banners to invest in them, while Simon has evidently determined that taking over a tenant in some cases is the best way to ensure success as a landlord. How these brands fare long term as Sparc-controlled retailers remains to be seen. In some cases, they actually needed to scale back their footprints, more than Simon may be likely to agree with, at least when it comes to Simon malls. Others also need help in other areas, like merchandising.
Moreover, while Simon CEO David Simon has long touted the 2016 purchase of Aeropostale as a success, it also remains to be seen how lucrative the ownership play proves to be for others as it expands.
"What else is he going to do?" Shlomo Chopp, founder and CEO of ShopFulfill, a retail infrastructure concept that integrates physical and digital operations, said in an interview. "Just let them go out of business and hope that someone else comes along? But Forever 21 was a stretch, with Brooks Brothers I don't think it's a bad move. For Brooks Brothers, they can cut SKUs to a minimum and stick with what sells best, it's a merchandising problem. But if they were to go and buy J.C. Penney, that's pure borrowed time."
Fighting the inevitable decline of the mall
Simon is simply fighting an uphill battle — the now accelerated decline of malls, according to Chopp and Egelanian. Simon, as an operator of mostly higher-quality shopping centers, is widely seen as protected from that.
That's partly due to the pandemic, which has toppled the weakest retailers into bankruptcy, with more store closures likely, according to an Aug. 11 client note from Wells Fargo. "We expect the pandemic will accelerate the rationalization of retailer store counts, much of which has yet to flow through earnings," analysts wrote, noting that in the second quarter, Simon Property Group's occupancy was down 150 basis points, with 4% exposure to bankrupt tenants. "We expect higher-productivity malls to fare better within the mall sector but malls have limited 'essential' services to drive traffic, putting them at a disadvantage vs. grocery-anchored open air shopping centers where customers are more comfortable shopping today. Well-capitalized operators such as Simon are able to offer assistance in the form of abatements to help small shop local tenants get through closure periods."
Both Chopp and Egelanian see Simon's immunity as overstated, however. And, while Simon may have successfully propped up Aeropostale, and the apparel retailer may even be profitable, the tactic of buying up tenants is unlikely to succeed beyond the short term, according to Egelanian.
The deterioration of malls and their increasingly irrelevant department store anchors, which goes back some 40 years, has wiped out traffic to specialty retailers, one reason many, including Gap, Sephora and others, are turning to strip malls instead. That has financial implications for REITs, which essentially trade like bonds: The required FFO productivity is undermined by "department store obsolescence, apparel retail evolution and the pandemic" a "triple threat that all but doomed all but the very best malls," according to Egelanian.
"Without department stores driving traffic and small (mostly apparel) stores paying historically high rents and operating costs, the mall REIT model simply no longer works, particularly in an era when retailers like H&M and Zara have redefined apparel value," Egelanian said. "The act of buying or propping up retailers in this sector cannot alter the larger systemic realignment that is in its final phase of playing out in American retailing and will eliminate 80% of the remaining malls still operating when it is complete."
Still, despite agreeing with much of that, Georgetown's Angel doesn't believe Sparc should be counted out just yet, given David Simon's knowledge of the sector. "As long as Simon has the solvency to get through the pandemic — there's a big fire sale going on and it's his chance to pick these retailers up cheap," he said. "At the end we might admire that he had the intestinal fortitude, or we'll look at him as an idiot who bought a dog with fleas."
Correction: An earlier version of this story included a typographical error in a quote. The quote has been corrected.