Activist hedge fund Starboard Value once had a plan for struggling department store chain Macy’s.
In January 2016, Starboard founder and CEO Jeff Smith and his team outlined in a presentation their vision for how the company could unlock what they said was $21 billion in assets — namely, Macy’s real estate holdings — by spinning them off from the retail business.
The department store retailer didn’t bite, and the hedge fund couldn’t rally enough shareholders to try to force the issue. This May, a frustrated Starboard finally surrendered, writing in a securities filing that it had sold its entire stake in Macy’s — almost 1% of the company.
The episode is emblematic of the different mentalities of retailers and the financial gurus that own their stock. While Starboard wanted to pump cash out of Macy's, the retailer wanted maximum control over its financial and geographic destiny.
Macy’s — just a decade after adding 1,000 new stores in an aggressive expansion — maintains that it is determined to reap what cash it can from its real estate. But in taking a slower, more careful approach, the company might have missed an opportunity to get the most value for its real estate.
Now, as the retailer sheds many dozens of unproductive stores, it could have trouble finding buyers for the properties it actually wants to sell. The reason for that is simple, well-known and even more troublesome for Macy’s: Department stores and the malls that house them are in a steady decline.
Starboard did not respond to requests for comment from Retail Dive. A spokeswoman for Macy's declined to comment specifically for this article and instead referred Retail Dive to previous public statements.
The activist and the retailer
Macy’s has historically chosen to own its real estate whenever possible as a way to add certainty to its balance sheet.
As of January 2017, the company owned outright 382 of its 829 stores in the U.S. “They did a calculation and decided it was more efficacious to own real estate and therefore control real estate costs rather than be subject to the vagaries of the marketplace by paying rent,” Mark Cohen, a former retail executive and current director of retail studies and an adjunct professor at Columbia University’s Graduate School of Business, told Retail Dive. “This is not a haphazard decision. It was a decision made a long time ago and a decision they have pretty much stuck to because they have financial capacity to own their own portfolio.”
By owning its real estate, Macy’s could guarantee itself a degree of financial stability. It can operate those stores with minimal expenses — essentially, just the cost of operating the store plus maintenance and other minor costs that pale compared to rent, Cohen said. “It’s stable, predictable, reliable as you look out to the future… This is a tremendously effective way to operate.”
“It’s stable, predictable, reliable as you look out to the future… [Owning your stores] is a tremendously effective way to operate.”
Director of retail studies at Columbia University Graduate School of Business
As Daniel Herrold, a senior director with the real estate brokerage and advisory firm Stan Johnson Company, describes it, big-box retailers like Macy’s see rent as debt and want as little of it on their books as possible. But where Macy’s saw a financially stable operating model, Starboard saw value that was trapped and could be passed on to shareholders — itself among them. Starboard estimated last year that Macy’s could unlock $10 billion of shareholder value by separating its $21 billion in real estate assets from the retail operations.
The disagreement in viewpoints went all the way down to the store level. As Herrold points out, Starboard wanted Macy’s to sell “the good stuff” — the most productive store properties in the most valuable real estate areas. Instead, Macy’s wanted to hold onto its best properties and sell off the laggards.
For example, Starboard estimated that Macy’s flagship Herald Square store in New York was worth roughly $4 billion and its Downtown Macy’s store was worth $3.4 million. These are among the crown jewels of Macy’s real estate holdings — and in some sense, Starboard was proposing pawning them.
The hedge fund suggested Macy’s could roll up its iconic properties and mall properties into separate joint ventures, which it could then co-own through an equity sale with a real estate partner. Macy’s would then lease back those properties from the joint ventures to itself so it could keep its stores in those locations. Down the road, Starboard suggested Macy’s could cash out of the joint ventures by putting them up for an IPO, reaping a windfall of cash for Starboard and other shareholders. To sweeten the deal for Macy’s, Starboard noted that the joint ventures — being real estate ventures capable of supporting higher levels of debt than retailers — could take on “substantial leverage” to the tune of $8 billion that could be used to pay off the debt on Macy’s the operating company.
Not a ‘fire sale’
There is a precedent for the kind of complicated financial engineering Starboard proposed.
In 2015, Sears sold more than 230 stores for $2.7 billion to a real estate investment trust (REIT) created for precisely that purpose. Called Seritage Growth Properties, the REIT is chaired by Eddie Lampert, the hedge fund mogul who is also Sears CEO and holds significant stakes in both Sears and Seritage. Canadian retail holdings company Hudson's Bay has also forked over properties to a joint venture created in tandem with Simon Property Group and Canadian REIT RioCan. The company's executive chairman said recently that Hudson's Bay moved too slowly in putting the joint venture up for an IPO, according to a transcript from Seeking Alpha.
Although shareholders have applauded some of these moves, not everyone thinks they represent sound business strategy. “Sears doesn’t really have an operating strategy,” Cohen said of perhaps the most prominent and controversial example of a retailer selling off its real estate assets. “They have an asset-stripping strategy. They are using their real estate portfolio to allow them to stay solvent… It is asset stripping at its ugliest and at its worse.”
About two months before Starboard's presentation, Macy's executives said they had examined the possibility of spinning off property into a real estate investment trust. They decided against it, based on the need for financial agility and the credit benefits of asset ownership to manage a changing, and worsening, retail sector. "We have lived through enough downturns and bankruptcies to know that there is a real benefit to the retailer of maintaining the flexibility of an investment grade rating and having access to capital in all markets, particularly when the industry is in flux," Karen Hoguet, Macy's chief financial officer, said in a November 2015 conference call, according to a Thomson Reuters transcript.
Instead of a wholesale — or, in Cohen’s words, a “fire sale” — sell-off of its properties, Macy's is going through its holdings, property by property, to evaluate the best strategy for each one. In the company’s own words from its most recent annual earnings report, the retailer “is focused on opportunities for sale transactions and, in some cases, redevelopment of assets. This strategy is multi-pronged and may include transactions, strategic alliances or other arrangements with mall developers or unrelated third parties.”
"I did my homework on the portfolio, and my reaction was: 'Wow, there is a treasure trove of real estate inside this retailer.'"
Macy's executive vice president of real estate
Doug Sesler, Macy's executive vice president of real estate, said at a June investor meeting that when he started at the company a little more than a year ago, "I did my homework on the portfolio, and my reaction was: 'Wow, there is a treasure trove of real estate inside this retailer.'" He said his team coined the term "value creation opportunities" for the various ways in which the company thought it could make good on its holdings, either by selling properties, selling parts of properties, redeveloping stores entirely or in part, adding wraparound developments that could be leased to other retailers, or by doing something as simple as building space for a Starbucks or a similar companion store in a Macy's parking lot.
Going by Sesler's strategy, Macy's might take a property like its flagship Herald Square store and instead of simply selling the coveted real estate, "densify" it by adding new retail around it and perhaps rooftop attractions as well, while retaining a Macy's presence at the site — and presumably retaining ownership, too, so Macy's could cash in on the rents from the new development.
Still cashing in
To be sure, Macy's has shown interest in making money from sales of its real estate as well.
Last year, the company sold its Brooklyn store for $270 million. This January, it sold its 248,000-square-foot Union Square Men’s building in San Francisco for $250 million, while retaining ownership of the site's main building. In February, it sold its downtown Minneapolis store property for $59 million. The company also recently inked a contract to sell two floors of its Seattle store, after selling four floors of the same eight-story building for $65 million in 2015, according to the Seattle Times. Altogether in 2016, Macy's made $673 million from sales of its real estate assets.
In January, the retailer also entered into a strategic alliance with Brookfield Asset Management that gives Brookfield the exclusive rights for up to two years to create a “pre-development plan” for any 50 of Macy’s real estate properties. According to filings with the Securities Exchange Commission, Macy’s has the option to contribute its asset into a joint venture or sell it to Brookfield outright for any property that the asset management firm draws up a plan for.
“What Macy’s seems to be doing is going through their portfolio one property at a time and determining what each property’s disposition ought to look like,” Cohen said. “Either leave it alone, close it, sell it, whatever. They’re not responding to this fire sale that these activists are really demanding. … [Macy’s is] intelligently examining their portfolio for properties that are not productive, in which they have excess space or that are just unsuccessful, and they’re getting rid of them.”
A missed opportunity
Macy’s big-ticket real estate transactions for coveted urban properties, such as the Brooklyn and Seattle stores, are only one piece of the puzzle. The company is also in the process of shuttering 100 stores across the U.S., some of which are owned properties. Those stores are being closed because they’re unproductive and many of them sit in malls with declining foot traffic. If Macy’s doesn’t see money-making potential in occupying those spaces, chances are that others won’t either — and it will only get worse as malls, apparel retailers and other department store chains retrench further. In other words, Macy’s might have already lost the opportunity to sell those properties.
"What’s happening is [Macy's] are just going to sit on it. It’s just not going to move... Now they’re left with a vacant building that they have to figure out how to get rid of, and there’s no market for it.”
Senior Director, Stan Johnson Co.
Retailers like Macy’s have “a limited staff and a lengthy decision process and that spells disaster in a retailer’s ability to be very nimble and flexible and be quick to market,” Herrold said. “I think if Macy’s would have really aggressively pursued this a couple years ago, they would have had more success. There wasn’t as much negativity in the department store industry.”
Instead, in Herrold’s view, Macy’s is left with real estate on its books that's at risk of obsolescence, when it could have sold off that risk. “Right now, Macy’s closes down a 150,000-, 200,000-square-foot building that they own and the prospects of selling or leasing that asset are remote,” he added.
While there are retailers that are expanding, including off-price stores such as T.J. Maxx and Ross that are stealing sales from department stores, those retailers often occupy smaller store spaces. Herrold noted there are other, less traditional tenants and buyers for those spaces — everything from fitness clubs to churches — but they generally don’t pay nearly as much in rent.
“The nature of the environment right now is that there are no users of that size that are growing aggressively and need that space. … What’s happening is [Macy's is] just going to sit on it. It’s just not going to move. Especially in the poorer retail locations, which is where they’re closing them. Now they’re left with a vacant building that they have to figure out how to get rid of, and there’s no market for it.”
In other words, if Macy’s wanted to make money from selling its properties — and it’s clear the company does, even if it has a different appetite for that than Starboard — the time to do it was before now. But that, ultimately, isn’t even Macy’s biggest challenge.
End of an era
The real estate markets for department store and mall properties are declining because department store and mall-based retail is declining. The value of Macy’s real estate holdings is inextricably tied to its core business. “The collapse of the mall business is in progress," Nick Egelanian, president of retail development consultants SiteWorks International, told Retail Dive. "It’s been going on 25 years."
“It’s the end of the department store era,” Egelanian said. Off-price stores, discounters, big box retailers, Walmart, e-commerce retailers and more have cut into the business of department stores. Egelanian and others have pointed to Macy’s own dominance and scale as the cause of its undoing, as it expanded by rolling up smaller chains into its more corporate fold, effectively suffocating their local identities and relationships with their clientele.
Macy’s has tried to reinvent itself by investing in e-commerce, experimenting with its supply chain and last-mile delivery, and making store improvements. It has added personnel to its digital merchandising team and combined it with its in-store merchandising marketing team. More recently, in June Macy's executives said they were working to simplify pricing, refocus the company's marketing strategy and unroll a loyalty program that rewards customers for spending more at the company.
Selling properties can provide cash to help fuel those efforts — a luxury not all retailers have. But will it be enough?
“I don’t think they have any future,” Egelanian said of Macy's. “Monetizing real estate is a decent strategy, but it’s too little, too late."