What do Kohl’s, Macy’s and Saks have in common?
The three department store retailers all have valuable digital businesses grabbing activist investors‘ attention.
On Monday, Kohl’s became the latest retailer urged to separate its expanding e-commerce business from the slow-growing, asset-intensive store operation or put itself up for sale, according to a letter that activist investor Engine Capital sent to the company’s board.
The New York City hedge fund, which owns approximately 1 percent of the Menomonee Falls, Wis., department store, believes Kohl’s e-commerce business could be “conservatively valued” at $12.4 billion, dwarfing the whole company’s current estimated $6.7 billion market cap.
In a letter to the Kohl’s board, managing partner Arnaud Ajdler and partner Brad Favreau pointed out that the retailer’s stock has underperformed the S&P 500 by 90 percent and peers including Macy’s, Dillard’s and Nordstrom by 19.1 percent since Michelle Gass became CEO in May 2019.
But Ajdler and Favreau believe “it is essential to run a market test” to see how much a third party is willing to pay for Kohl’s, with the activist group estimating a buyer would pony up “a significant premium of 50 percent, or at least $75 per share.”
However, it should be noted that Kohl’s stock has outperformed the S&P 500 over the 12 months at a pace of 31.1 percent to 26.5 percent. And the gap was significantly larger (161 percent to 35.6 percent) since the retailer outlined its new strategy 14 months ago, which included growing activewear to 30 percent of the total business.
Engine Capital acknowledged these numbers in the letter, describing them as “the result of good timing” while adding that Kohl’s stock underperformed by 123.4 percent when compared to the department store’s peers in a 12-month timeframe.
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Kohl’s stock jumped more than 5 percent in Monday morning trading after Engine Capital published its missive.
“In conclusion, it is the board’s job to drive value and the board has had ample opportunities to do so over long periods,” Ajdler and Favreau wrote in the letter. “We are not pushing for one of the aforementioned solutions over the other, but we—and other shareholders, clearly—do not believe the status quo is acceptable…We urge the board to be this agent of change and publicly commit to a review of strategic alternatives to create value for shareholders.”
Ajdler and Favreau also argued that a private equity buyer would likely take advantage of Kohl’s’ 12-month free cash flow of $1.7 billion and run the retailer with “significantly more leverage than the board is willing to, which would lower its cost of capital and therefore put a buyer in a position to pay significantly more for the company than where it currently trades.”
The move is certainly not without controversy, especially given the shaky relationship between private equity and retail. During the height of the Covid-19 pandemic, multiple financially distressed PE-owned apparel retailers such as Neiman Marcus, J.Crew and True Religion among others collapsed into bankruptcy after taking on enormous long-term debt in the years prior.
And even while e-commerce sales shot up to record numbers during 2020 as many stores were closed for extended periods and shoppers showed hesitation to return, digital natives themselves have slowly realized that a physical store presence often buoys an online-only business model. Digital-only businesses, especially during the growth stage, often operate on thin on margins to due the exorbitant costs involved with shipping and delivery, distribution, marketing and advertising. Add in returns in categories like apparel and footwear and e-commerce-only brands have even more of an expense headache on their hands.
Additionally, a split essentially goes against omnichannel movement that has pervaded the industry for nearly a decade. Many merchants are still trying to figure out how to provide a unified experience no matter where shoppers start and end their journey.
For the time being, it appears Kohl’s is willing to listen to new ideas.
“The Kohl’s board and management team continuously examine all opportunities for maximizing shareholder value,” a Kohl’s spokesperson told Sourcing Journal. “Our strong performance this year demonstrates that our strategy is gaining traction and driving results. We appreciate the ongoing dialogue we are having with our shareholders and value their input and perspectives.”
Kohl’s is in the same pickle presently faced by one of its department store counterparts. Two months ago, Jana Partners urged Macy’s to split up its physical and digital businesses. And in November, another stakeholder, NuOrion Advisors, urged the department store to take drastic steps to digitally transform its current business model. In a letter to CEO Jeff Gennette, NuOrion said the company’s board should evaluate taking on a strategic investment from outside investors, citing the Saks.com spinoff as a success story that Macy’s could outperform.
The letter included outside-the-box suggestions such as introducing electric vehicles (EVs) from Tesla and Rivian on the first floor at its major flagships, and partnering with top cryptocurrency players to begin accepting new forms of digital payments.
Macy’s appears to be, at least on the surface, taking the activists’ calls seriously, retaining the services of consulting firm AlixPartners to examine the company’s current structure and mull next steps.
Engine 1’s Ajdler and Favreau cited Macy’s decision in their letter, noting that Macy’s stock has improved 23.3 percent since Gennette said the company is talking to AlixPartners. In the same span, Kohl’s stock jumped 10.4 percent. Despite Engine 1’s concerns about Kohl’s being outperformed by peers, the chain saw third-quarter net sales jump 15.5 percent to $4.3 billion on net income of $243 million, ultimately leading the company to raise its full-year outlook for the second time this year.
This isn’t even the first time this year Kohl’s has had to deal with activist investors. In February, a group of four firms that owned approximately 9.5 percent of the company urged Kohl’s to make various changes like implementing a sale-lease program for its real estate, pivoting to women’s fashion away from the current activewear focus and cutting spending on experimental tech. The activist group was also highly critical of Kohl’s Amazon partnership, its 2020 debt raise and what it called “excessive” executive compensation.
The proxy fight ended in April with a truce. Kohl’s installed three new independent directors on its board, including Lululemon CEO Christine Day, PVH board member Margaret Jenkins and former Burlington Stores CEO Thomas Kingsbury.
Additional reporting by Jessica Binns.