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The Latest Developments in Big Box Retail: Cabela's and Costco

By Daniel B. Kline – Oct 26, 2016 at 5:25PM

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With the recently announced $4.5 billion deal between Cabela's and Bass Pro, the combined entity will employ 40,000 employees in 180 stores and feature millions of square footage of hunting, fishing, and camping equipment. We also take a look at Costco following its break-up with American Express.

Many investors were bearish on Costco (COST -1.05%) as the wholesale retailer made its transition from American Express to Visa. In this episode of Industry Focus: Consumer Goods, Vincent Shen and contributor Dan Kline talk about how the company managed to make the switch with just a few minor stumbles, as they focus on the more pressing challenges the company is going to have to address in the next few years.

The team also dives into Cabela's (CAB) buyout by Bass Pro Shops. Find out why the outdoor sports giants are banding together, details behind the deal, and what this will mean for the combined entity going forward.

A full transcript follows the video.

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This podcast was recorded on Oct. 11, 2016.

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I'm Vincent Shen. Welcome to the latest episode of Industry Focus, the podcast that dives into a different sector of the stock market every day. It is Tuesday, Oct. 11, and I am joined via Skype by contributor Daniel Kline, who is beaming in from an area of the country that has been in the headlines quite a bit recently -- that's West Palm Beach in South Florida. How are you doing, Dan?

Dan Kline: I'm happy to say we're still here.

Shen: Yeah, I was really happy to hear that you guys came out OK following the hurricane. I heard it was pretty rough.

Kline: I don't want to minimize the people who actually lost property or got hurt, but compared to what they were predicting, it wasn't that bad. It was very windy, very rainy, scary. I'm sure if you live right on the ocean, it was terrifying. But they were predicting 125 to 130-mile winds, and we only got about half that. So, we're very lucky.

Shen: Yeah. It seems like certain regions were right in the path, others were able to avoid it. Overall, I think, especially in your situation, having just moved down to Florida in the past month or two, and having to encounter what was generally considered to be one of the biggest storms in recent memory, that's interesting timing, to say the least.

Kline: I'm hoping none of my neighbors put together that I have bad luck when it comes to the weather. They're predicting snow for next week.

Shen: Our two big stories for today, first, we have the multi-billion dollar deal that was recently announced between the privately held Bass Pro Shops and its major outdoor retail rival Cabela's, ticker C-A-B. Second, we'll take a look at investor favorite Costco, just to see how the company is faring after its switch from American Express. Dan, let me provide a little bit of background for Bass Pro and Cabela's before we dive into the details behind the buyout. In case anyone has never had the opportunity of visiting one of these stores before, or even heard of them, maybe if you're a die-hard city dweller, both Bass Pro and Cabela's are two of the major big box stores catering to outdoor enthusiasts. They sell apparel, equipment, accessories for activities like hunting, fishing, camping. That includes firearms as well.

With that, Dan, I'm going to let you take it away. Can you give us a little bit of detail behind the deal?

Kline: These are two very similar companies. They each have around 100 stores, they each have around 20,000 employees. And it was sort of the case of, given all the internet competition, there wasn't really room for two players. It's not necessarily that they have too many stores. But if you combine them, their buying power goes up, their branding goes up, their marketing goes up, or both go down, and it gets easier to not have to compete with each other when they're both looking at Amazon and other online retailers selling a lot of the same things.

It's worth noting that these aren't just stores. They're destinations. They're 180,000 to 200,000 and up square feet. They have shooting galleries, live animals, restaurants that serve wild game. It's a really fun place to go. And in some ways, those have been the most resilient retailers -- stores where there's a reason to go when you're not necessarily going to buy anything.

Shen: Yeah. I want to point out, based on that, we were talking about before the show as well, it's really incredible, some of the attractions that their biggest flagship stores offer. For Cabela's, they take two different approaches. They have their current smaller store approach, think 40,000 to 100,000 square feet. Then, there's the legacy format, their larger stores, going up to 250,000 square feet, the biggest location being in Hamburg, Pennsylvania. You mentioned shooting galleries and things like that. This has, of course, the shopping, but then a restaurant, aquarium, museum, animal displays for regional game for hunters. You can actually take a virtual tour of that store specifically with Google Street View technology to give you a sense of how large it is and what it has to offer.

Bass Pro Shop actually takes it to the next level. Their stores are largely in the 150,000 to 250,000 range for their Outdoor World flagship branding. The largest store in the Bass Pro fleet is an unbelievable 535,000 square feet. They basically took over an old sports and concert arena in Memphis, Tennessee, called the Pyramid. Think of a former stadium that's now a big store that has two restaurants, a hotel, a bowling alley, an aquarium, the tallest free-standing elevator in the world which leads to an observation deck at the top of the Pyramid. The Pyramid itself is one of the tallest in the world. To put that in perspective, that 535,000 square feet for that store, by comparison, the average Wal-Mart Supercenter -- which is huge, walking through that is its own experience -- they're only 180,000 square feet. So, this thing is just absolutely enormous.

Kline: It's worth noting that most of the Cabela's and Bass Pro Shops are not in malls, they're in outlying areas, cheaper real estate. The big store has something important going for it. There's a reason to go there. I used to walk around with my son when he was four or five into one of these. But, we'd buy a little candy, maybe have lunch there. I'm not a big fisherman or hunter, but we would look at the stuff and play with the shooting gallery. And I spent a little bit of money. It was very crowded on the weekends, so the destination draws. The problem with that is, on Tuesday, as someone who has a background in retail, you don't have the same customer base. There's no families out on Wednesday afternoon looking to browse and not buy. So, you have the positive that this huge store almost functions as a museum. But you also have the negative that, a lot of the week, it's not that busy.

So, going forward, there's a pretty big opportunity, and it sort of ties in to the Cabela's small format. You have all these malls around the country that have realized they can't just be stores. They have to have movie theaters and bowling alleys and restaurants and other destinations to drive business, because people aren't shopping in retail stores the way they used to. A smaller-format Cabela's, maybe with one attraction, builds into that really well. You're going to see a lot of vacancies in malls. There's a lot of Sears and K-Mart anchor stores that are going to become vacant. And the new Bass Pro Shops/Cabela's is really going to get some deals to be able to expand, if that's what they want to do.

Shen: Absolutely. I love that idea, actually. They definitely have the attraction/entertainment aspect down. There's plenty of stories and testimonials you can hear from customers, especially in the more rural parts of the country where these stores cater to the people who are into fishing, gaming, and camping, where they will drive hours to go to one of these stores, because the selection and the things to do are limitless when you get to one of these bigger flagship locations.

Kline: This is really just a smart mash-up. You simply didn't need two companies of a similar size fighting with each other. As we've talked about, we saw this happened in sporting goods. Sports Authority went out, and Dick's has been thriving because of it, because there's a certain amount of sporting goods -- and Cabela's and Bass Pro Shop are loosely in the sporting goods space -- that you want to touch. You don't necessarily want to buy a fishing rod that you've never handled. So, a certain percentage of people might go into a Bass Pro Shop, handle the fishing rod, and then go buy it online for cheaper. But, that person might at least buy something on the way out. Maybe they need some lures, maybe they really want some fudge, it doesn't really matter, they're going to spend money. They don't have to advertise to get you to not drive down the road to Cabela's, and that's an advantage.

Shen: Yep. Diving into a few of the details behind the deal. Keep in mind, Bass Pro Shop is privately held, where as Cabela's is publicly traded. So, the cash offer for Cabela's was $65.50 per share. In total, that's about a $4.5 billion deal. Part of that deal, also, is Cabela's has its CLUB store co-branded credit card. That was previously managed by an entity they created, World's Foremost Bank. Part of the negotiation process was finding some financial firm card processor to take over that part of the operation. Capital One will be taking over that. There will be no change for customers themselves who are part of the Cabela's CLUB, and also the Bass Pro side -- they have a card and loyalty program, too. So, all that will keep going in operation as the companies come together. The combined entity will actually have a network of about 180 stores and 40,000 employees. The new company will also remain private, with the deal expected to close in the first half of 2017.

Dan, did you have a chance to pull up any info on the buyout premium? I have to say, overall, Cabela's shareholders should generally be pretty happy based on the previous trajectory that their stock had seen in the past year or so.

Kline: Yeah, it's about a 19% premium, if I remember correctly, over where the stock was trading when the deal was announced. It's one of those where you can't exactly say that's all it is, because the stock had moved at various points as this deal has been rumored and talked about. This is one of those cases where the quarterback of the football team and the head cheerleader, everyone wants them to get together, so eventually, they're going to go to prom together whether they like each other or not.

What they're not talking about, because you don't want to scare people, is there's going to be some synergy from this. There's going to be some cost-saving. They're going to keep both brands. Supposedly, they're going to keep both headquarters. But the reality is, if you have a guy who's in charge of purchasing sleeping bags at Cabela's and a guy at Bass Pro Shop, there's no reason to have those separate, people. So you're going to start to see some back-office functionality. And maybe they'll have separate marketing teams. Maybe they'll have separate brands. But purchasing and payroll and some of those things are going to come together, so it's going to get cheaper for these two brands to exist.

Shen: Also keep in mind that their geographic footprint of the store fleets themselves are pretty complementary. Bass Pro has the large majority of its stores in the eastern part of the United States. Only about a dozen locations spread out between Colorado, California, Nevada, Arizona, and Washington. Cabela's adds about 30 to 40 more stores in those states in the western part of the country. So, while there's quite a bit of overlap toward the East Coast, Cabela's gives Bass Pro Shop that exposure in the more western states. 

Then, going back to that premium that you mentioned, the 19%, that's to the Oct. 2 close, right before the deal was announced. But when Cabela's announced that they were pursuing strategic alternatives back in December of 2015, since that point, that's a 40% premium, that $65.60 per share. Then, if you go back even further than that, which is part of the story of why this deal even came to be, is that an activist hedge fund, Elliott Management, they took an 11% stake in the company in October, and immediately, they stated their intention to push Cabela's toward finding an entity to buy it out. Since that point -- about one year ago -- there's a 96% premium since the Elliot Management stake was disclosed. Again, for a stock that hasn't traded in the $65 range since around early 2014 -- the shares peaked around $71 during that period -- this is a pretty nice takeaway for shareholders. I think a lot of people who came in during that peak are happy to recoup quite a bit of their investment.

Kline: You have to be happy. But the reality is, the reason the stock has gone up since this rumor has happened is, there was only one logical buyer, and a deal was going to happen. It was simply the right thing to do. Even just looking at going from 100 stores to 180, you improve your supply lines, improve your warehouses. Even as you look at your online ability to fulfill orders, you now have locations and warehouses, so you can leverage things like ordering online and picking up in stores. The stock basically doubled since it became a rumor, because it just made so much sense. And now that it's happened, there's every reason to believe it's the right move.

Shen: Yep. Final takeaway if you're Cabela's investor: As it stands right now, the offer from Bass Pro Shop values the company at about 22.5 times trailing 12-month earnings. So, quite favorable based on Cabela's outlook. Frankly, the company was in a tougher spot before Elliot Management came along and started pushing the company.

Kline: Yeah, it had a rough quarter. When you're looking at this type of store, comparable sales is really the metric. Comparable-store sales were down 1.3% to the most recent quarter. That's not a disaster -- that's not Sports Authority numbers. But you look at all the people creeping up on it. You have a stronger Dick's, you have Amazon, you have various online retailers, REI, which is a much smaller-format store that inches up on this. So, you can see where the pressure was coming from. Getting bigger fast is a really good way to push back against that.

Shen: The company ultimately had quite a few challenges to overcome if they wanted to work on their revenue, their profitability, expanding their network of stores. Ultimately, you mentioned some of those other names, this is a retail environment that does not take hostages.

Kline: Yeah. To wrap up, this is also a case where a healthy company was having very negative stock pressure because of the short-term nature of many investors. Nobody was looking and saying, "OK, down 1.3%, but Cabela's is well-positioned, it's in the right places, it has a type of store that's doing well even in the internet economy." By going private, the company can now say, "We're going to invest, we're going to do certain things, and we're not going to be tied to the quarterly reporting cycle." For a retail store in a quickly changing environment, that might mean shuttering the very big store, or making a big change to a format, or opening up 10 new mall stores, and that might not reflect well in the one, two, three quarter picture. But, as a private company, you can take the long view in a way that, frankly, retail companies can't when they're publicly traded.

Shen: But, one thing I will counter that with before we wrap up on this deal is that, the company, bottom line, net income fell 10% in 2014, another 6% in 2015, all this while revenue grew 11% over the same period. So, definitely, there are parts of the business that they needed to work on, frankly. Overall, in the outdoor sporting goods industry, with this tie-up and combined entity, there's still a ton of competition. Keep in mind, you mentioned REI, there's also Dicks, you also mentioned Gander Mountain, Big 5, Academy Sports, Modell's. That doesn't even include the e-commerce side of it. Besides Amazon, there are a lot of smaller players that are pure plays online. So, Bass Pro with Cabela's, larger entity. I think they have a pretty bright future. But ultimately, on the investing side, Cabela's shareholders, there's not much to do at this point but see the deal go through. It's expected to close in the first half of next year.

Next up, we have our discussion of Costco. Before we dig into the company following its breakup with American Express, I wanted to thank Tommy John for supporting the show. Tommy John is revolutionizing men's underwear with a focus on fit, fabric, and function. Shirts that stay tucked, socks that stay up, and underwear that keeps everything in place, whichever way a man moves. It's funny that, when I was still wearing a suit everyday for work, I thought that all guys suffered together and were willing to put up with socks that would bunch up around your shoes every hour, having to retuck your shirt all the time. The Fool might let me get away with more casual dress around the office, but after having the opportunity to wear Tommy John gear, I have seen the light. Think of it like a mattress. You invest in that because you spend a third of your life sleeping. Well, you spend most of the remaining two-thirds in underwear most of the time. Tommy John can make that two-thirds of your day so much more comfortable with its breathable, lightweight, non-pilling and quick-drying fabrics. Tommy John offers a wide selection of styles, and the company provides a best-pair guarantee. If their underwear isn't the best you have ever worn, it's on Tommy John. As a special offer to our listeners, get 20% off your first order by going to and using the promo code "fool". Plus, you can get free shipping on any order over $50. That's, with promo code "fool".

All right, Dan. Costco. This is right in your wheelhouse. I know you've been following this company for some time. Can you give us some background? I mentioned American Express a few times. What exactly happened with this transition that they've made to Visa?

Kline: Costco switched from its long-term credit card provider, American Express, to Visa. It was very much an abrupt transition, at least in the stores. There was messaging for almost a year to card holders. But basically, you went into Costco on June 19, and you could use your American Express. When you went in on June 20, that card no longer worked. The retailer no longer even took American Express at all, and you had to use your new Visa card. When that happened, the media exploded. "Oh my God! People are going to leave Costco! They're never going to handle this, this is a disaster!"

Some of its rivals, BJ's and Sam's, offered free entry to their stores for people holding the old cards. It had seemed like they made a mistake. That was backed up a little bit by the fact that Citigroup, which provides the cards, was overwhelmed with calls, about 1.5 million calls in the first few days. It seemed like people were having big problems, it was causing checkout problems, and this was going to create some real ill will. The reality is, things smoothed out pretty quickly. Within a few days, the call volume was well down. I talked about with some of the Citigroup people about this. Once people figured out the switch, they realized, "OK, now I have a Costco Visa, not a Costco American Express." And the rewards were actually a fairly decent amount better, an extra percent on gas and some tick ups across the board. This was played up like it was going to be a huge drag on earnings. I think -- you have some of the numbers in front of you -- it just wasn't.

Shen: I think the company specifically mentioned in one of its recent reports that the switch to Visa from AmEx has saved the company enough money in fees to offset some of the falling-through prices that it's seen that have negatively impacted its business. So, we see that the transition wasn't the end of the world, wasn't as big of a negative impact that a lot of people feared it would be. That was definitely a news cycle that got a lot of headlines. But what about longer-term outlook for Costco? Something I know they've had challenges with is with e-commerce, that's been lagging, it seems like it's passing them by entirely. What do you think?

Kline: I don't want to say I expect the bottom to fall off Costco. I think there's a certain percentage of its users that, "Internet be damned, it's fun to go to Costco and sample things that you wouldn't sample." Like, someone has cut up a Twizzler into little pieces -- you know what a Twizzler tastes like, but it's still fun to get one for free as you walk around and look for bargains and hunt for things, and come home with a pallet of meatballs even though you're a vegetarian. There's sort of the thing about going to Costco that's always going to protect some of their business. But as you mentioned, they've done very little on the internet. They send emails, they have some Web specials. But for the most part, it's not a great shopping experience, it doesn't feel like going to Costco in any way with the bargain hunting. It's not what they've built on.

I do expect that, at some point, people are going to realize that the cost savings aspect of Costco -- you pay your $55 membership so you can save money by buying whatever it is, your toothpaste for your breakfast cereal in bulk quantity to save money. The problem is -- and, I'm a Costco member and an Amazon Prime member -- many of the things I used to buy from Costco in inconvenient quantities can be purchased from Amazon in the amount that I actually want them in. So, instead of having to buy six deodorant sticks, and I have to remember where they are over the next eight months or however long it takes to use them, I could just order the same thing from Amazon at roughly the same price. Costco has not had major sales dips because of this, but at some point, you have to think they're going to.

Shen: Yeah. I think, it's kind of similar to the topic we were talking about previously. Maybe not as directly. Bass Pro and Cabela's create these attractions. But at the same time, I have been to a Costco on Friday evening and seen whole families there, and it's the Friday night entertainment. It's very amusing to see. And powerful, I think, as part of Costco's business model. This warehouse model translates very well to that in-person shopping experience. Now, how do you take that appeal and attractiveness of the warehouse bulk shopping experience and translate that into e-commerce, especially in a situation where, arguably, in most cases, those bulk orders and the savings you get translate to more expensive logistics for the company to get that item or order to you? It's going to be difficult.

Kline: Absolutely. I'm guilty, I spend a Sunday afternoon entertaining my 12-year-old by promising him a $1 churro at Costco, and walking around. I mean, you can eat -- I can't, I have a gluten allergy -- but they have cheap pizza and hot dogs. People will go and have lunch and browse the store and come home to find a book on sale, or something ridiculous they never planned for. I don't think you can replace that aspect. I think the problem is, there are some interesting digital things you can do in bulk.

Amazon has actually beat them to the punch. Amazon owns a company called I don't know if you've ever heard of Woot, but what they do is a sale of the day. It's now morphed into more than that, but basically, they take a few items that they purchased -- on clearance, likely, from someone else, or have in their own warehouses that wouldn't sell -- and they put out, "OK, today we have this HP laptop, it's $249," and that's maybe half of the regular price. And people go crazy and buy them. I know I buy a lot of t-shirts from them. I've ordered things and thought, "Oh boy! It will be great to have a 12-pack of HDMI cables!" 

I think that's very much like the Costco experience. You go to their website every day, and you don't know what's going to be there. Then, you make a purchase that might not be the smartest purchase. Costco could do that. They have a user base. They could even do it on a broader level. They could put a car on sale, they could put health insurance on sale, or, "Come into a store and get a hearing aid exam." There's a lot of ways that Costco could leverage its physical stores, its ability to buy product. If you've ever watched Shark Tank, whenever we talk about Costco, they're notorious for negotiating, getting the price down and getting things very cheap. So it's not crazy to think Costco could say, "OK, Christmas is in 10 weeks, we're going to have a different toy every day on our deals site," and mimic that in-store experience.

Shen: If they are able to successfully launch something like that -- and, I do know of Woot, but I did not know that Amazon had taken it over. That's news to me. Ultimately, this is a company with $120 billion in trailing-12-month revenue. And in that time, their net income margin is usually around 2% or less. So, profitability is really thin. People talk about the business benefits from those membership fees --

Kline: It's roughly 70%, 66% to 70% of profits, depending on the quarter.

Shen: There you go. That would be something the company has to manage and work around as they transition to e-commerce. That is something they will really have to invest in and face off against, and realize it's a do-or-die situation at some point in the future.

Kline: There are some trends. The Costco members, overall, are good. When you look at the same-store sales, and you subtract out the fact that gas prices are a drag because gas prices have been lower, they actually post some slight gains. It's basically flat when you factor gas in. That's not bad. But when you look at the membership numbers, overall membership revenues are up because they've managed to transition some people into more expensive memberships -- either business membership, and in a couple of countries, they've raised prices. But the overall renewal rates have ticked down a very slight amount, about 0.1% when you look at the different markets. That is by no means a cause to panic. It could absolutely be that a small amount of people, with the credit card, just went, "Nah, I never really used this, I'm not going to take the new credit card."

About 85% of the credit card portfolio moved over, which is pretty close to the active number of people on the old credit card. So, that 15% that wasn't active, some of them might have said, "Nah, I'm not going to renew this, I'm just going to cut this card in half and not pay my membership fee this year." So, these aren't warning signs. They're almost like baby warning signs. You look at them and it's like, "OK, if they start to lose 0.1% here and 0.1% there, at what point does it snowball and become renewal rates going from 89% to 83%?" Then it becomes a real problem.

Shen: Absolutely. OK, I take it that you're still relatively bullish with Costco, and think the prospects will be able to --

Kline: I think they have a lot of time. I think there's an absolute flaw in their business. They pretty openly said they don't care that much about the internet, and they'll get to it when they get to it -- I'm really paraphrasing, nobody said anything that brash. That's indirectly what they said. But, I think because of the nature of their business and the fact that the mall as a destination has maybe faded, that Costco as a destination can buy them two or three years to figure out an internet strategy, or figure out more things like gas, that you can't buy on the internet. Amazon is not an effective delivery method for a tank of gas. So, if Costco can bring me in for gas, an eye exam, a hearing aid exam, maybe they'll add haircuts, maybe they'll expand their restaurants, it doesn't necessarily have to be directly competing with Amazon. Just has to be continuing to give people reasons to pay that $55 and occasionally visit the store.

Shen: Yeah. Well, that is all the time we have for today, but you can continue the conversation with us, as always, and the rest of the Industry Focus crew, via Twitter @MFIndustryFocus, or send us any questions or comments via email at [email protected]. People on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear during the program. Thanks for listening and Fool on!

Daniel Kline has no position in any stocks mentioned. Vincent Shen has no position in any stocks mentioned. The Motley Fool owns shares of and recommends, Costco Wholesale, and Visa. The Motley Fool recommends American Express. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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