Multinational retail giant Hudson's Bay (TSX:HBC) has experienced another round of upheaval in the past week. Last Friday, the company revealed that its CEO will step down at the end of the month. On Monday, activist investor Jonathan Litt of Land and Buildings Investment Management announced plans to try to gain control of the board. And on Tuesday, Hudson's Bay announced a new wide-ranging partnership with shared-office start-up WeWork. Most notably, it will sell the Lord & Taylor flagship store building to an affiliate of WeWork.
These developments have set the stage for a proxy battle between Litt and Richard Baker, the executive chairman of Hudson's Bay, who is now also serving as interim CEO. Let's look at what the recent flurry of events means for Hudson's Bay and some of its key competitors.
Activist pressure ramps up
Hudson's Bay is the second major department store company in recent years to be hounded by activist investors demanding an aggressive real estate monetization effort, following Macy's (NYSE:M).
Land and Buildings declared a 4.3% stake in Hudson's Bay in June. Initially, it tried to persuade management and the board to redevelop stores that aren't making enough money relative to the value of the real estate they sit on. However, the fund quickly lost patience with Hudson's Bay's leadership, which remained fully committed to the retail business.
Since late July, Land and Buildings has been threatening to shake up the Hudson's Bay board of directors by calling a special shareholder meeting. On Monday, the fund made it clear that it won't be appeased by the departure of CEO Gerald Storch. Land and Buildings will go ahead with its plan to call a special meeting at Hudson's Bay, as it believes the board bears primary responsibility for a market cap that's a fraction of the company's real estate value.
The ace up Richard Baker's sleeve
With a proxy fight looming, Baker and his leadership team scored a big win on Tuesday by announcing plans to sell the Lord & Taylor flagship building on Fifth Avenue in Manhattan for $850 million.
The buyer is WeWork Property Advisors, a joint venture between shared-office start-up WeWork and Rhone Capital. The roughly 600,000-square-foot Lord & Taylor store will operate through the 2018 holiday season. After that, the upper portion of the building will be redeveloped to serve as a new corporate headquarters for WeWork, as well as WeWork office space. Meanwhile, the Lord & Taylor store will be downsized to just 150,000 square feet.
The agreement also includes a $500 million equity investment in Hudson's Bay by Rhone Capital and a pact to convert space on the upper floors of stores in Toronto, Vancouver, and Frankfurt into WeWork office space. The companies will also cooperate to refer customers to one another and potentially to convert more underutilized retail space into WeWork offices in the future.
In addition to providing a big cash windfall, the deal with WeWork could bring more customers into Hudson's Bay's stores because of the proximity of the new WeWork office space. Still, Hudson's Bay shareholders don't seem very impressed. The company's stock price barely budged on Tuesday, and its market cap is still a fraction of its estimated real estate value.
What the turmoil at Hudson's Bay means for the industry
The muted reaction to the Lord & Taylor deal suggests that Hudson's Bay shareholders want more radical change. That's not surprising, as Hudson's Bay's retail operations -- and especially Lord & Taylor -- have been struggling mightily for the past two years. This bodes well for Land and Buildings' activist campaign.
The more Hudson's Bay downsizes to monetize real estate, the more sales dollars will be up for grabs by rivals such as Nordstrom (NYSE:JWN) and Macy's. For example, the big downsizing planned for the Lord & Taylor flagship is likely to push more shopper traffic to the Macy's flagship store, which is just half a dozen blocks away.
If Litt gets his way, the Saks Fifth Avenue flagship store -- with an appraised value of $3.7 billion -- will be the next candidate for downsizing. That would encourage the epicenter of luxury retail in Manhattan to migrate north, anchored by Bergdorf Goodman, Macy's corporate sibling Bloomingdale's, Barneys New York, and the upcoming Nordstrom flagship store. All four are located between 57th and 61st streets, while the Saks flagship stands across from Rockefeller Center between 49th and 50th streets.
Although a downsizing of the Lord & Taylor and Saks Fifth Avenue flagship stores would thus be good for Macy's and Nordstrom, the fact remains that both companies get most of their full-line sales from mall-based stores. Thus, the future of Lord & Taylor and Saks Fifth Avenue's mall-based stores is of paramount importance.
Even there, it's likely that the value of the real estate outweighs the value of the retail operation in many cases. Most Lord & Taylor and Saks Fifth Avenue stores are in valuable malls, but the stores aren't making very much money, as evidenced by Hudson's Bay's weak financial results.
If the downsizing trend spreads to mall-based Lord & Taylor and Saks Fifth Avenue locations, mall owners would be able to replace those stores with new restaurant and entertainment options. That could materially improve results at Macy's and Nordstrom by reducing competition while also driving more traffic to the malls.