Selfridge's & Co. in London may look fancier, but the department store is operated largely the same today as when it was founded in 1909, and still serves as a model for retailers everywhere. Image source: Selfridge's.
Much of what we recognize today as the modern department store hasn't really changed in the past 150 or so years since Harry Gordon Selfridge managed the early Marshall Fields stores. They're buildings featuring dozens of departments, restaurants, and employees walking the floor to assist customers with their purchases. We can also thank him for creating the imperative of the holiday shopping season, as Selfridge also reportedly created the phrase, "Only xx days until Christmas."
Same as it ever was
Yet it's the same old mode of commerce that J.C. Penney (JCPN.Q), Kohl's (KSS -4.17%), Macy's (M), and Sears Holdings (SHLDQ) still follow today, regardless of how up-to-date they may appear. While the idea of providing a broad mix of merchandise at reasonable prices fueled their expansion in the 1950s and 1960s, and helped spur the growth of the shopping mall, too, that could also mean they're ultimately doomed in the digital age, when consumers have available to them an even deeper, broader selection of goods -- many times at better prices -- all at the click of a mouse.
With private equity circling these aging beasts looking to wring from them whatever vestiges of value they can find -- strategies that rarely have anything to do with fixing what truly ails them -- it may be time for investors to ask if the department store model has run its course.
A tough sell
Kohl's has been struggling to attract consumers. Over the past five years, its revenue has barely inched higher, rising at a glacial 1% rate compounded annually. In comparison, Wal-Mart (WMT -0.27%), which is some 25 times larger in terms of revenue and should find it harder to move the needle, has for all its own woes seen sales grow at 3.5% rate annually.
Yet Macy's is little better, with 2.5% annual growth, while both J.C. Penney and Sears are significantly below where they were five years ago. Even with the former's vaunted turnaround, it remains a distressed company that needs everything to remain just so if it wants to continue to survive. It tried to shake up the image of what a modern department store could be when former CEO Ron Johnson came in and turned things upside down, but quickly retreated in the face of an ugly consumer response. It's easy to imagine that if the U.S. economy lurches into a recession again, J.C. Penney would be hard-pressed to survive.
Yet it is also the one department store chain that has skirted the attention of hedge funds which now plague its rivals. Sears CEO Eddie Lampert has used his private equity acumen to strip the once-iconic retailer of virtually every valuable asset it held. Last year, he began monetizing the retailer's real estate, spinning off its stores into a real estate investment trust, something the folks at Starboard Value are pushing Macy's to do.
Since the tax benefits of such maneuvers are now in the sights of politicians -- Congress voted last month to end the tax breaks realized from those real estate deals -- the private equity firm is pushing Macy's to pursue joint ventures with investors instead to generate value for shareholders. Macy's was already pursuing that goal, but it's also slashing some 4,800 jobs too.
Kohl's has struggled to attract customers and worries that private equity may pounce while it's down. Image source: Mike Mozart.
Smelling blood in the water
Kohl's fears its depressed state may attract hedge funds that will attack it as they have other retailers. Private equity was behind many of the biggest recent moves:
- Staples attempting to merge with Office Depot
- Jos. A. Bank getting acquired by Men's Wearhouse
- Dollar Tree's acquisition of Family Dollar
- PetSmart's decision to go private
And that's just the move Kohl's is now considering to head off monied interests from making a play for it. According to The Wall Street Journal, the department store operator is considering several strategic alternatives, including breaking itself up. That's certainly a drastic move, maybe even one worse than a hedge fund moving in on it, but it may be what's needed in this age of e-commerce.
According to the market researchers at Slice Intelligence, Amazon.com (AMZN 0.32%) garnered 42% of all e-commerce sales made this past Christmas, 17 percentage points more than the next 10 largest retailers combined. Although bricks-and-mortar stores still account for the vast bulk of all retail sales, e-commerce's impact will only continue to grow. Department stores like J.C. Penney, Kohl's, and Macy's are tasked with fighting a battle with an outdated business model.
Kohl's may go private and Macy's may shed its stores. Investors should ask if any similarly situated retailer has a different better option available. They may conclude the department store has reached a time where it should close up shop.
