Activist investor Jonathan Litt of Land and Buildings Investment Management has been pushing for radical changes at department store conglomerate Hudson's Bay (NASDAQOTH: HBAYF) since mid-2017.
Earlier this week, he renewed his attacks on the company's board and management. This time around, Litt is making his biggest demands yet. He wants a full breakup of the company, with its real estate, its European operations, its Canadian business, the Saks Fifth Avenue luxury brand, and the Lord & Taylor upper-midrange brand all going separate ways.
There is certainly some logic to his proposal. Hudson's Bay hasn't lived up to its potential, and its stock appears deeply undervalued. However, Litt's proposal for a full breakup of this multinational retail giant seems unrealistic.
Great real estate -- but little to show for it
Hudson's Bay chairman, Richard Baker, has built his empire over the past decade by acquiring department store chains that were undervalued compared to what their real estate is worth. His biggest coup came in 2013, when he acquired the Saks Fifth Avenue chain for just $2.9 billion. A year later, the Saks flagship building in Manhattan was appraised at a whopping $3.7 billion.
Hudson's Bay has grown through a series of mergers. Image source: Author.
In total, Hudson's Bay's real estate could be worth about $11 billion, based on the company's appraisals and internal estimates. Even after deducting its substantial debt, this real estate is almost certainly worth several times Hudson's Bay's meager $1.2 billion market cap.
Nevertheless, Hudson's Bay stock has lost more than half of its value over the past three years. It's no secret why: The company has been persistently unprofitable and has steadily burned through cash in recent years. In fiscal 2017, Hudson's Bay posted a normalized net loss of 564 million Canadian dollars ($425 million). Free cash flow was even worse.
Demanding a breakup
In light of Hudson's Bay's poor financial results and dreadful stock performance, Litt thinks the company should sell its assets piecemeal. Specifically, Litt is urging Hudson's Bay to:
- Sell the Saks Fifth Avenue chain to "a leading luxury department store company" while selling the valuable Manhattan flagship store -- and perhaps some of Saks' other valuable real estate -- separately;
- Follow up the sale of a roughly 50% joint venture interest in its European operations to competitor SIGNA by selling the other half of the business to SIGNA as well;
- Close the Lord & Taylor chain of stores, sell its real estate, and sell its brand to "a mass merchant"; and
- Create a REIT for its Canadian real estate. Unneeded space at Hudson's Bay stores in Canada would be subleased to third-party tenants.
Together, these actions would amount to a complete breakup of the company. If Hudson's Bay could pull off all of these moves, the upside for the stock could be substantial. However, some aspects of Litt's plan may be overly ambitious.
Is this the best way?
The biggest obstacle to Litt's breakup idea might be finding buyers for Saks Fifth Avenue and Lord & Taylor (at reasonable prices).
Saks' main competitor in the luxury market is Neiman Marcus, which is buckling under a heavy debt load and is in no position to pursue any acquisitions. The only potential merger partner with a reasonably strong balance sheet is Nordstrom (NYSE: JWN).
However, Nordstrom hasn't shown any interest in buying a competitor. Nordstrom is also a much different brand than Saks Fifth Avenue, priding itself on its accessibility and wide range of price points, compared to the latter's exclusivity. Even if Saks Fifth Avenue were to remain as a separate brand, there could be a serious culture clash.
Nordstrom has cultivated a much less exclusive image than Saks Fifth Avenue. Image source: Nordstrom.
As for the Lord & Taylor brand, the only plausible buyer is Walmart, which opened a Lord & Taylor e-commerce shop on its website earlier this year. It's true that Walmart has bought up a variety of upscale clothing brands in recent years, but those were mostly up-and-coming labels, whereas Lord & Taylor is a tired department store chain with a steadily shrinking customer base.
Finally, selling real estate willy-nilly would generate a giant tax bill for Hudson's Bay. It could also mean walking away from the expected benefits of expensive store renovations.
The new management team deserves some time
It's reasonable for investors to demand better performance at Hudson's Bay. Still, it's important to keep in mind that CEO Helena Foulkes has been on the job for less than a year. Her turnaround initiatives haven't had much time to work yet.
A number of catalysts could improve Hudson's Bay's performance in 2019. For one thing, by selling a 51% stake in its European retail operations and turning control over to SIGNA, Hudson's Bay has removed a significant source of recent losses and freed up its own management team to focus on improving performance in North America.
Furthermore, Saks Fifth Avenue has seen strong sales momentum recently. The completion of a multiyear renovation project for its Manhattan flagship store could drive further gains next year. Finally, store closures at Lord & Taylor and a focus on improving operations at its discount chain Saks OFF 5TH will create a foundation for boosting the profitability of those struggling businesses.
If Hudson's Bay is still floundering a few years down the road, a full breakup of the company might be the best option. But it probably makes sense to give Foulkes and her new team a chance to turn the company around first.
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