Retail Mergers: Doing Business in Real Estate
If, as the song says, you were a rich man, or woman, would your first investment impulse be to buy a supermarket chain? Or a string of department stores? If not, you may wonder why so much big money is buying so many stores these days.
The takeover wave in retailing is becoming a flood. Allied Stores (Brooks Bros. and other stores) has attracted a $3.56-billion offer from a shopping center developer. May Department Stores Co. (May Co. and others) has bought Associated Dry Goods (Lord & Taylor and others). Safeway Stores is being acquired in a leveraged buyout, a deal in which a company is purchased with money borrowed against its own assets. Dayton Hudson Corp. is buying the Gemco chain from Lucky Stores, the supermarket operator that is itself the target of a buyout proposal from money man Asher Edelman.
The wave didn’t start yesterday. Two years ago, the Limited Inc. made a tender offer for Carter Hawley Hale Stores, and the game really got hot last year when R. H. Macy’s managers moved to take the company private in a leveraged buyout.
What’s the sudden attraction in this business? The big money sees opportunities in real estate even though we are at the end of an era of expansion in American retailing.
Unpleasant Surprises
The investment bankers, as you might expect, are already pocketing their fees. But the takeover fiesta’s consequences for shoppers are not likely to be favorable. The consequences for employees and job opportunities in retailing are likely to be decidedly unfavorable. And there might even be some unpleasant surprises for investors in the paper being peddled to finance these deals if the economy should go into a recession.
Like so many other phenomena in our economy today, this takeover wave mostly represents a liquidation of past investment, rather than new growth in business. About the only growth we can hope for will be among what analyst Fred Wintzer of the Baltimore investment firm Alex. Brown & Sons calls “new concept retailers”--Crazy Eddie, Circuit City, Toys ‘R’ Us and others.
Basically, the takeovers are happening because the nation is overstored and markets are saturated. At 30,505 supermarkets and 8,684 department stores, the numbers now will start to decline. New malls won’t be built, and retailers will expand by merger.
Thus the stores in the existing malls have suddenly acquired greater value: Either they can become acquisition candidates for an ambitious chain, such as May Department Stores, or their own managers can buy them by borrowing against the collateral of the stores’ own real estate in order to pay off the public shareholders.
Value of Real Estate
Here’s how that works. The stores in place either own their real estate, and carry it on the books at historic cost, or occupy it on leases written years ago at lower rents. If you were in a similar position with your own house or rented apartment, there would be two ways to turn those historic values into immediate cash: You could sublease the apartment at a higher rent, or you could take a second mortgage on the house.
Just so, the retailers are able to sublease their outlets to new-concept retailers who want to get into the existing shopping centers and will pay to assume the lease. Or, with the aid of investment bankers who find institutions to finance the deal, the retail managers can take a second mortgage and buy the company. The managers then work to pay the mortgage lenders and ultimately own the company free and clear. It seems to be an entrepreneurial breakthrough.
But there’s a catch. Debt service costs go up. Just as your monthly payments would go up if you took a second mortgage on your house, so the retailer’s interest payments will rise. Just as you would have less discretionary income, so the retailer will have to work harder just to pay the bank.
This is unlikely to benefit shoppers. With new competitors no longer coming to town and the local store needing higher cash flow to meet debt payments, shoppers will see fewer low-price deals on merchandise.
Employee layoffs will become common as stores struggle to cut costs and increase cash flow to pay debt. This is already happening at Safeway, where the company has incurred $150 million in fees and commitments to commercial banks and investment bankers, even though the buyout won’t be formally completed until November. When it is completed, Safeway concedes that its cash flow will be inadequate to service billions of dollars in debt, so it will have to sell assets.
The chain will be broken up, with Safeway stores in some communities--certainly Washington, perhaps San Diego--being sold in package lots.
If you’re an investor, you’re probably late if you think that now’s the time to buy retail stocks. Federated Department Stores, for example, has risen more than 70% in the last year and is selling at an all-time high.
Otherwise, investors inclined to buy some of the bonds that finance these mergers might ponder the possibility of a recession. We’ve had them before, you recall. But in the past, the average store could survive a slow season because, like any sound business, it had a reserve, a cushion against adversity. Now, with the higher fixed costs of its new debt, it can’t cut back. But it can default. Waves sometime end in wipeouts.
Call it the treadmill economy. We have the money moving faster and faster, but you have to wonder if we’re getting anywhere.
