The Retail Apocalypse is going to get worse before it gets better

In My Humble Opinion
1

I’ve posted on this before:

That dark big box (and other) retail isn’t coming back, is it? (2017)

So are malls dying or not? (2015)

Actually, it’s going to get worse and never get better, as I believe that the demand for bricks-and-mortar (B&M) retail will never go back to its 1990s peak (or whenever the peak was–I would assume before 9/11).

The economy of Indianapolis is not terrible (I hear), but there are massive retail holes all over the place. Castleton is one of the prime retail areas, but there are whole huge shopping centers there with one or two stores left–or nothing. In good locations next to some pretty high-traffic centers.

Since I wrote my last post on this topic, a major Indy-based supermarket chain, Marsh, has gone down the tubes. The city is now littered with a ton of small shopping centers with dead anchors. Ah, and Toys R Us just happened.

I have seen very few of the retail holes fill in over the years–not with retail, at least. The Nordstrom hole in the Circle Center Mall downtown became office space (Nordstrom had two stores open and closed one… Ostensibly not a fail on its part, as it grabbed better Fashion Mall space once it became open and then closed the other location. But the lack of demand for this “prime” downtown retail space was telling.) A Ross Dress for Less store filled in a gap in the center with Trader Joe’s in it in Castleton.

Other than Ross and Dollar General, stuff that caters to the less affluent, what is on the rise right now in terms of retail? Anything doing all that great? It seems like the last major national retailer to rise was Kohl’s (no idea how successful it actually is).

OK, but why is it going to get worse? More anchors are going to fall. On the chopping block:

• Sears
• Kmart
• JC Penny
• Macy’s (ugh, if depression were a store, this would be it)

Over the long term, it’s hard to point to anything that seems certain. Even high-endish Nordstrom and Saks are not doing all that great. Both are in the aforementioned Fashion Mall, the most “premium” mall in Indy. If one of those were to go, what could possibly take their place? (I’m not saying that that is imminent, but I actually had an ex-Saks employee tell me that she wouldn’t be surprised if it just disappeared overnight one day. One person’s opinion, but…).

The thing is, once an anchor dies, all the little retail starts to die too. Domino effect. No anchors are on the rise to take the place of old ones. And I don’t think some future prosperity is going to create new retail giants, either. People will continue to buy online. Further, another trend we’ve discussed on here, the lack of change in fashion over the past 20-25 years encourages people to wear clothes longer or hunt for bargains in used clothing. For example, my ex was recently buying Anthropologie items from a few years ago for super-cheap to replace things she’d worn out.

Here’s a Forbes article I thought was not on target:

Physical Retail Is Not Dead: Boring Retail Is

First, an 11% decline is still massive. Second, how much of that 80% is stuff that is very resistant to change, such as groceries? Third, sales can stay the same while locations die. It’s not as though Kroger has had to build more stores to make up for the Marsh locations that went dark.

Next this:

The article has a good argument about the collapse of the middle: more and more physical retail is going to cater to the poor and the rich, less to the middle class. I would say, however, that this is making a different point than “physical retail is healthy.” If Macy’s, which caters to the middle, collapses and is replaced by a store that sells everything cheaper, that would seem to me to be a one-to-one trade at best, not exactly a reflection of general abundance or opportunity. Further, Dollar General is boring. Big Lots is boring. Both are sad. They’re successful because they’re cheap.

Further, saying that “retailers that differentiate themselves” through the conditions stated above will be successful is pretty vacuous, virtually tautological. The point is that differentiation is harder than ever before in the retail world, inasmuch as people can go on Amazon or Ebay and find precisely what they want without having to go to B&M.

Bonus topic. I think Amazon’s acquisition of Whole Foods is a big mistake UNLESS it is just grabbing the locations to do something truly surprising and different. Do I think Bezos has something up his sleeve? If so, it’s not visible yet. Whole Foods is a good example of how something that is special and “differentiated” at first can fairly rapidly be commoditized and made boring.

That’s my post. Thoughts?

2

One of my regrets is not investing in the dollar stores when the great recession hit in 2008. I knew that stores like that (small, easy to get to stores with low prices) would see demand go up, and that has happened. Stocks for family dollar, dollar general & dollar tree have all gone up quite a bit since 2008.

Anyway, lack of disposable income and online shopping seem to be the big reasons that B&M stores are going down. I don’t know what kinds will survive.

Kroger did buy some of the empty marsh stores though. I forget where in Indy, but down in Bloomington the north side marsh is now a Kroger.

I don’t know where it ends. Personally, about the only thing I buy in a B&M store is groceries and gasoline. I buy auto parts at B&M stores, but only after buying them online and picking them up in store.

3

What you said, yes. And:

Yeah, a significant percentage of them were bought, maybe about 1/3. Some retaining the employees that were there, which is good.

What I said ended up unintentionally distorting the facts, but I really just meant to point out that maintaining that 80% B&M sales ratio doesn’t necessarily imply that we will see as many locations in service. Things can get a lot more compact, especially with better logistics than existed in the past.

4

I keep seeing that Amazon killed Toys R Us, and such, which completely skips the huge amount of debt that Toys R Us had.

They were the victims of a leveraged buy out in 2005. They were bought for $6.6 billion by Bane Capital and others, but, just like a mortgage, only 20% was put down, and the rest was financed using Toys R Us itself as the collateral. Toys R Us was then given more than $5 billion in debt.

Making those payments is a huge disadvantage to play with. Even losing sales to Amazon, Walmart, and others, Toys R Us still might have survived if so much of their revenue didn’t have to go to cover their debt.

5

I remember the folks complaining about how mall and big box stores were putting the small community markets out of business … now the internet is putting malls and big box out of business … the question is what will put the internet out of business? … it’s just business “evolution” …

When I was growing up, the mall was The Place to meet up with friends where the parents weren’t looking … how much do you suppose Social Media has taken that roll now? …

6

I read that article, thank you. But I don’t yet fully understand. Could you explain to me how the private equity firms can borrow money from a bank in order to purchase a business and then have the business be on the hook for the loan. Not sure I get that part. I mean, what do the bank records say as to who took out the loan?

7

In the last year I’ve seen reports of how Amazon is seeking to establish a presence in physical stores and Walmart is seeking to establish a greater presence as an online seller. And I couldn’t help thinking “At least one of you is making a huge mistake.”

8

These transactions can be very complicated, needless to say. The article says, LBOs mostly occur in private companies, but can also be employed with public companies (in a so-called PtP transaction – Public to Private).

Toys R Us was PtP:

On 17 March 2005, a consortium of Bain Capital Partners LLC, Kohlberg Kravis Roberts (KKR) and Vornado Realty Trust announced a $6.6 billion leveraged buyout of the company.[28] Public stock closed for the last time on 21 July 2005 at $26.74—a 63% increase since when it first announced that the company was put up for sale. Toys “R” Us became a privately owned entity after the buyout.

So how does the company get “on the hook” for the debt? Well, I don’t know the details, but those Bain guys probably formed a company called something like “Toy Holdings,” which was what bought Toys R Us. Then “Toy Holdings” is on hook for the debt, but it is more or less synonymous with Toys R Us.

The name and structure can be virtually anything they want to make it. For example:

The company was bought by the management of the American big box chain Kmart in 2005, the Kmart management formed Sears Holdings upon completion of the merger.

9

Thanks for your reply. You can’t explain it either, it seems. I was curious because I thought you might know but I don’t blame you for not knowing. It strikes me that it can’t be anything other than private loans, or, if funded by a public bank, collusion between people who are scratching each others backs. Unless I’m missing something…

10

Like anybody else, I’m not a Walmart fan, so I wouldn’t mind seeing them get another bloody nose, as they did with Sam’s Club recently (they shut a bunch down, including one near my home).

I am an Amazon fan, but I wouldn’t mind seeing them get mildly burned by the Whole Foods acquisition. The curse of capitalism is that companies are virtually forced to grow until they start to screw up and doing damage to themselves and others. I don’t mind Amazon being big, but I don’t want it to take over the world, either.

11

I don’t think so. There’s a good chance the future lies in getting the right combination of on-line and B&M options for your customers. The big mistake would be assuming that your current business model is going to continue to work successfully 10 or 20 years down the road.

12

Ok. I’ll answer definitively. Aeschines is exactly right about how it can happen.

It happened slightly differently in the the Toys R Us going private transaction. The details barely matter. In the Toys R Us transaction, the consortium of buyers formed an entity called Global Toys Acquisition, LLC to become the holding company. The holding company arranged to (1) form a wholly-owned subsidiary called Global Toys Acquisition Merger Sub, Inc. and (2) borrow up to $6.2 billion from a number of sources to buy Toys R Us, Inc. The holding company got Toys R Us’s shareholders to approve a merger with Global Toys Acquisition Merger Sub, Inc. in which Toys R Us, Inc. was the surviving company. So, the old shareholders of Toys R Us, Inc. got money. Global Toys Acquisition, LLC came to own all of Toys R Us, Inc. paid for (mostly) with money it borrowed. Global Toys Acquisition, LLC then planned to use the earnings from Toys R Us, Inc. to pay all of the debt off. Since the only thing Global Toys Acquisition, LLC owns is Toys R Us, Inc. and the only thing it does is run Toys R Us, Inc., there is no practical difference between the two although the difference matters for tax and liability purposes.

Why were the lenders willing to give Global Toys Acquisition, LLC the money? Because the lenders believed that Toys R Us, Inc.'s assets and business prospects would allow the parent company to repay all the loans.

If you want to read all the gory details, they are here:

https://www.sec.gov/Archives/edgar/data/1005414/000119312505091145/dprem14a.htm

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The lender may have been you, if you have a High-Yield fund in your retirement account.

As Tired and Cranky says, “The details barely matter.” The outgoing and incoming managements of the bought-out company are in agreement so can do as they please (subject to regulatory approval, which is hardly an obstacle in “business-friendly” U.S.A.) The company borrows and redeems shares.

The company’s sellers are happy — they wouldn’t have sold if they didn’t like the above-market price they’re getting. The company’s buyers, or rather the management company that leads the buy-out, are happy — they get a chunky management fee up-front and are likely to sell much of their stake while the market is still giddy. Investors, like gamblers, have their shot — sometimes you make your point and sometimes you hear the croupier chant “Seven Out; Line away. Last Come and the Do-Nots Pay.” The junk bond funds who supply the greenbacks are serving their customers — if they keep getting burned, they’ll just ask for higher interest rates next time. The store’s customers and employees are likely to end up unhappy — high debt is not a recipe for growth or confidence — but the transaction was never about them.

Welcome to modern American capitalism. Adam Smith is turning over in his grave.

14

Agreed. It’s total garbage.

While we’re on the topic, Nordstrom failed to go private recently. The Nordstrom family et al. tried to get financing for a buyout. They were unable to get it done. Whether that’s good or bad for Nordstrom is hard to say. I wouldn’t say it’s on a very solid path right now, but a buyout could have been disastrous as well.

15

Thanks all. I imagined just such an arrangement, I just couldn’t imagine who would lend money to them. But if its private funding, from multiple sources, then, yes I can see it.

16

Regardless, the self-limiting factor is that the lenders have to believe they’re going to get paid, right? It’s not just a matter of increasing the interest rate they charge, since higher rates increase the chance of default.

17

The legal structure is a bit more elaborate, but the business is the collateral pledged by the new owners for the purchase loan. It’s the same way most people buy a house.

LBOs are risky but can pay off under the right circumstances. Here is a Quora discussion of some of the factors involved, with a few examples of successes.

Remember that in 2005, Toys R Us was a category killer, in the process of crushing FAO Schwarz and KB Toys. Its collapse is only noteworthy now because it was the toy store that (debt notwithstanding) managed to hang on the longest. The LBO was a gamble that the market for toys would keep growing and that TRU’s dominance would continue. They didn’t foresee the severity of the 2008 downturn or the expansion of Amazon (or the rise of the direct-download video game market), but plenty of retailers not laden with debt have also died in recent years after missing those same two factors…

18

Do you really think so?

It’s not like there’s only going to be one retail channel in the future. There will be both online stores and physical stores in the future. I’m pretty sure of it. The relatives size of the market in physical stores is probably going to be smaller, but that doesn’t mean that there’s no room for a new entrant to make money.

19

Some people have the unsupported belief that if a big corporation decides to do something then it must be a sensible idea even if it looks foolish.

Personally, I think there’s a good chance both companies are screwing up. They’ve been successful following the same formula: be the top company in a field where the top company dominates the field. I’m assuming both companies understand how they became successful.

But for some reason they’re both trying to defy that formula in another field; they’re both trying to come in as a second-tier company in a field where the top company crushes second-tier companies. Amazon will end up becoming the next K-Mart and Walmart will end up becoming the next Pets.com. The big question is whether they’ll sink enough money into these attempts that it will endanger their core business.

20

Molecular assemblers?