Just when retailers thought their imperative was to combine their e-commerce and stores into one, smooth, silo-free operation, along comes Saks Fifth Avenue, attracting hundreds of millions of dollars from investors after splitting them apart.
In a series of conversations, various people familiar with the design and execution of the Saks separation declared it a success and suggested that other retailers should — and ultimately will — follow suit. That could happen quickly. Saks owner HBC has already gone on to give the same treatment to its off-price Saks Off 5th and Canadian department store Hudson's Bay businesses. Activist investment firm Jana Partners, after floating the idea at a conference, is now reportedly pushing Macy's to explore it seriously as well. And "financial sources" told Women's Wear Daily that Kohl's is next.
The motivation behind extracting the e-commerce side of a retail business is largely, if not entirely, financial, stemming from Wall Street's deep devotion to tech-oriented companies. So far, though, it's been applied just to department stores — if two only hypothetically — and not specialty or big-box retailers.
"The general view is that these are businesses in long-term decline," GlobalData Managing Director Neil Saunders said by email. "As such, the focus is on how to extract value through reengineering and restructuring."
The split
As of March, "Saks Fifth Avenue" is actually two entities. One, Saks.com, is an e-commerce player that is also developing an online marketplace; the other, SFA, is a fleet of 40 brick-and-mortar stores. Making this happen took months and the contemplation of thousands of "what-if" scenarios, according to sources familiar with the process.
That resulted in more than 150 operating agreements and more than 150 transition agreements to govern the relationship, ensuring that activities like merchandising and branding are consistent so that Saks customers will be none the wiser, sources said. Making the move at Macy's similarly would require 200 to 300 such clauses, according to Cowen & Co. Managing Director Oliver Chen, whose specialty includes retail and department stores.
"There's lots of integration and the customer clearly doesn't want to or need to know, and needs to have a seamless experience," he said by phone. "It's very, very complicated, but complications can be worked out if you have 300 rules to follow."
It seems likely that, over time, at least some of the agreements and partnerships will have to be revisited, and a person familiar with the separation process at Saks said there's room for that. But these issues are difficult even when the online and offline teams reside in one company, and mandating coordination through legalities and fees is less than ideal, according to Colorado State University Business School Professor Jonathan Zhang.
"It's very, very complicated, but complications can be worked out if you have 300 rules to follow."
Oliver Chen
Managing Director, Cowen & Co.
Indeed, a former Saks employee, who worked in merchandising there until last year and asked to remain anonymous in order to preserve contacts in the business, said cooperation was already breaking down last year, as aspects of the new arrangement were put in place. Once they were on the e-commerce side, team members became difficult to get on the phone, the former employee said.
"When you really execute a seamless customer experience and also make sure that your employees are collaborating and there's no infighting, it's a very hairy process," Zhang said by phone. "It's tough. And as we know, legal contracts are the last resort, right?"
The value
Nonetheless, the maneuver has already netted a significant amount of money. Private equity firm Insight Partners ponied up $500 million to take a minority stake in the new Saks.com, and the luxury website could garner quite a bit more if, as rumored, it goes public with a $6 billion valuation. More than one person familiar with the move also noted that it evens the playing field with the likes of Farfetch and Mytheresa because the dot-com Saks business can more readily entice not just investors, but also superior tech talent.
GlobalData's Saunders countered that there was nothing stopping Saks from competing for those hires pre-split, "other than a lack of thinking and imagination." Others say it will be true as long as Saks.com persuasively bills itself as a techie company, something that took Walmart years to achieve.
"The e-commerce side is now able to position themselves, to the investors and also to the employee pool, as a tech-focused company," Colorado State's Zhang said. "They are able to make themselves appear more attractive and more modern. But to transform public perception of a brand, I'm not going to lie, takes time, and it is a challenge."
Thanks to how the split was arranged, however, Saks.com also has some benefits its tech-focused rivals don't.
What Saks.com gets to keep
Proponents of Saks.com's independence may tout its fresh position as a luxury e-retailer with digital cachet, but the online entity also ended up with some of the department store's most valuable and longstanding strengths.
That includes, according to people familiar with the set-up, its merchandising, buying and marketing teams and its intellectual property. SFA, the stores company, pays the e-commerce company for those systems. Saks.com pays SFA for services like BOPIS, returns and alterations that take place between four walls. That could spell trouble for the stores side, as it indicates that the dot-com business is "firmly in control," Saunders said.
"This is very much about a financial move which allows the stores to be starved of investment with very little implication."
Neil Saunders
GlobalData Managing Director
"Not only does this severely devalue the store-based business, it means that all decisions will be made by an online team that may not understand, or care to understand, how stores need to operate," he said. "The brand and IP assets are also protected if the stores part of the business goes bankrupt or enters liquidation. This also signals that this is very much about a financial move which allows the stores to be starved of investment with very little implication."
A person familiar with the new setup consistently described the stores' value as distribution points and real estate assets, rather than as the marketing and customer acquisition tools that many retailers (including DTC companies) have found them to be. That value proved impossible to quantify, though it has been acknowledged, and in fact Saks.com might see fit to open its own stores some day, the person said.
Why department stores
Saks online opening new physical locations may be a head-spinning notion, given that the whole point was to unload the brick and mortar, but many an e-retailer has eventually deemed stores necessary in order to scale. Then again, that has never meant "department stores," and that's a clue to why the segment is being targeted.
"The unfortunate thing is Macy's and Kohl's stock trades at such substantial discounts to e-commerce businesses, so they really haven't gotten credit for those [online] parts of their businesses," Cowen's Chen said. "Investors most likely apply a discount to the physical sides. It comes back to the stock price. Macy's trades at half-a-point times sales and e-commerce businesses trade at double that. From a financial perspective, a board of directors has to evaluate alternatives to maximize shareholder value."
That discount may derive not just from the perception that e-commerce is more attractive, but also from the reality that many department stores are — literally — not at all attractive.
"The focus of splitting stores and online appears to be on department stores, rather than on retailers like Target or Best Buy or others, because most department stores haven't invested properly in their stores or their propositions and, over a long period of time, have run their businesses into the ground," Saunders said. "This has pushed down the valuation and has eroded the value of the business. Because this has occurred over such a long period of time, it is now complex and costly to reverse many of the problems. And, on top of this, Wall Street is very reluctant to see retailers make massive investments to secure their long term futures."
None of that makes another spin-off inevitable. While Cowen's Chen believes that Macy's must evaluate the possibility, he also says nothing is likely imminent. Further, while Macy's may be vulnerable to activism during earnings season, there are significant differences between the diversified department store company and Saks Fifth Avenue, according to Shawn Grain Carter, a Fashion Institute of Technology professor of fashion business management.
"Saks is a luxury brand and has struggled under their Canadian ownership with Hudson, [while] Macy's and Bloomies have a solid retail department store business in apparel and home furnishings, a Backstage off-price business, and strong, rapidly growing e-commerce business," she said by email. "It's doubtful that [Macy's CEO] Jeff Gennette would split the corporation just to appease Wall Street and one activist investor."
The spectre of Sears
Because the major advantages — higher valuation, easier recruiting, most of the operational expertise and all of the IP — have accrued to Saks.com, Saks' stores side may be in for a vicious cycle, experts warn.
The stores' biggest, if not only, advantage probably now lies in their real estate value, the forte of HBC chief executive Richard Baker. In 2014 the real estate mogul famously snagged a $3.7 billion valuation for the Saks Fifth Avenue flagship alone, surpassing the $2.9 billion HBC paid for the entire Saks company the year before, though that has since dropped precipitously to less than $2 billion.
"The focus ... appears to be on department stores, rather than on retailers like Target or Best Buy or others, because most department stores haven't invested properly in their stores or their propositions."
Neil Saunders
Managing Director, GlobalData
For many observers, this reengineering of what had been a single omnichannel retailer conjures the fate of another department store that over several years leveraged its real estate and IP assets — agreeing to various financial and operational arrangements until it all but disintegrated.
"In the new relationship, the online business can extract value from the stores business via fees and licensing agreements," Saunders said. "These are the types of strategies employed by Sears, where they would play one part of the business off against the other. Of course if at any time the stores business should need to be restructured, it can be placed into bankruptcy without affecting the online business. There is nothing at all illegal or even immoral about this. But the strategy should be seen for what it is, and not spun as some kind of benevolent move that is beneficial to the long term health of the business and both divisions."
The verdict
More than one person familiar with the preparation and execution of the Saks split spoke of it as a proven success. But it has only been in effect for six months, and some outside observers remain cautious.
"It's hard to imagine that splitting apart a company is going to make the company more efficient than if it was running both at the same time," BMO Capital Markets Managing Director Simeon Siegel said by phone. "It doesn't mean it won't make it more valuable, and the reality is plenty of retailers don't own their entire business."
The complex web of agreements necessary to preserve teamwork between Saks.com and Saks stores concerns some analysts, though Siegel and others noted they do have precedent. Retailers have had to figure out how to calculate a store's role in an e-commerce sale, and using stores as fulfillment centers takes coordination, for example.
"You can make an argument that splitting apart retail from e-com is just another manifestation of outsourcing a portion of the business. However, that's a hard argument to make."
Simeon Siegel
Managing Director, BMO Capital Markets
"You can make an argument that there is no 100% vertically integrated retailer," Siegel said. "The question simply becomes — What does a business believe it can optimize versus what does the business believe it should outsource? And we have seen incredibly compelling, presumed to be fully integrated businesses that clearly have partners. Lululemon, the paragon of vertical integration, still obviously has partners. You can make an argument that splitting apart retail from e-com is just another manifestation of outsourcing a portion of the business. However, that's a hard argument to make. So, the burden of proof will fall on the business to show that."
While the fervor around department stores spinning off their e-commerce derives from perception, much will depend on execution, which observers said will take time to evaluate. "When brick-and-mortar and e-commerce sales are in the same company, you think that siphoning sales from stores to e-commerce is better than seeing those sales go to a competing e-commerce company," Erik Gordon, professor at the University of Michigan's Ross School of Business, said by email. "When brick-and-mortar and e-commerce are split, you are not as happy. Are the two companies going to compete with each other? They have to, because they will have different shareholders who will want the company they are invested in to win."
Enthusiasm for the Saks separation was high among the people speaking on background; those speaking on the record were in wait-and-see mode. Wariness stems from the unknowns: Wall Street's tech vogue could diminish or the bubble could even burst, for example, or the staid Saks brand may tarnish the new e-commerce company's shine, according to Zhang.
BMO's Siegel agreed that stratospheric investor sentiment around e-commerce could drift back to Earth, but said what happens next remains to be seen.
"There's an interesting dynamic where valuations now are obviously doing their own thing," he said. "Digitally native companies that are coming to market are worth more than their older, more mature, and many times more scaled competitors. Whether these companies grow into their valuation or fall back is a question that we have not even begun to answer."
