May 7, 2018 Consensus

The Weekly Consensus – May 7, 2018 (Volume 10, Number 19)

The Big Story
Moral Hazard (Again) at an American Icon
Marshall Schleifman

Mount Rushmore National Memorial depicts the familiar faces of four presidents chosen by sculptor Gutzon Borglum because of their importance to the history of the United States.  When the monument was completed in 1941, the undisputed “Mount Rushmore” of retailers would have featured Sears Roebuck & Company.  A dominant retailer across several generations, Sears was the largest U.S. retailer as recently as the early 1990s, when it was then displaced by Walmart.  In 2004, Sears was acquired by Kmart Holding Corporation, controlled by hedge fund ESL Investments run by Eddie Lampert, which marked the beginning of a long chapter of struggles and decline.

Under ESL’s watch, Sears’ deterioration has accelerated, and its brand has become a nonfactor in today’s consumer landscape.  Meanwhile, its stock price has eroded from over $100 to $3 today.  However, Eddie Lampert has positioned ESL’s investment to fare better than Sears’ other shareholders.

In addition to collecting handsome management fees over the course of nearly 15 value-losing years, ESL has slowly but surely aligned itself in opposition to fellow shareholders.  Through several transactions in recent years, the firm shifted control of many of Sears’ most attractive assets from shareholders to other ESL-affiliated entities.  With loans from ESL to Sears totaling over $800 million and a current Company market capitalization of less than $400 million, ESL’s financial returns will be shaped more by the recovery on its loans than from appreciation in Sears’s stock price.  This clearly raises a moral hazard dilemma:  If Sears wins, ESL wins.  If Sears loses, ESL may win more (or at least lose less).

This dynamic was the subject of a $40 million legal settlement last year pertaining to one transaction in which Sears sold some of its best real estate to and then leased it back from a Real Estate Investment Trust in which ESL is a major owner.  With that litigation resolved, ESL has pivoted to a new proposal to carve out the best of Sears’s remaining assets.  On April 20, 2018, ESL proposed to buy Sears’ Kenmore brand, its Home Improvement business, its PartsDirect division and some real estate.  Sears shareholders should again be leery of transactions between ESL and Sears – after all, they are both managed by one person serving multiple constituencies.

On its surface, last month’s proposal letter was well-drafted by lawyers anticipating self-dealing scrutiny.  It’s sufficiently conditioned with “coulds” and “woulds” and makes assurances about creating mechanisms for an arm’s length transaction.  But as Charles Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware, commented, “You can create special committees and make all the arguments you wish, but ultimately, human nature always wins out.  If it’s between his interests and the company’s interests, the concern is his interest wins.”  As we have seen in cases of other businesses where controlling shareholders made self-serving decisions as the ship was sinking, examining those decisions post-mortem is telling.  If Sears eventually finds itself under the microscope of a bankruptcy court judge, which many industry observers expect it will, the fireworks of litigating deals made between Sears and ESL may be an attraction that rivals the famous sculpture carved into the Black Hills granite of South Dakota.


Headlines of the Week

Flipkart is said to have approved a $15 billion Walmart deal

The board of Flipkart Online Services Pvt has approved an agreement to sell about 75% of the company to a Walmart Inc.-led group for approximately $15 billion, according to people familiar with the matter, an enormous bet by the American retailer on international expansion. Google-parent Alphabet Inc. is likely to participate in the investment with Walmart, said one of the people. That would seal a Walmart triumph over Inc., which has been trying to take control of Flipkart with a competing offer. Flipkart’s board ultimately decided a deal with Walmart is more likely to win regulatory approval.

VF completes sale of once-key apparel brand Nautica

VF Corp. completed Tuesday the accelerated selling off of another one-time key apparel brand. The Greensboro apparel marketer said Authentic Brands Group has finished its purchase of Nautica for an undisclosed price. VF put the brand on the block Feb. 16 with the deal announced March 19. The deal is the latest in a brand sell-off trend that includes Jan-Sport in the fourth quarter of 2017, Licensed Sports Group business in April and its Contemporary brands in August 2016. “We came to a point where (Nautica) didn’t necessarily hit all of our strategic touch points financially,” Steven Rendle, VF’s chairman, chief executive and president, said Feb. 16. “We are ready to take the helm of this classic American brand,” said Jamie Salter, chairman and chief executive of ABG.



Apparel & Footwear

As Vow To Be Chic shutters, Zola raises $100M more

Bridesmaid gown rental startup Vow To Be Chic is shuttering operations after five years, CEO Kelsey Doorey told The Knot. According to a company email to customers on Wednesday, the primary reason for shuttering its operations is due to a lack of capital.

“Sadly, our capital constraints mean we have no choice but to stop operations today,” the email said. Rent the Runway, which also offers rentals in the category, swooped in on the news Thursday, offering Vow to Be Chic customers via Twitter 50% off bridesmaid dresses and packages. Meanwhile, wedding registry startup Zola, has garnered $100 million in Series D funding, Techcrunch reports. The company, which is also five-years-old, was launched by CEO Shan-Lyn Ma, a former executive of e-commerce companies Gilt Groupe and Chloe + Isabel.

Chico’s becomes the latest retailer to sell on Amazon

Chico’s FAS, the parent company of Chico’s, White House Black Market and Soma, announced Monday it plans to sell Chico’s merchandise on Amazon. Chico’s shares had jumped more than 4 percent in the premarket, but then retreated and were down 1 percent in the regular trading session. The company said shoppers in mid-May will find a “select assortment” of clothing and accessories, including its athleisure line, no-iron shirts and jewelry, on Amazon. Chico’s said it could begin selling items from White House Black Market and Soma via Amazon, “as the new business channel gains traction.” Chico’s said it will keep control of marketing, pricing and promotions for its products in this new partnership. “Chico’s FAS will be one of the few vertically-integrated specialty retailers with Prime eligibility on,” Chico’s FAS CEO and President Shelley Broader said in a statement.


Athletic & Sporting Goods

Adidas is still crushing Nike and Under Armour in America

Adidas posted another quarter of double-digit sales growth in North America last Thursday, beating competitors Nike and Under Armour on their home turf.  The company said that first quarter sales in the region grew 21% over the previous year, a performance fueled by a renewed focus on marketing and celebrity partnerships with the likes of Pharrell Williams. North American sales have recently slumped at both Nike and Under Armour.  Shifting consumer tastes towards casual street wear have helped the brand, which sells the popular Stan Smith sneakers.  The trends have produced a remarkable run for Adidas: Its North America sales have now increased by 20% or more in nine consecutive quarters.


Vista Outdoor To Sell Bell, Giro, Blackburn, & Other Brands

Vista Outdoor announced plans to sell Bell, Giro and Blackburn, as well as their other sports protection brands. They are also selling Jimmy Styks paddle boards, Savage Arms, and Stevens firearms, focusing their business on ammunition, hunting and shooting accessories, hydration bottles and packs, and outdoor cooking products.  The company says the plan is a result of a comprehensive strategic review, which began in November 2017 when new CEO Chris Metz joined the company, and is not a result of recent boycotts of Bell, Giro, Blackburn, and Camelbak by consumers over Vista’s involvement with the NRA.

Berkshire-based Implus buys STABIL

Implus, a portfolio company of Berkshire Partners, has acquired STABIL, a maker of footwear traction products. No financial terms were disclosed.  Implus, a provider of athletic, fitness and outdoor accessories, announced the acquisition of 32 North Corporation d/b/a STABIL®, the maker of STABILicers® performance footwear traction products made in the United States and Canada. STABIL will be integrated into Implus’ current portfolio of leading traction brands which includes Yaktrak®, SnowTrax® by Yaktrax and ICEtrekkers®. In conjunction with the transaction, Implus will maintain STABIL’s sales operation based in Biddeford, Maine, with fulfillment transitioning to Implus’ headquarters in Durham, N.C.

Cosmetics & Pharmacy

Script Volume Growth Helps Boost CVS Health in Q1

CVS Health has posted solid earnings for its first quarter and affirmed its 2018 guidance as the close of its acquisition of Aetna comes into sight. The company posted net revenues of $45.7 billion for the three months ended March 31, an increase of 2.6% over the previous year. Operating profit grew 8.5% to $1.9 billion. The company posted earnings per share of $0.98. Same-store prescription volume growth in the company’s retail/long-term care segment grew 8.5% year-over-year, driving a 5.6% increase in segment revenues, which totaled $20.4 billion for the quarter. Same-store sales grew 5.8% and pharmacy same-store sales increased 7.3% in the quarter.

Birchbox Has Sold Majority Ownership to One of Its Hedge Fund Investors after Sale Talks with QVC Fell Through

After many months of acquisition talks, Birchbox has found a buyer: One of its own investors, the hedge fund Viking Global Investors. Viking Global has acquired a majority stake in the beauty startup after agreeing to invest around $15 million of new cash into the business, multiple sources said. Viking Global is also taking over a startup that currently has tens of millions of dollars in debt, sources say, as Birchbox tries to kick-start profitable growth to emerge from that shadow. With the deal, Birchbox’s other investors — which include top venture capital firms including Accel Partners and First Round Capital — are getting wiped out, and are expected to walk away with nothing. Birchbox had raised nearly $90 million in financing from investors since its 2010 founding, and was once valued at nearly $500 million.

Sephora Adds Spa-grade Facial to In-store Services

Sephora has announced that beauty fans who enter its store doors will now be able to obtain a spa-grade facial, as part of its in-store services. The San Francisco-based company will offer the Perk Hydrating Facial, an exclusive skincare treatment in partnership with HydraFacial. As part of the 20-minute in-store service, a specially trained advisor will provide the consumer with a skin care consultation, then perform the service and discuss product recommendations, including a Digital Skincare Guide, which can be emailed to the client for future reference. The facial is complimentary with a $75 minimum product purchase and available at over 100 stores across the country.


Discounters & Department Stores

Macy’s Acquires Story: A Small But Bold Move That Could Save The Department Store

Macy’s just announced that it is acquiring Story, a highly innovative retail store in downtown Manhattan. It’s only one store so it’s not a huge deal. But the significance of it is big because of what Story is. If you’re not familiar with it, Story is a unique retail concept whose founder is Rachel Shechtman. The idea is to sell things in the store of course but it’s more than that. About every three months, everything in the store goes away and entirely new inventory is brought in. More than that, every new cycle has a new theme. Themes they’ve done recently include: Love, Home For The Holidays, Beauty, Remember When and many others.

Bon-Ton bankruptcy pinches shopping choices in smaller Wisconsin cities

Standing near the Beaver Dam Boston Store last week, its windows plastered with signs touting everything inside — what’s left of it, anyway — as 80 percent to 95 percent off the original price, retired schoolteacher Lois Sell was feeling pinched by a shrinking set of shopping choices. Kohl’s is nearby, but it’s not her favorite. Downtown Beaver Dam has a boutique, she said, but “it’s very exclusive.” And she wouldn’t think of buying clothes at the local Walmart or Shopko. Or on Amazon.

Walmart, Target Recycle Baby Gear

Both Walmart and Target are reaching out to parents feeling guilty about their seemingly endless contribution to landfills. They are focusing on the headaches around car seat disposal. Although car seats make kids radically safer, they’re problematic. While most used baby gear can be donated or sold, changing regulations means car seats need to be replaced often, and many come with expiration dates. And for safety’s sake, they shouldn’t be sold or reused. But many curbside recycling programs won’t accept them.


Grocery & Restaurants

Nestle Is Said to Near Starbucks Store-Products Unit Deal

Nestle SA is close to a deal for Starbucks Corp.’s business that sells coffee beans and drinks in supermarkets, according to a person familiar with the situation. The deal would not involve the Seattle-based company’s cafes.

Sainsbury’s and Asda defend £13bn merger to create grocery powerhouse

Sainsbury’s and Asda say their planned £13bn merger will maintain the number of stores operated by the brands and cut shoppers’ costs. The deal – likely to face close scrutiny by competition authorities – will create a grocery powerhouse overtaking Tesco as the number one player in the sector, with combined revenues of £51bn.

Home & Road

Spectrum Brands Restructures in Wake of Poor Second Quarter Results

Spectrum Brands Holdings has implemented a new operating structure, announcing plans to organize globally around divisions focused on consumer products and home improvement, while remaining committed to the sale of its small appliances and personal care and global batteries and lighting businesses. The company is also now under the leadership of David Maura, who in addition to holding the executive chairman title, became chief executive officer, succeeding Andreas Rouvé, who stepped down from his CEO and director role. Spectrum had announced in January its plans to sell its small appliance brands, which include George Foreman, Black + Decker, Remington, Russell Hobbs, Juiceman, Breadman and Toastmaster. In delivering its second quarter fiscal results, the company lowered its fiscal 2018 full-year guidance and authorized a new three-year, $1 billion common stock repurchase program

Wayfair Sees Q1 Sales Momentum But Loss Grows

Wayfair’s first quarter net revenue and revenue derived from website sales in the U.S. both surpassed a billion dollars for the first time, but the company’s losses almost doubled during the period. For the first quarter ended March 31, Wayfair posted a net loss of $107.8 million, or $1.22 per diluted share, versus a net loss of $56.5 million, or 66 cents per diluted share, in the year-earlier period. Wayfair adjusted net loss, excluding one-time charges, was $80.4 million, or 91 cents per diluted share, versus an adjusted net loss of $41.4 million, or 48 cents per diluted share, in the year-prior period. Despite the deeper net loss, loss per adjusted diluted share topped a MarketBeat-published analyst average estimate, which placed the loss at $1.16.

Jewelry & Luxury

How one woman plans to overhaul the culture at the world’s largest jewelry retailer

Virginia C. Drosos, the new CEO of Signet Jewelers (SIG), has been working to turn around the world’s largest retailer of diamond jewelry since taking the helm in August 2017. A key part of her three-pillar turnaround plan, known as “The Path To Brilliance,” is transforming the company’s culture. A year ago, Signet, which is the parent company to well-known brands such as Kay Jewelers, Zales and Jared: The Galleria of Jewelry, found itself at the center of allegations of pay discrimination and sexual harassment, which were detailed in a Washington Post story. By the summer, then-CEO Mark Light resigned, with the company citing “health reasons.”

Texas Jeweler James Avery Dies at 96

James Avery, who started his eponymous retail chain in his in-laws’ garage in the 1950s, died Monday. He was 96. He served in the U.S. Air Corps during World War II.  Following WWII, Avery earned a bachelor’s degree in industrial design from the University of Illinois. He began teaching at colleges, and it was while at the University of Colorado that he first began to explore jewelry-making techniques. In 1954, he and his wife, Texas native Sally Ranger, spent the summer in Kerrville visiting her parents. It was then and there that Avery started what would eventually become an 80-store chain in his in-laws’ two-car garage.


Office & Leisure

Millions of dollars paid to former executives at Office Depot

Boca Raton-headquartered Office Depot has paid millions of dollars in severance to departing executives in the past year, as the company’s latest CEO, Gerry Smith, replaces top leaders. While former executives typically receive severance and bonuses related to their employment agreements, Office Depot’s proxy statement to shareholders for its annual meeting on Friday includes an unusual amount of detail on what has been paid to departing executives, and incentive compensation for Gerry Smith, who became CEO in January 2017. One reason may be that shareholders are being asked to vote on the company’s executive compensation plan at the meeting.

While the vote is only advisory, shareholders are being given at least a glimpse at the millions paid in the most recent effort to turn around Office Depot, a long-struggling retailer that has had two CEOs in the past five years. The proxy gives details on current executive compensation as well as “golden parachute” payments to former executives.

Newell Is Swimming in Strollers After Toys ‘R’ Us Collapse

Newell Brands Inc. is slimming down — but thanks to the demise of Toys “R” Us, it has a glut of goods in one of its key categories. The maker of Graco strollers and car seats didn’t foresee the liquidation of the 800-unit toy-and-baby-goods seller, which is in the process of shutting down its U.S. operations. “We built a plan that assumed only 182 stores were going to come out this year,” Newell Chief Executive Officer Mike Polk said on the company’s earnings call Friday. Polk estimated that Toys “R” Us had about $200 million of baby gear when it began liquidation, with Newell’s market share in the “high 30s.” Newell, a maker of goods as diverse as Crock-Pot slow cookers and Sharpie markers, said Friday it’s expanding a turnaround plan to include more brand divestitures, including a $2.3 billion sale of its Waddington Group tableware business. Since the baby market’s not shrinking, “that hole will be filled by other retailers” in the second half of the year, Polk said.

Technology & Internet

Amazon offers retailers credit-card fee discounts when they use its payment system Inc. is offering to pass along the discounts it gets on credit-card fees to other retailers if they use its online payments service, according to people with knowledge of the matter, in a new threat to PayPal Holdings Inc. and card-issuing banks. The move shows Amazon is willing to sacrifice the profitability of its payments system to spread its use.

The world’s largest warehouse owner buys its rival to acquire more e‑commerce tenants

For Prologis Inc., the world’s largest warehouse owner, the biggest challenge to growth has been acquiring land in the markets most important to its e-commerce tenants. The solution: buy a rival. The real estate investment trust (REIT) agreed to acquire DCT Industrial Trust Inc. for $8.4 billion in stock and assumed debt.


Finance & Economy

U.S. March Consumer Spending Picks Up; Inflation Hits Fed Goal

U.S. consumer spending picked up in March while the Federal Reserve’s preferred inflation gauge hit the central bank’s 2 percent target for the first time in a year, reinforcing the outlook for further interest-rate hikes.  The rise in consumer spending, which accounts for 70 percent of the economy, gives the economy some momentum at the end of an otherwise weak quarter, and provide some support for forecasts that consumption will accelerate this quarter as tax cuts and a gradual pickup in wages filter into Americans’ bank accounts and sentiment. At the same time, the income figures were slightly below forecasts, reflecting the weakest gain in wages and salaries since October.


Retail leads planned job cuts in 2018 while technology bounces back

Companies announced plans to cut 36,081 jobs in April, a 43 percent decrease from March, a private survey reported.  April bucked the trend of increasing job cut announcements, which hit a height in March when the most job cut announcements were made in a single month in nearly two years.  Retailers announced the most cuts in April — 7,844. Retail leads all sectors in job cuts this year, with 64,370 — far surpassing the next two closest sectors, health and consumer.

Unemployment is below 4% for the first time since 2000

The unemployment rate has dipped below 4% for the first time since 2000.  The United States added 164,000 jobs in April, the Labor Department reported. That was slightly below what economists expected. Unemployment dropped to 3.9%, the lowest since December 2000.  Wages grew 2.6% from a year earlier. That was also slightly below expectations.  The report indicates another month of solid job growth for an economy that has been expanding for almost nine years — the second-longest streak on record.