Department stores should keep a hold on their sites

Department stores have been under some pressure to split off their e-commerce operations. It’s an idea that should be left on the shelf.
Macy’s Inc has felt the push from activist investor Jana Partners LLC, but says it won’t spin off its e-commerce business. A demerger at Kohl’s Corp is off the agenda because the company is more focused on maximising the value from people who might buy the chain. That’s the right call. But if rising inflation forces a retail contraction that weighs on department store share prices, the companies may find it harder to stick with their decisions.
Hudson’s Bay Company’s Saks Fifth Avenue started the splitting trend a year ago when it separated its online business into a unit known as Saks. The private equity group Insight Partners invested $500 million in Saks, valuing it at $2 billion. The group’s 41 department stores remain wholly owned by Hudson’s Bay. The Saks digital unit was eyeing a $6 billion initial public offering in the first half of this year, Dow Jones reported in October.
Supporters say separation makes it possible to direct investment to the e-commerce arm, unencumbered by the requirements of stores. Stand-alone digital companies also may find it easier to attract tech talent. But the most obvious reason for department stores to split is to achieve a higher valuation.
Over the past two years, both online retail and luxury spending have surged, elevating the worth of digital luxury players. MYT Netherlands Parent NV, for example, which operates the upscale Mytheresa website, has an enterprise value that is 1.2 times its next 12 months’ sales. The ratio for Farfetch Ltd is 1.5 times. In contrast, Macy’s Inc and Nordstrom Inc trade on 0.5 times.
This is why some investors assume that valuing department store e-commerce sales separately could generate a windfall. Consider Macy’s, whose digital sales this fiscal year are expected to be about $10.4 billion, according to analysts at Cowen Inc. Putting this on a multiple of 0.8 to 1.2 times generates an enterprise value of about $8 billion to just over $12 billion, the analysts estimate. According to Bloomberg data, that’s more than the whole of Macy’s.
But this isn’t the full story.
Across the retail sector, stores and websites are becoming increasingly intertwined. While people who advocate splits say the ownership of different divisions makes no difference to shoppers, there are risks to the consumer experience.
Separate companies owning the brick and mortar stores on one hand and the plumbing behind e-commerce on the other adds more costs and complexity. Arrangements to handle orders placed online but collected in stores must be established, as well as returns made to stores. Retailers from Target Corp to Zara owner Inditex SA are increasingly using store inventory to fulfill online orders. Although Saks is navigating these challenges — it also ships from stores, for example — these elements are generally more complicated when the two businesses are separate.
The bigger danger is that each part of the business runs its operations for its own benefit, to the detriment of the shopper experience and ultimately of sales.
Right now, shareholders are giving department stores that resist splitting the benefit of the doubt. Macy’s last month announced better-than-expected results, sending up its shares as much as 10%. Kohl’s set out plans to become a “focussed lifestyle concept,” opening 100 smaller local stores over the next four years and expanding its relatively new Sephora beauty partnership into a $2 billion business. Although the shares fell after its investor day, its stock has been supported by the prospect of a sale. The company said on Monday that its adviser Goldman Sachs Group Inc had engaged with more than 20 parties on potential strategic alternatives including a sale.
But investors’ patience may wear thin if American consumers, who have so far proved remarkably resilient, start to rein in their purchases. Rising inflation makes this a distinct possibility. And it is the mid-market, in which most department stores operate, that will feel the pinch first. Luxury online retail sites such as Farfetch and Mytheresa may hold up better. Under these circumstances, investor pressure to spin off digital operations could strengthen.
Then, companies such as Nordstrom Inc, which hasn’t yet faced calls to separate its e-commerce unit, could be drawn into the fray too.
Even if the demands increase, spinning off online will make little difference to department stores’ sales. In fact, if customers face substandard service, their operating performances could get worse.
Macy’s, Kohl’s and potentially Nordstrom should prepare to defend their decisions to avoid spinning off e-commerce.

—Bloomberg

Andrea Felsted is a Bloomberg Opinion columnist covering the consumer and retail industries. She previously worked at the Financial Times