In the middle of the barrage of acquisitors for Kohl’s, I wrote Two Real Estate Moguls. Note to Kohl’s: Repel, Repel, Repel. At the time, it was based on my belief that either of the two suitors — Simon Properties and HBC — would ultimately turn Kohl’s into a real estate move. David Simon, CEO of Simon Properties, and Richard Baker, CEO of the Hudson Bay Company, both became billionaires, not because of their retail acumen. They were, and still are mega-wealthy based on their brilliant abilities to unlock the value of retail real estate under the guise that their primary purpose is to re-energize and grow their retail businesses. Under those circumstances, I advised Kohl’s to “repel, repel, repel.”

Now that Kohl’s is close to signing a deal with the Franchise Group, a publicly-traded holding company that acquires and manages mainly franchise companies. Franchise owns brands in various retail industries including American Freight, Buddy’s Home Furnishings, The Vitamin Shoppe, Pet Supplies plus Sylvan Learning, and Badcock Home Furniture. Founded in 2019, it had revenues of $3.3 billion in 2021 and they have a market cap of about $1.5 billion. Their bid is $60 a share, which would value Kohl’s at about $8 billion. Morningstar currently values Kohl’s at just $58 a share; Kohl’s revenue in 2021 was close to $20 billion.

The Good News

Franchise, as a holding company with various unrelated retail businesses in different industries and doesn’t have any great synergies among any of them. I also don’t see any kind of valuable interrelationships for Kohl’s, except perhaps, to carry compatible products from the other entities. I also don’t believe that the corporate management group can add any strategic value to Kohl’s, which is the good news. Because, as I have written, I believe Michelle Gass and the team have a long-term strategy that if given the time and capital to implement, Kohl’s could accelerate on a profitable growth trajectory.

The Bad News

Franchise Group intends to pay the $8 billion price by borrowing $1 billion, then financing the rest using Kohl’s extensive real-estate holdings as collateral. Whoa! Have we seen this before? Leverage the assets for debt so the investor doesn’t have to invest a ton of cash. The problem for Kohl’s is that to roll out their winning strategies, they need the cash. Therefore, the debt will stall their move forward because their cash flow will be used to pay down the debt. Catch 22. S&P Global Ratings put Kohl’s on a negative CreditWatch following the announcement and says that if the deal goes through, it’s likely S&P would lower its ratings on Kohl’s. The deal “would leave Kohl’s more leveraged with less asset protection from its valuable real estate,” CreditWatch says.

Franchise Group brings nothing to Kohl’s table strategically. It has no relevant experience and cash capacity. This deal will likely require Kohl’s to sell and lease back much of its real estate which will then burden the enterprise with rent expenses that it has never had to shoulder before.

Mark Cohen, Director of Retail Studies at Columbia Business School, who has held senior positions in major retail companies, notably as CEO of Sears Canada, made these observations about activist acquisitions: “The activist playbook on retail acquisitions shows mostly failures – something which intelligent investors have to take into account at some point. History bears it out: Retailers acquired by entities with no relevant experience fail. Retailers who are acquired through the use of excessive leverage fail. Retailers who are forced to sell off assets to manage excessive leverage fail. This is the same-old/same-old movie with the inevitable same-old/same-old crappy ending.”

He continues, “This Franchise Group brings nothing to the table strategically. It has no relevant experience and cash capacity. This deal will likely require Kohl’s to sell and lease back much of its real estate which will then burden the enterprise with rent expenses that it has never had to shoulder before. Turning Kohl’s stores into a franchise operation? I don’t think so. Load the enterprise up with debt and rent expenses, and what do you have? As I said same-old/same-old crappy movie with the same-old/ same-old crappy ending.” That said, Cohen believes, “The company’s current strategy is not sufficiently robust to keep it viable let alone create substantially better performance than Gass has been capable of delivering.”

Taking the Longview

I will close by repeating what I have said before. If the sale and leaseback of the stores do not steal the capital required for Kohl’s to implement their strategies, and if Gass and the team are not disrupted for any reason by the holding company in the implementation of their plan, I believe Kohl’s can find a path to sustainable and profitable growth.

Let’s take a look at the situation Kohl’s is up against, and it isn’t pretty.

Mr. Richard Baker

I have already expressed my opinion of HBC’s intent to acquire Kohl’s, under the leadership of the now high-profile Richard Baker. My advice was that Kohl’s must do whatever they can to repel such a deal. Why? Because however many billions of dollars Baker has amassed during his career, they were not the result of his retail acumen. They were, and still are, the result of his brilliant ability to unlock the value of retail real estate under the guise that his primary purpose is to re-energize and grow his retail businesses. While the jury may still be out on whether his leadership over HBC’s retail entities has, or is, yielding positive results, the jury (in my head) has decided on the verdict. While many of his initiatives are still playing out, they are all moves that are ultimately based on unlocking, yes, real estate value. And therefore, in my opinion, they will only have negative results on the retail businesses. With all due respect, Mr. Baker’s brain is hardwired in real estate. Thus, he is programmed to view all of his properties occupied by buildings that happen to be retail stores (and websites) as well…real estate. In fact, there was a telling moment during an interview at a WWD CEO Summit a couple years ago when he said, and I’m paraphrasing here, “The retail business is really hard, real estate is a lot easier.” Well, duh, of course it is.

Here is what failure looks like. Acquire a bunch of once-cool brands on the cheap, license third parties to run them, then license them out to a mall developer who then shovels them into hundreds of dying JC Penney stores that happen to be in dying malls.

Mr. David Simon

Lo and behold, and not surprisingly, another billionaire real estate mogul is David Simon, CEO of Simon Property Group. He has already waded into owning retail with Brookfield Asset Management by acquiring JC Penney, fast-fashion retailer Forever 21 in 2020, and teen retailer Aeropostale in 2016. How did he get there? He took all three out of bankruptcy. Retail is not a certain paradise: Brookfield divested Forever 21 in 2021.

Simon dug even deeper into retail by forming a partnership with (ABG) Authentic Brands Group, naming it Simon Properties Authentic Brands Retail Concepts (SPARC). This clever move brought ABG’s brands under the SPARC umbrella including Nautica, Lucky Brand, Brooks Brothers and Eddie Bauer, just to name a few. In my opinion, the “Authentic” part of ABG should be replaced by “Old.” And the RC part of SPARC (Retail Concepts) should be replaced by Real Estate Concepts.

The reason I say “real estate concepts” is because SPG must preserve as much income as possible from the tenants in his challenged malls, particularly the anchors such as JCP. So, it would appear that Simon envisions a synergy by marrying JCP with ABG brands and inserting some of them into his empty mall spaces that were increasing even before the pandemic. I would say that this is definitely a “Real Estate Concept.” I think Simon believes he might stem the tide of declining traffic in his malls with his retail portfolio. And I believe the CEO of ABG, Jamie Salter sees great licensing and leasing deals enhanced by a SPARC synergy.

Whoops. Wrong picture. I don’t think so. A positive synergy is 1+1= 3. When you have an antiquated stable of dying brands plus a lackluster anchor in many of his malls on life support, you have 1+1= less than 0.

Bear with me: Long story short, here is what failure looks like. Acquire a bunch of once-cool brands on the cheap, license third parties to run them, then license them out to a mall developer who then shovels them into hundreds of dying JC Penney stores that happen to be in dying malls.

And Now, Onto Kohl’s

Red alert to Kohl’s! As reported in a WWD article, a source close to the Kohl’s auction

process said, “No one will outbid David Simon if he really wants it. He wants to bolster JC Penney by merging it with Kohl’s. I think he is going to keep both nameplates and have one team do it all. There could be a tremendous amount of cutting, even closing down Kohl’s Wisconsin headquarters.”

Well, I don’t know the “source,” but reading “have one team do it all” and “closing down KohI’s Wisconsin headquarters,” would indeed be the kind of tactical, short-term decision-making of someone who has no strategic vision. And I wonder what Richard Baker thinks about the statement, “no one will outbid David Simon if he really wants it.”

For Kohl’s, I say repel, repel, repel both of them! SPG, in partnership with Brookfield Asset Management (the second largest U.S. shopping mall owner) put in a $68-a-share offer valued at more than $8.6 billion for Kohl’s. And I say, forget the numbers. What’s the strategy? Where’s the synergy?

First of all, unlike Simon’s deal with ABG and using those tired brands to fill space in both his JCP anchors and other vacant mall space, Kohl’s is not tired or old. They don’t need and likely don’t want any of the ABG brands in store. And more importantly, forget about stuffing Kohl’s into weak or dying malls. Ironically, Kohl’s stole about $5 billion of JCP’s market share in the 1990s directly attributable to their location strategy of placing one-floor, medium-sized, neighborhood stores designed for quicker and easier shopping for the working mom who didn’t have the time to drive to, and shop through the malls.

I suppose there would be some operating economies of scale, backend stuff, and some other cost-cutting opportunities. But if you separate Simon’s idea about retail as real estate, I happen to believe that Marc Rosen, JCP’s new CEO and Kohl’s CEO, Michelle Gass are both strategic thinkers and long-term visionaries. If they are given enough runway with no interference, each can significantly increase the success of their respective brands.

A Final Word About JCP

The problem for Rosen with either a Simon or Baker deal would be the level of interference from his real estate owners. Richard Baker would tend to default to real estate solutions and opportunities with only a second thought about the impact on the retail business. And as mentioned, Simon’s SPARC model is also driven by real estate priorities. That being said, a WWD article said, “Simon has been crowing over the investments lately. And he, in effect, was already doubling down, touting this as a transitional and investment year, setting up bigger gains in retail for the future. Simon told analysts in February that the company’s “platform investments,” including Penney’s, SPARC, ABG and Rue Gilt Groupe produced “terrific results in 2021.” JC Penney in particular, seems to be a source of pride. “Penney’s success is an excellent example of how to better understand our company,” Simon told analysts in November.

Simon seems to have caught the retail bug, said WWD. While he is still very much in the real estate game (80 percent of his cash flow), he has encouraged investors to look at his company more broadly. “We have growth levers beyond our real estate assets that are unique attributes of our company.” He also told the analysts that the retail business was more like “a tail wagging the dog. But you know, it’s an important tail and it’s a beautiful tail and it wags nicely and is very friendly.”

Of course, bringing Kohl’s on board would give that tail even more heft. Let’s stick with the metaphor: Simon’s comment reveals that in my opinion, he will always feed the dog (real estate) first and pat its head (retail) second.

Message to Kohl’s

Don’t be SPG’s or HBC’s tail. Repel, Repel, Repel!

The groundbreaking Sephora and JC Penney collaboration has ended. And then just as quickly, Kohl’s tripled down on their in-store Sephoras, with plans to expand from 200 to 600 stores by the end of 2022 with an additional 250 stores in 2023. This will bring the total number of Kohl’s locations with in-store Sephoras up to a whopping 850 by the end of next year, eclipsing the number of Sephoras that were ever inside JC Penney, which peaked at around 650 stores in its heyday. An while we’re on that subject, Sephora stores in JCP looked like they were dropped in from another planet, completely unrelated to the environment they shared. Apparently, customers noticed: Sephora did about $600 per square foot in JCP while the rest of the footage did around $150 to $200. In other words, the collab paid off big for Sephora, but JCP did not get any crossover business.

The Kohl’s collaboration raises a few important questions about Sephora’s branding strategy, as well as its core customer demographic. It’s an interesting decision that Sephora has partnered with retailers like JC Penney and the Midwest-based Kohl’s. These are retailers have slim to no glamour and cater to middle class families.

Cosmetics retailers are expected to be – and remain – groundbreaking. That feeling of entering a physical store and being exposed to the latest cosmetics trends is still sought after by consumers of all ages.

The question becomes: Is Sephora making the mistake of going down market, like so many upscale retailers that have come before?

The Midwest is not a Trendsetting Beauty Market

It’s not surprising that Sephora execs are focused on expanding the company’s physical footprint through retail partnerships. An impressive 85 percent of skincare and cosmetic sales still happen in physical stores. While the mid-tier department stores Sephora has partnered with are certainly accessible, the demand for prestige cosmetics may be elusive.

How many upscale mall and online customers will continue to be loyal Sephora ‘s legacy with their most pressing beauty needs when the customer base shifts to Midwestern moms and grandmas as the bulk of their business? How will they correlate the sophisticated Sephora brand image to a more modest milieu? And how will a new audience influence Sephora’s product development and brand-name offerings?

I spent the first 20 years of my life in Neenah, Wisconsin –– the same home state as Kohl’s. While the retailer enjoys a glowing reputation for CSR, in the land of beer and cheese the people there will be the first to tell you that they aren’t vying for any beauty trendsetting accolades.

The high school in Euphoria wasn’t set in Milwaukee for a reason. Obviously, the gap in trend adoption has closed slightly as social media and influencers make cosmetic trends more accessible to the masses. However, there’s still the widespread, unspoken mindset of needing permission to try out trends that haven’t yet hit the Midwestern mainstream. It’s questionable whether Sephora will be able to retain the glamour element, which is essential to upscale cosmetic sales, when many members of its core customer base are late adopters.

Going Down Market Should Be a Real Concern

Evaluating the hiring process for in-store Sephoras should have been essential in assessing whether Sephora at Kohl’s would be a strategic partnership for both parties. My biggest concern is whether the talent hired to work at in-store Sephoras will create an elevated Sephora shopping experience for Kohl’s customers, or if it will just take all of the magic out of buying prestige cosmetics –– sending the Sephora brand downstream. After all, the Sephora brand is built on a high level of sophistication and cool factor, and high cool-factor beauty consultants fulfill the brand promise.

Skilled labor is an important draw to in-store cosmetics sales. At their best, cosmetic stores such as Sephora, Ulta, even cosmetics/skincare sections of department stores, are staffed with skilled beauty advisors that have undergone substantial cosmetics training. Just for the record, there are two types of cosmetics training:

Brand Training

Product training that is done through individual brand partners. Urban Decay, for instance, may train associates on a specific eyeshadow palette or new release. Associates often receive said product for free, so it’s a job perk for those working in frontline cosmetics. This isn’t broad range training, but training that focuses on a specific product or product range. Training focuses on product ingredients, proven results, brand history, and application techniques.

Store Training

This is training that’s done by the retailer. This focuses on store rules, training associates on all of the lines carried in-store, and clienteling. This is broad range training done by Sephora for in-store associates.

The question is whether Sephora-in-Kohl’s associates still receive both brand/product training and Sephora training. Are the in-store beauty advisors trained by the brands Sephora carries, or are stores staffed with Kohl’s employees that are multitasking in different areas of the store? This is what will ultimately determine whether Kohl’s Sephoras will offer a customized in-store experience. Will associates be chock full of cosmetic and skincare expertise to share with customers, or will the cosmetics retailer simply melt into the generic, family-centric Kohl’s shopping experience? From a native Wisconsinite, I’m not confident that the cool factor of Sephora will translate.

Hope and Possibility

Cosmetics retailers are expected to be –– and remain ­­–– groundbreaking. That feeling of entering a physical store and being exposed to the latest cosmetics trends is still sought after by consumers of all ages. Ensuring that customers perceive a brand as on the cusp of the latest fashions is essential to any cosmetic company’s ability to sell new shades and products. Yes, customers may still stop by Kohl’s to snag their Sephora products without going to the mall. But it won’t be long before positive perception of the company as a trendsetting force begins to wane… and next-gen customers begin to seek more progressive alternatives for their cosmetics needs.

Spoiler alert: This is a strategic perspective, not a financial review – on purpose.

The current three-front perfect storm for Macy’s and Kohl’s could arguably be described as a pursuit of a post-Covid higher level of positive “normal,” managing through inflation and supply chain impediments, and the threat of greedy activists. And the major stories coming out of their recent investor presentations were their focused repositioning strategies, aligning merchandising and distribution with young consumers’ preferred products, and enhancing shopping experiences.

Target

Target has proven my often predicted “localization” and “personalization” strategy as critical for success among legacy retailers who are in the process of transforming. As an essential retailer during the pandemic, Target gained time and a capital advantage, which they brilliantly put to use by investing heavily in perfecting their omnichannel model, ramping up on their youth-focused national and private brand initiatives (including the launch of Ulta Beauty’s in-store shops), and most importantly, rapidly expanding their local, neighborhood small-store strategy. As of 2019 (no recent updates available), there were over 100 small stores (an average of 40,000-square-feet), about 23 on college campuses, and their strategy is to add 30 to 40 a year. According to Cornell, “We’re opening up Target stores near America’s most iconic tourist destinations: Times Square, Disney World and the Las Vegas Strip. Because we learned from our store at Herald Square, there are few places that help travelers feel more at home than Target.”

Macy’s

At the recent UBS Global Consumer and Retail conference, Macy Inc.’s EVP and CFO, Adrian Mitchell said their off-mall specialty brick-and-mortar strategy of smaller, local stores will contribute “a material level of volume over time. The data seems to show that those off-mall locations that are very convenient to where customers live, shop and work are actually quite relevant and an important part of how we think about our strategy. We very much believe that Market by Macy’s, serving our Macy’s brand, and our Bloomie’s small-store format serving our Bloomingdale’s brand, are critical to the growth of our stores’ channels, and critical to the growth of our omnichannel business.”

Michelle Gass said, “We are evolving our position from a department store to a more focused lifestyle concept, centered around the active and casual lifestyle. This is unique and we can own this space. Make no mistake, this is a transformation, it is a complete reinvention of our business model and our brand.”

Mitchell continued, Market by Macy’s is seeing “sales beyond our expectations … so getting that location right is really important, and we’re seeing those convenient high-traffic locations really produce. It’s a fundamentally different experience but a relevant experience. I’m really excited that the number of new customers shopping these stores is materially higher than mall-based stores.”

Check those boxes on localization and personalization! Mitchell pointed out that doing business at a very local level has customer experience scores meaningfully higher than Macy’s mall-based stores and provides easier navigation, quick and easy checkouts, and more sales associates to assist and interact with customers.

Bloomingdale’s small-store Bloomie’s strategy was launched in Alexandria, VA, offering contemporary and luxury brands, services, tech-enabled stylists, new store design concepts and a restaurant. While the rollout strategy was not outlined by Mitchell, I have to assume that if the Alexandria location is successful, a similar expansion strategy will be put in place.

While Macy’s stated in 2019 that they would close 125 stores between 2020 and 2022, only about half have been closed. Jeff Gennette, Chairman and CEO of Macy’s said, “We have delayed most of the remaining closures we earmarked in 2019 in order to maintain a physical presence in many markets while we scale up our off-mall format stores. In addition to being a place for discovery and shopping, our stores are now also fulfillment hubs supporting our digital operations through buy-online, pick-up in store, curbside pick-up and same-day delivery. Keeping these cash-positive stores open also helps to fund the investments we are making to reposition our fleet over the next several years.”

Macy’s and Bloomingdale’s are also developing online marketplaces which will greatly expand the number of products, brands, categories and all in greater depth. Mitchell said, “Digital sales per capital in markets where we have stores, even mall-based stores are three times more productive than markets that don’t have it. So, the notion of winning in omnichannel is also recognizing the critical importance of stores.” And in another nod to their off-mall strategy, he said, “We feel that we have to place our stores in more convenient locations. I will say very clearly that repositioning and optimizing the physical footprint is a must-win initiative for Macy’s to be relevant over the next 10 years.”

Kohl’s

Just as Kohl’s pioneered an off-mall, small-store distribution strategy opening stores in neighborhoods and shopping centers during the 90s, capturing young working moms who did not have the time to drive to and shop through the malls, they are once again envisioning a new fleet of smaller neighborhood stores (35,000 vs. their current 80,000-square-feet stores). They plan to roll out 100 over the next four years, following the launch of its first prototype in Seattle this fall. CEO Michelle Gass told WWD the small stores have “a level of flexibility and hyper localization.” For example, in Seattle there would be an intensified assortment of outerwear that’s localized and tailored to the local climate and customer base. Kohl’s has invested in a new platform to use data science for more granular merchandising decisions on a local store level. As a part of Kohl’s repositioning, they are also investing in modernizing and refreshing the store layout to elevate the shopping experience.

About Sephora’s beauty shops, currently in 200 Kohl’s doors, Gass said it’s “a game changer,” generating $2.2 to $2.4 million in sales per Kohl’s store. Executives also said that 25 percent of those shopping Sephora are new Kohl’s, and many decide to shop other categories while in the store. Kohl’s plans another 400 Sephora shops by the end of 2022 and 850 by the end of 2023, projected to generate $2 billion in sales.

Gass said the Amazon shops (now in all of Kohl’s roughly 1200 stores) generate “millions of new customers” who are primarily returning Amazon purchased goods (an estimated 2 million returns in 2020) however, while in store, many are shopping and purchasing other goods.

And to change Kohl’s culture mindset, Kohl’s is eschewing the department store moniker. Gass said, “We are evolving our position from a department store to a more focused lifestyle concept, centered around the active and casual lifestyle. This is unique and we can own this space. Make no mistake, this is a transformation, it is a complete reinvention of our business model and our brand.”

Don’t Follow the Numbers

I’m exaggerating about ignoring the numbers to make a point. There are a multitude of sources that have covered the numbers and speculation of what they mean, and as I said, this article is about the strategy. There is also a media obsession about the activists who foolishly create a narrative of how they can “unlock value” in the short term … AKA making a lot of money fast.

I say pay attention to the strategy. Because if the strategy and its execution are right, the money will follow. Just look at Target. Macy’s and Kohl’s, with similar strategies, are slightly behind Target in their execution, some of the lag due to their nonessential classification during the pandemic.

I say give them a break. However, I must emphasize that “execution” is the operative word. I once lauded Ron Johnson for his transformative vision for JC Penney (which I still do). However, his extremely poor execution crippled the brand, which to this day is still struggling to stabilize out of bankruptcy.

A former CEO, Allen Questrom, took the helm of a limping JC Penney in the early 2000s and famously and figuratively told Wall Street “don’t follow the numbers.” Between the lines, he told the financial world and shareholders not to expect a profit for about five years. He went on to successfully execute a strategy that did right JCP’s sinking ship.

Likewise, I witnessed CEO Brian Cornell telling analysts that he was committing to a capital investment of some $8 billion over about five years to essentially turn Target’s business around. And right there in real time, during the meeting, I watched their stock price on Yahoo drop like a rock as he advised that the bottom line was going to be squeezed. He not only turned it around, but he also recently was awarded the NRF Retailer of the Year.

To Macy’s and Kohl’s: Stay focused on the long-term, listen to your customers and fine-tune the strategy as needed, and execute, execute, execute. Any retailer can have a good idea, but pulling it off is what defines the greats.

A year ago, Kohl’s beat back a campaign by four activist investment funds to unseat its board and shake up its operations. The activists settled for smaller changes at the board level: adding three new directors, creating a standing finance committee to oversee capital allocation, and authorizing a $2 billion share repurchase program.

The department store didn’t get a very long reprieve, though. In early December, Engine Capital called for Kohl’s to either spin off its ecommerce business as a separate entity or sell the whole company. And in January, Macellum Advisors (the leader of last year’s activist campaign) resumed its attack on the company.

Kohl’s isn’t a lost cause, differentiating it from weaker department store chains such as Lord & Taylor and J.C. Penney that went bankrupt during the pandemic. Also, Kohl’s doesn’t have the founding family as a large shareholder to push back against activists’ demands, unlike Nordstrom or Dillard’s.

In another twist, Kohl’s received at least one and possibly two private equity buyout offers last month. This has added to the pressure on the board and management, putting Kohl’s in a tricky situation as it tries to mollify shareholders while focusing on executing its long-term strategy.

Rise of the Activists

Shareholder activism has been on the rise in the U.S. for years. Dedicated activist funds try to earn high returns by investing in underperforming companies and agitating for change.

In many ways, Kohl’s is an obvious target for activists. Between 1999 and 2011, the company quadrupled net sales from $4.6 billion to $18.8 billion. However, sales have stagnated around $19 billion since then (aside from 2020, when the pandemic crushed sales). Kohl’s inability to grow the top line has caused its operating margin to contract, reducing its earnings. As a result, between the beginning of 2001 and the end of 2021, Kohl’s stock declined slightly, whereas the broader market more than tripled.

At the same time, Kohl’s isn’t a lost cause, differentiating it from weaker department store chains such as Lord & Taylor and J.C. Penney that went bankrupt during the pandemic. Just as importantly, Kohl’s doesn’t have the founding family as a large shareholder to push back against activists’ demands, unlike Nordstrom or Dillard’s.

Activist investors see multiple pathways to making big gains in Kohl’s stock. These include reinvigorating top-line growth, driving margin expansion, and using financial engineering tactics to unlock a higher valuation. Yet many of their suggestions are half-baked ideas, and they don’t have a firm grasp of what it takes for a retailer to succeed in the long run.

A Naive View of Retail

Engine Capital’s proposed strategy for Kohl’s is an extreme case. In early December, the fund sent a letter to the Kohl’s board, highlighting the stock’s weak historical performance and calling for a “review of strategic alternatives.”

In the letter, Engine Capital asserts that Kohl’s should spin off its ecommerce business because it “could be conservatively valued at $12.4 billion or more.” That valuation of roughly two times sales corresponds to what Insight Partners paid for a minority stake in Saks Fifth Avenue’s ecommerce business last March.

Yet Kohl’s has a much different margin structure than Saks. With lower AURs, shipping costs are a bigger burden for online orders, making tight integration between the stores and ecommerce absolutely essential. Separating the two channels would hurt both in the long run. It’s also quite possible that Insight Partners overpaid for Saks.com. Other pure-play ecommerce firms’ valuations have plunged over the past year as physical retail has reopened. (For example, shares of both Wayfair and Chewy have lost about half of their value since last February.)

Thus, Engine Capital’s main proposal probably wouldn’t reap the short-term windfall that the activist fund expects. Meanwhile, it would risk crippling Kohl’s in the long run.

Macellum Advisors has a little more retail knowledge. Founder Jonathan Duskin has led activist campaigns at half a dozen other retailers over the past decade, with mixed results. The fund has some vague suggestions for operational improvement, e.g. improve the merchandise assortment, simplify the value proposition, and bring private-label sourcing in-house.

However, most of its proposals relate to financial engineering. Macellum urges Kohl’s to ramp up share repurchases beyond the company’s recent target of $1.3 billion annually. It claims these buybacks can be funded partly by reducing what it sees as wasteful expenditures on growth initiatives and partly by entering sale-leaseback arrangements for billions of dollars of real estate. Duskin and company seem to ignore the fact that cutting investments in growth wouldn’t just lead to flat sales: it could cause revenue to erode rapidly. (Just ask Sears or J.C. Penney!)

Macellum’s letter to the board also touts the ecommerce spinoff idea. Lastly, the fund urges the board to try to sell the company outright: something that Engine Capital also proposed.

Potential Buyers Come out of the Woodwork

Perhaps emboldened by the presence of activist investors pushing for Kohl’s to sell itself, private equity firms are now circling the retailer. Last month, Acacia Research (itself backed by another activist fund, Starboard Value) offered $64 per share in cash for the company. Prior to the offer, Kohl’s stock had been trading a little below $50.

Sycamore Partners quickly jumped into the fray and has reportedly offered $65 per share. Kohl’s has acknowledged receiving offers for the company without confirming the potential buyers.

These proposals value Kohl’s at around $9 billion. Either buyer would likely finance the bulk of the purchase price by selling Kohl’s real estate and leasing it back. That would saddle the company with higher rent obligations going forward, but it would be more affordable than turning to the debt markets. When the Nordstrom family attempted to take Nordstrom private in 2017, banks demanded interest rates around 13 percent.

Kohl’s most recent guidance calls for adjusted earnings per share between $7.10 and $7.30 in fiscal 2021. Compared to that earnings power, the Acacia Research and Sycamore Partners offers look like lowball opening bids.

Looking for Quick Gains

One common thread ties together the activist campaigns and buyout offers for Kohl’s: investment funds see an opportunity to make a lot of money quickly. That’s why in recent weeks, Engine Capital and Macellum Advisors have urged Kohl’s to sell itself, even though both funds initially argued that the stock was worth far more than what Acacia and Sycamore have offered.

Meanwhile, if a private equity firm can snag Kohl’s for $65 or even $75 per share, it would likely make a killing within a few years. By putting in $2 billion-$3 billion up front and financing the rest with sale-leasebacks and a modest amount of new debt, the buyer would get a business capable of generating about $1 billion of free cash flow annually.

Ironically, shareholders would likely make even bigger gains by being patient. Kohl’s expects to report a record profit for fiscal 2021. Macellum Advisors and Engine Capital think that isn’t good enough, pointing to other retailers that have posted even stronger revenue and profit growth compared to 2019. They also claim that since Kohl’s has failed to grow its sales over the past decade, the company’s current strategies are likely to be equally unsuccessful.

Yet Michelle Gass became Kohl’s CEO less than four years ago. The pandemic has disrupted more than half of her tenure. Additionally, the global supply chain crisis has led to delayed receipts for new merchandise, particularly in women’s apparel, hindering efforts to reignite sales growth there. Finally, Kohl’s just began to open Sephora shops in its stores last August. The Sephora partnership is a promising initiative to drive traffic and expand Kohl’s customer base, but it will take two years to complete the in-store rollout.

Of course, there’s no guarantee that these initiatives will get Kohl’s back to sustainable growth. But it would be foolish to throw in the towel (as the activists urge) just because of the company’s mediocre results in recent years. It’s simply too early to know whether Gass’ turnaround strategy will ultimately succeed. Once Kohl’s completes the Sephora rollout and gets inventory levels back to normal, it will be possibly to evaluate management’s success more fairly.

Target investors also had to endure meager sales growth and weak share price performance for most of the past decade. They have been richly rewarded over the past three years, though, as CEO Brian Cornell’s growth strategy has finally gained traction. This demonstrates the value of patience, as sound retail strategies don’t always pay off quickly.

Fortunately, Kohl’s has a decent shot at fending off both its suitors and its activist shareholders. Given that Kohl’s stock traded above $80 as recently as 2018, the board is unlikely to agree to a sale at a price that private equity firms would be willing to pay. And if the company keeps reporting record earnings, activist funds will struggle to convince other shareholders to support a board or management shakeup. That’s probably good news for customers, employees, long-term investors, and the retail industry as a whole.

Full disclosure: The author owns shares of Kohl’s and Nordstrom.

Is Amazon a suitor for Kohl’s? If not yet, perhaps it should be. And maybe Kohl’s is entertaining the possibility. Back in 2017, I stated that Kohl’s was launching its first few Amazon in-store shops as tests to drive younger customer store traffic to make a few Kohl’s sales across the aisle when they were visiting Amazon.  Five years later it is still a win/win for both brands.

At the time, I suggested that the partnership could very well be viewed as a much larger, long-term, first-stage strategy of Amazon to acquire Kohl’s. In the intervening five years that has not happened. Now since the financial sharks are circling, smelling the blood of what many of them describe as underperforming bottom feed, they are offering up bids to acquire Kohl’s, mainly for short-term financial engineered gains. Recent reports covering the vulnerability of Kohl’s suggest that there are other non-financial, more strategically interested parties that might want to bid for an acquisition. Is it possible that Amazon might be one of those?

Amazon is not getting big fast enough in the physical apparel and grocery categories. Financially, with their $1.6 trillion market cap vs. Kohl’s $8 billion cap, and Kohl’s share price at around $60, as the investment sharks circle, causing volatility, Amazon could swoop down and acquire Kohl’s for the equivalent of lunch money for them.

Why Amazon?

From a strategic perspective, in my opinion, this is a no-brainer. Almost on day-one of Amazon’s launch, Jeff Bezos stated that Amazon must “get big fast.” He also said that they must achieve a level of dominance in apparel and grocery. He sold Wall Street on the get big fast mantra, thus not having to show a profit for about two decades. Indeed, he got huge fast, showering money on the investors who stuck with him. The genius of the man was a systemic plan for the future, with the eventual expansion into the brick-and-mortar sector of retailing as a necessity. Along with that vision, he apparently viewed the roughly $400 billion apparel and $800 billion grocery industries as large enough to become a major player in.

For the past several years Amazon has been fiddling around with testing various quasi tech-driven brick-and-mortar stores: Amazon Go cashierless stores; bookstores; Amazon 4 Star stores; Amazon Fresh grocery stores (offering a “just walk out” option); and the acquisition of Whole Foods. So, Amazon currently has about 611 physical stores. And I say “fiddling around” because 500 of those stores are Whole Foods.

The Whole Foods Misstep

Flawed strategy lesson #1 for Amazon would be the Whole Foods acquisition.  It was wobbly when they bought it for about $13 billion. They certainly were not acquiring a dominant share of the market. The Whole Foods core consumer demographic does not align with Amazon’s DNA. It’s more of a niche brand and, therefore, does not have a scalable runway.

Amazon Fresh does have some initial traction as smaller 40,000 square-foot grocery stores. Initially launched in 2020, they now have 23 across the US. Embedded technology in the store allows customers the choice of “just walking out” or physically checking out through a standard cash register line. However, is this their answer to getting big fast and reaching some level of dominance in the grocery industry? I don’t think so.

A Retread Amazon Apparel Store

Amazon recently announced the launch of Amazon Style. The 30,00 square-foot store is all  about a technology infrastructure supporting a modern showroom model design with displays of sample merchandise. The system is designed with QR codes for customers to select merchandise via their smartphone apps. Their selections are automatically sent to a designated fitting room, delivered by a salesperson. The customer has a tech-enhanced interactive mirror that allows orders of other apparel, also automatically delivered to the fitting room.  Long story short, the entire shopping journey can be achieved without engaging with a human associate. And the customer leaves through an automatic electronic checkout, or the goods can be delivered to her home, all of which will have been requested by the fitting room technology.

As my friend and colleague Chris Walton wrote in a Forbes article, there is nothing new about Amazon Style.  He said,  “The experience is one part Hointer (circa 2012), one part Rebecca Minkoff’s Magic Mirror (circa 2014), and one part Amazon’s own GH Lab experiment at the Mall of America (circa 2018).”  To cut to the heart of this model and all the other retail tests they are pursuing, Amazon is leaning into what they know best, and brilliantly.  However, their tech genius lacks a sensitivity of the human factor and the “art,” so to speak. Technology is an awesome tool, but that is all it is – a tool.

Why Acquire Kohl’s

Amazon is not “getting bigger fast” in the physical apparel and grocery categories. Financially, with their $1.6 trillion market cap vs. Kohl’s $8 billion cap, and Kohl’s share price at around $60, as the investment sharks circle, causing volatility, Amazon could swoop down and acquire Kohl’s for the equivalent of lunch money for them.

And strategically, Amazon gets a high level of apparel dominance overnight, along with about 1162 stores that can also be used as distribution centers, enhancing the speed of last mile delivery and convenience and accessibility for consumers.

Amazon would also be acquiring a profitable, financially stable and growing business (regardless of what the activists say). And in my opinion, Amazon would benefit from a visionary management who understands the retail business. Amazon would also be able to test all their technology enhancing ideas more easily and quickly in real time in stores that already have foot traffic vs. having to attract shoppers. Finally, Amazon would be acquiring an omnichannel model and all its synergies. All of this as opposed to spending billions of dollars and potentially years to build their own fleet of stores at best, or failing at worst.

Grocery?

Go figure on this puzzlement as well.  Kroger at a $28 billion market cap? Just saying…