What exactly is Terry Lundgren up against?

After activist investor Jeffrey Smith of Starboard Value said he now has a stake in Macy’s Inc. and that the stock could fetch $125 by unlocking its real estate positions, investors cheered the remarks by gobbling up shares of the department store retailer.

The stock rose nearly 8 percent Monday and added $1.72 billion in market capitalization in a single day. At the close of the market Thursday, shares of Macy’s added another 1.1 percent to $72.80 while hitting a new 52-week high earlier in the day.

A source familiar with the companies said there are talks between Starboard Value and Macy’s executive team and that relations are amicable. So far. The source stressed that the hedge fund is “an active investor” and the tone of the talks could change — and the level of activism could escalate — if Macy’s drags its heels.

Smith is clearly taking cues from the William Ackman playbook, but he may be more Carl Icahn-esque in his approach — if his takeover of Darden Restaurants Inc. last year serves as a gauge. In that case, Smith gained control of the parent company of Olive Garden in 2014, replaced its board, and later, its executive team.

However, he has a tougher road ahead if he’s looking to shake things up at Macy’s.

While Smith may be a hungry lion, Macy’s is not the limping gazelle that Darden was when he took control of it. Darden’s stock was sagging for many years prior to the takeover and it had weak leadership, according to reports prior to the changeover. Shares of Macy’s, on the other hand, have been on a steady upward trajectory and its board is formidable. For the 52-week period, the retailer’s shares are up 26 percent. The 52-week low is $54.84 and the high is $72.87. Total market capitalization is $24.3 billion.

Led by Lundgren, the board of Macy’s also includes Stephen Bollenbach of KB Home; Deirdre Connelly, former president at GlaxoSmithKline; Craig Weatherup, former ceo of Pepsi-Cola; John Bryant, ceo of Kellogg Co.; Meyer Feldberg, dean emeritus at Columbia Business School; Joseph Neubauer, former chairman of Aramark; Annie Young-Scrivner, executive vice president at Starbucks Corp., and Sara Levinson, cofounder and director of Kandu, among others.

But if Smith made a charge at Macy’s, could the board fend him off? With Darden, Smith outmaneuvered its board and forced a proxy fight that led to his takeover. One major stakeholder that supported him was the Vanguard Group — which also happens to be Macy’s largest institutional shareholder with 5.5 percent of its shares.

With Darden, Smith supported another activist fund, Barington Capital Group, in pushing for a complete spin-off of all of the company’s real estate into a publicly traded Real Estate Investment Trust — which could be a tactic Smith deploys with Macy’s. Noteworthy is that since Smith gained control of Darden, shares of the company have been up 65 percent to $72.36. The 52-week high is $73.40 and the low is $43.56, with a market capitalization of $9 billion.

In the Darden episode, Smith keyed into value of the real estate holdings, much in the same way other activist investors have done at other retailers — such as Ackman of ­Pershing Square Capital Management. Although Ackman failed in his fight against Target Corp., it put a spotlight on the value of retail real estate. With Macy’s, it’s possible that Smith saw the opportunity to unlock real estate value when the company had its first-quarter conference call earlier this year.

On that call, management said it was engaging in a strategy to focus on the firm’s top 150 stores. The retailer has more than 850 units, and said on the call that particular focus will be given to the company’s “30 platinum doors, our very best.” Starboard pegs the value of Macy’s Herald Square flagship at about $4 billion and the San Francisco and Chicago properties are valued at more than $1 billion.

The portfolio also includes 400 mall sites valued at about $13 billion. Starboard has the combined value of Macy’s real estate at $21 billion.

Jonathan Eyl, director of corporate solutions at Nasdaq OMX, described Smith as a serious player and Starboard as a powerhouse.

“They’re an alpha activist,” Eyl said. “Starboard has enough firepower to actually push for change and obviously Macy’s stock flew after he actually came out stating he did take a stake in the company. I would put him right up there with [Carl] Icahn or [William Ackman’s] Pershing Square.”

Smith has tapped into the topic du jour in retail with real estate. “We’re seeing a lot more chatter and a lot more news about retailers spinning off their real estate assets and it sounds like this is what Mr. Smith really wants Macy’s to do. Whether or not they budge on it, it’s their call,” Eyl said.

Last month, Darden’s board approved spinning off its real estate into a separate, publicly traded REIT. The company said at the time that its plan was to transfer “approximately 430 of its owned restaurant properties to the REIT, with substantially all of the REIT’s initial assets being leased back to Darden.”

The company said the leases are expected to “have attractive rent coverage ratios, fixed-rent escalations and multiple renewal options at Darden’s discretion. The potential REIT would be well-positioned to expand through real estate acquisitions of other businesses.”

REITs are attractive to investors due to the higher returns. A public REIT can offer a 27 percent total annual return in one year versus about 14 percent for a large-cap U.S. stock, according to REIT.com. For a five-year period, REITs have a return of 16.6 percent, versus 15.5 percent for a large-cap stock.

“Starboard, they’ve had a following in the past, now more than ever,” Eyl said. “If you have one of these alpha activists come into the stock, there’s bound to be other institutions or hedge funds that follow them afterwards, more of the event-driven funds.”

But in a research note Thursday, Stifel analyst Richard Jaffe said he doesn’t believe that a sale-leaseback of some or all of Macy’s properties would appeal to the company or necessarily be in the best interest of shareholders.

“Macy’s has regularly reviewed its real estate options and has recently indicated that it would explore all options,” he wrote. “However, Macy’s has expressed its reluctance to a sale-leaseback transaction, having explored it several times in the past. While a transaction would likely drive up the share price in the short-term as investors anticipate the benefits of the cash following a sale, the company would have debtlike lease obligations in the long-term, likely eroding earnings.”

He noted that Macy’s is focused on enhancing profitability, including through store closings and expense savings through reorganization. On Monday, the retailer said it was closing its Pittsburgh flagship and selling the 1.2 million square feet of space in which it’s housed. Reviews of stores with substantial amounts of vacant space, including units in Seattle and Minneapolis, are also being undertaken.

The retailer is looking into expansion through a new off-price venture, Backstage, and opportunities on the international front.

“We believe the slower rate of growth has driven investors to look for alternatives to enhance shareholder value,” Jaffe said. “While it is unclear what type of deal will occur, we believe there is a middle ground in which Macy’s can sell certain properties and still maintain favorable lease terms — low rent — and its low-cost operating structure. We believe this would preserve much of its profitability while providing a high return to shareholders.”

Jaffee has maintained his buy rating on Macy’s stock as well as his $75 target price.


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