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It’s a stressful period for Macy’s Inc., yet Terry J. Lundgren doesn’t wear it on his Alfani sleeve.

“I do find working out and eating properly are very important for your mind to stay fit,” the retailer’s chairman and chief executive officer says, where he talks as readily about his four-day-a-week exercise regimen and his private-label three-piece suit (boasting it cost only $360) as he does about business declines and contending with the activist investor pushing for sea change at Macy’s.

This story first appeared in the January 6, 2016 issue of WWD. Subscribe Today.

It’s not only the trim, 6-foot, 3-inch Lundgren that requires a workout, though. The retail veteran, 13 years at the helm of Macy’s, has to figure out how to get the department store back in shape as he tackles new challenges and priorities imposed by external forces. Only a year ago, Lundgren delivered record Macy’s profits. Now business, tourism and the stock price are down. The weather is loopy. Inventories are too high. Macy’s core department store business — anchored by women’s fashion, which represents roughly a quarter of the total volume — seems a limited or no-growth proposition. And this year, the forecast is for reduced earnings, from $4.20 to $4.30 a share excluding items, down from last year’s $4.40.

Amid the pileup of concerns, Starboard Value, led by activist/agitator Jeffrey Smith, is advocating real estate spin-offs to lift shareholder value.

So the question becomes obvious: Is the $28 billion Macy’s under siege?

“No,” Lundgren responds matter-of-factly.

“Since the first quarter of 2009 till the third quarter of 2015, our total shareholder return was 540 percent and that compares to the Dow’s 121 percent. So we have had really great performance and strong, consistent execution. I feel very strongly we have the talent and the drive and the determination to win and we have the support from our vendors to win.”

Lundgren also reveals that he has some major shareholders in his camp, and that he’s met twice with Smith. They had good “nonhostile” exchanges, he says. While thus far Starboard’s campaign at Macy’s appears nonconfrontational, at least outwardly, Smith has allied with other shareholders to push his agenda, raising speculation of a looming proxy battle for a seat on the board.

Smith isn’t exactly known for playing nice. He’s considered an alpha activist, part of the top tier of boardroom bruisers — a player who has produced big changes at companies before. His claim to fame is his battle over Olive Garden parent Darden Restaurants, where he dislodged the entire board. Smith, who declined to comment for this article, disclosed his Macy’s investment in July at a CNBC/Institutional Investor conference, where he said, “We believe there’s an opportunity to create two leading companies, Macy’s operating business, as well as the real estate company….There’s $29 billion of enterprise value at Macy’s today, $21 billion of that enterprise value is made up of the real estate value.” He claimed at the time that Macy’s Herald Square flagship is worth $4 billion, and the Union Square San Francisco and Chicago flagships are each worth $1 billion. On Macy’s stock, Smith contended it should be worth more than $125 a share. (For the past 52 weeks, Macy’s stock has ranged from a high of $73.61 to a low of $34.05.)

While all seems copacetic at the moment with Starboard, Lundgren isn’t taking any chances. Reacting to the activist’s threat, he’s assembled a squadron of professionals to advise on strategy. On the banking side, there’s Credit Suisse and Goldman Sachs. On the real estate side, Greenstreet, Cushman & Wakefield and Tishman Speyer. Tax experts from Skadden Arps and the law firms Wachtell, Lipton, Rosen & Katz, and Jones Day are pitching in.

“We are responding to all of our shareholders. We are not sitting back. We are taking aggressive action,” Lundgren says.

Macy’s already nixed Smith’s call to create a REIT, or real estate investment trust. “I think the activist focus was on the value of our real estate and how we could unlock that value,” Lundgren says, adding that the retailer was onto unlocking real estate value “well before the activist came into our stock.” For example, it was already being decided that the Brooklyn flagship would be downsized and redeveloped into mixed use via a joint venture with Tishman Speyer.

Regarding the REIT, “We worked very hard on that and moved forward, just really trying to understand the pros and cons,” Lundgren says. “The question came up about whether the size of it was something the company could afford. Our belief was that the regulators were going to impose a tax at some point in time and that REITs already formed have escaped a potential extra burden. The company came away learning more about value in real estate. We have shifted the thought process to possible joint ventures. We are very enthusiastic about the possibility.”

Macy’s real estate is something of an aphrodisiac for the Wall Street set, which likes nothing more than finding hidden value. In September, Morgan Stanley evaluated Macy’s 578 owned and ground leased locations and came up with an aggregate value of $18.5 billion, with a range of $16 billion to $20.8 billion.

While it’s up for debate how easy it would be to get that price for Macy’s real estate, the projection far exceeds the $11 billion market capitalization the retailer had at the start of this year. That suggests that if Macy’s real estate fetched anywhere near what some think it could, the stores are worth much more than the operating business itself.

While Smith at last count controlled just 3.2 million shares of Macy’s, or 1 percent of the company, his move on the retailer has put blood in the water and other activist players are potentially circling like sharks. In the third quarter of 2015, HG Vora Capital Management boosted its stake in the retailer by 425,000 shares to 2.4 million shares. The investment firm has taken part in activist campaigns in the past and is run by Parag Vora, who previously advised real estate and consumer businesses for Goldman Sachs’ real estate investment banking unit. D. E. Shaw & Co. also increased its holding in Macy’s by 1.3 million shares in the third quarter, for a total of 1.4 million shares.

Collectively, investors who could be characterized as activists control 3.1 percent of the company’s stock, according to S&P Capital IQ. That’s not a commanding position, but activists have increasingly had the ear of larger institutional shareholders who can force issues, ultimately voting for change at annual meetings.

“To make big changes, you’re going to need support from big shareholders and you’re more likely to find that support in cases where the company’s really underperforming,” says Christian Plath, a corporate governance specialist at Moody’s Investors Service. He described Smith’s Starboard as “one of the top 10 or 15 activists” with the ability to “bring a lot of firepower and expertise to bear.”

Macy’s recent stock performance provides more ammunition for Smith. Shares of the retailer fell 45.4 percent to $34.98 last year, a steeper decline than competitors such as Nordstrom Inc. (off 31.4 percent) or Target Corp. (down 1.6 percent). Macy’s stock was holding its own in the global market rout that kicked off 2016 on Jan. 4, trending slightly higher as Wall Street logged its worst decline on an opening day since 1932.

The pressure on Macy’s could soon grow.

Typically, activist activity revs up as a company prepares for its annual meeting. Macy’s bylaws state that investors wanting to bring business before other stockholders must give written notice at least 60 days before the meeting, which is typically held in May. So right now, activists can quietly push Macy’s for changes and vie for board seats while threatening to wage a very public proxy battle that would make their case directly to shareholders and force a vote at the meeting. Once on a board, activists can throw a ceo off balance by eroding the chief’s base of support, peeling off independent directors and building momentum for their agenda.

And these latter-day corporate raiders have become emboldened. Despite the failed reinvention of J.C. Penney Co. Inc. that was fueled by William Ackman’s activist efforts, investors are increasingly digging in at companies. “There’s nothing sacred anymore,” says one prominent fashion investment banker familiar with activists. “There’s no one big enough to escape these guys.”

Big-time ceo’s are using more “shark repellent,” the banker says, understanding the thinking of institutional investors and regularly going over their vulnerabilities and how to address them.

Often by the time activists show up, the wheels are already turning and the company is ready to act. Macy’s, as Lundgren mentions, was already planning to close stores and monetize certain real estate prior to Starboard emerging on the scene. The retailer agreed to sell off about $362 million in real estate in four separate deals last year, including the downtown Brooklyn flagship where Macy’s will still own and remodel the first four floors and lower level representing 310,000 square feet and Tishman Speyer will convert about 10 floors into 378,000 square feet of office space. The project will start in the spring and is scheduled to be completed in fall 2018. There may be a few other, smaller real estate transactions that closed in the fourth quarter and will be revealed in the year-end report.

“It’s definitely been a year of transition,” Lundgren says. “The industry and Macy’s are clearly facing a challenging period. But we are fortunate on a couple of fronts. Our online business has grown in its momentum and acceptability. We have been leaders in the subject. We were early adopters. There’s been continuous improvement and investment over the last 20 years. The good part is we got in front of the business.

“We’ve been through crises before and we came out better than we were before,” Lundgren adds. “In 2001, everybody was saying the department store is dead. That’s when we started to reshape Macy’s,” with a major consolidation converting the former Sterns stores into Macy’s and Bloomingdale’s. In 2005, Macy’s bought May Co., doubling the company’s volume and store count and leading to further synergies. “In 2008-09, there were similar cries, that retail and the fashion world is coming to an end — we got through it.”

“People are now once again saying that.”

He concedes, “This time it’s different.”

Consider the current retail landscape. It’s been reshaped by the digital revolution, price deflation in apparel, tourism declines, shifts in spending patterns, and a need to recast big-box stores into entertainment centers that go beyond shopping. Consumers are spending less on fashion and more on dining out, theater tickets, spas and other activities falling under the rubric “experience.”

“Department stores must be a place for customers to come and get away from the everyday challenges of their lives, and to be entertained when they shop,” Lundgren says. “But I would argue that Macy’s is the biggest entertainment retailer in the world” by virtue of the Macy’s Thanksgiving Day Parade, annual Flower Show and Fourth of July fireworks.

Yet splashy fireworks and floats are no longer enough for today’s fickle consumer. “We need to do more events in the stores,” Lundgren acknowledges, referring to the majority of Macy’s locations. “We’ve got to have more and more of a rhythm. Clearly it happens in Herald Square. It’s like a movie theater. There is something going on all of the time. Every time we have Thalía Sodi [the Mexican soap star who has an exclusive line at Macy’s] we have huge crowds in the store. Or when Tommy Hilfiger does personal appearances. He stays and stays. Last time he brought Rafael Nadal,” the tennis champion.

“I actually challenged my group to come up with lots of new ideas,” some of which are unconventional, like last month’s “ugly sweater parties” held before sunrise at the Herald Square, State Street Chicago and Union Square San Francisco flagships. There were aerobics and yoga classes, dancing and monogramming ugly sweaters, and at Herald Square, about 1,400 people showed up, including Lundgren. “I can’t believe people are crazy enough to show up at 6 a.m.,” he says.

“We have had a lot of things going on in the organization, which is good,” Lundgren adds. “When you are facing the kind of year that all retailers are facing, it’s important to have new initiatives under way as opposed to starting them” in 2016.

He recites a litany of initiatives the retailer unveiled in 2015: buying Blue Mercury; launching the Backstage off-price business and an e-commerce site in China on Alibaba Group’s Tmall Global, and forming a single merchandising organization for stores and online and a marketing organization for stores and digital involving relocating 1,000 merchants, planners and marketers at New York offices so they can closely collaborate. Macy’s also revealed it would close 35 to 40 stores in 2016; signed deals to open the first Macy’s store overseas, in Abu Dhabi; set the rollout of LensCrafters shops in hundreds of Macy’s locations beginning this year, and began testing Best Buy shops inside 10 Macy’s. At Bloomingdale’s, off-price units called Bloomingdale’s, The Outlet, are being steadily opened; a second overseas store is set for Abu Dhabi in 2018; the chain’s first store in Hawaii opened in November, and the team is working on what ceo Tony Spring calls “a total comprehensive plan” for the 59th Street flagship.

If there’s a rock star in retailing, it’s Lundgren. The 63-year-old began his career in 1975 as a trainee with Bullock’s, the former Los Angeles-based division of Federated Department Stores Inc., which merged with Macy’s in 1992. He held positions of increasing responsibility in buying, store management and human resources, managed a Macy’s store in the South Coast Plaza in Costa Mesa, Calif., from 1981 to 1983, when it was a Bullock’s; served as the division’s director of stores and in 1984 was named senior vice president and general merchandise manager. In 1987, he was named president and ceo of Bullocks Wilshire, then the most upscale and high-fashion chain of specialty department stores owned by Federated.

Lundgren left Federated in 1988 to join Neiman Marcus, where he first served as executive vice president. Shortly thereafter, he was named chairman and ceo. He returned to Federated in April 1994 as chairman and ceo of Federated Merchandising Group, was instrumental in developing the company’s private brands, and was the heir apparent to run all of Macy’s. In 2003, he became ceo of Federated.

He’s been bold and controversial, orchestrating Macy’s takeover of May Co. in 2005 for $11 billion, replacing the venerable Marshall Field’s nameplate and other May Co. nameplates with the Macy’s name, and later creating the My Macy’s localization organization, which he repeatedly said was worth it to get stronger sales. He’s been as much a front-row presence at fashion shows as he is at a New England Patriots game or the U.S. Open, although he no longer golfs with Donald Trump. Nor does Macy’s sell Trump merchandise anymore in the aftermath of the presidential candidate’s comments on Mexican immigrants, made in the early days of Trump’s now media-saturated campaign. When Macy’s dumped the Trump merchandise — men’s wear and fragrances — Trump accused Lundgren and Macy’s of “choking” in the face of political pressure. “I hate chokers,” Trump said. Lundgren, for his part, sounds ready to move on, saying simply, “Macy’s is not allowed to carry merchandise from politicians.”

In sum, Lundgren is credited with progressive digital and social media strategies, bringing some sizzle back to Macy’s selling floors, restoring confidence in the sector, and forming a strong management team. He has surrounded himself with seasoned retail executives, most homegrown, including Jeff Gennette, president, and Karen Hoguet, chief financial officer. “He doesn’t have to be the smartest guy in the room,” says one retail expert who has counseled Macy’s. “He likes to surround himself with talented professionals and inspires senior leaders and thousands of managers and associates with big meetings at the Madison Square Garden theater.”

Lundgren put Gennette in charge of the integration of the online and store merchandising and marketing teams. “Business is much more efficient,” says the retail expert. “Had he not done that, business would have been even more difficult.”

Lundgren does like the attention and prestige that comes with running America’s largest department store, and if there is any criticism, it’s that he enjoys it too much, having numerous outside activities and perks. Still, as one ex-Macy’s official says, “When I was in meetings with Terry, he was very engaged. He’s also in the stores a lot and very much in the market where he needs to be. He’s established strong relationships with vendors, but it’s not like he’s in there going through each line.”

There are other criticisms, including that Macy’s was late to get into the off-price game, which has been one of retailing’s fastest-growing sectors. Lundgren acknowledges the delay, but gives a good reason for it: He wanted Macy’s to first invest in the Internet and omni strategies, rather than others. Macy’s online presence, as well as its logistics, are considered top-notch.

Others say Macy’s missed the boat on Canada, which Nordstrom entered last year and Saks Fifth Avenue will enter this year, and was late to venture overseas with Macy’s.

There’s a perception that Macy’s needs to reclaim its reputation for innovation.

With the Backstage off-price business, Macy’s has a long way to go. The key to its success is to open many more stores for buying leverage to encourage vendors to cut orders specifically for Backstage, so the merchandise is differentiated. But there is a risk of cannibalizing the regular Macy’s stores. Retail sources said the customer is not so different, and believe there may be less of a difference between Backstage shoppers and Macy’s shoppers than there is between Saks Fifth Avenue and Saks Off 5th consumers.

Macy’s has also been criticized as being too dependent on big brands that are overdistributed and not innovative enough, but tough to give up on since they have established large shops inside Macy’s doors and cover margins with markdown money at the end of each season.

“They are doing a great job in social media and the Internet, but they’ve got to be first and faster with hot trends, generate more traffic and continue to develop strategies to continue to draw more Millennials,” says the retail expert. “It’s tough for them competing with fast-fashion chains. They’ve got to become more productive with existing space and get more compelling fashion with value.”

Naturally, Lundgren defends the lineup of big brands. “They’re working very hard to reinvigorate. I don’t think I would count them out. There are always brands in the mix that work in a down cycle. We definitely have some.”

He declined to cite any, though sources noted that historically, Macy’s has done best in such areas as bridal registry, cosmetics and private brands, most notably INC and Hotel. Under Armour and Calvin Klein, as well as the Finish Line shops, are also among its strong performers.

But as Lundgren observes, times have changed. The holiday shopping season showed sharp changes in consumer patterns — the swing to online and mobile shopping and diminishing mall traffic; the hunger for bargains, and the reduced appetite for apparel. Macy’s and Lundgren may be under pressure from Starboard and others, but the greater pressure is being exerted by the consumer. The ceo’s key challenge is whether he can transform the Macy’s juggernaut into a nimble, fast-adapting machine to cope with a retail landscape morphing by the minute.

Lundgren maintains he’s open to performing radical surgery on the selling floors to lift productivity and reverse the tide of declining shoppers in the store, and has said Macy’s will focus more of its resources on the top 150 Macy’s stores out of its 829-unit fleet, which includes Macy’s and Macy’s Backstage units and Bloomingdale’s and Bloomingdale’s outlets. There are also the 76 Bluemercury shops owned by Macy’s.

“You know me — I will try anything in a store that isn’t working particularly well,” he says. That includes bringing in a new category of merchandise or a business that Macy’s doesn’t operate in, such as electronics or food. “We have things in the hopper that we are not ready to talk about.”

There’s also talk about Macy’s doing a deal with Google or Apple on a wearable-tech initiative. The test with Best Buy electronics, he says, will be expanded based on the initial results.

“I would consider a Whole Foods if they could make the store more productive,” Lundgren admits. “At Herald Square for example, I do not believe it would make the store more productive. It has to be the right location.” He knows Walter Robb, the co-ceo of Whole Foods, but hasn’t met with Robb to broach the subject of putting Whole Foods in Macy’s yet.

The Starboard situation has altered Lundgren’s routine and how he looks at the business. “I am spending more time on real estate. It is taking more of my time,” he acknowledges. “I could say we are thinking more broadly about this. Every time I see something happening in our industry, I immediately call our group together. We are always learning from others.”

The company has stepped up store closings and has new criteria for evaluating sites. “We’re forecasting more where the trend line is,” Lundgren says, adding that all Macy’s stores are cash-flow positive, despite the slow business in fashion. The slowdown is particularly evident in the moderate to upper-moderate zones, which Lundgren attributed largely to price deflation and increasing competition from fast-fashion chains, which are outperforming department stores. Also, J.C. Penney and Kohl’s Corp. are improving, after losing market share to Macy’s in years past.

“No one wants to go through a difficult business period,” Lundgren admits, but adds, “It’s actually very energizing for me. I like it when people say I can’t do something, or say something negative about my company. I use that as a motivator to prove my critics wrong. As an athlete friend of mine once told me, a setback is just a setup for a comeback.”

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