Long before Jerry Storch became chief executive officer of the Hudson’s Bay Co., Richard Baker, HBC’s governor and executive chairman, let him in on a secret.
In early 2013, they met for lunch at Ai Fiori on Fifth Avenue close to HBC’s offices on 38th Street, when Storch was doing consulting work following his stint as Toys ‘R’ Us ceo and earlier serving as a vice chairman at Target. Baker wanted to discuss HBC’s retail holdings at the time, the Hudson’s Bay and Lord & Taylor chains. “Richard asked me to visit stores, so we visited Queen Street [Hudson’s Bay flagship in Toronto] when it wasn’t in the wonderful shape it is today,” Storch recalls. “We went down to Philadelphia and looked at a Lord & Taylor store, and much to my surprise, we also visited a Saks Fifth Avenue,” in Bala Cynwyd, Pa.
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That’s when Baker revealed his secret. “Richard explained how he was going to purchase Saks Fifth Avenue, and I said, ‘But they’re not for sale.’”
It didn’t matter. Baker had his sights set on Saks long before the company was in play. Ultimately, HBC bought the luxury retailer for $2.9 billion in late July 2013.
It was typical Baker. He plays the retail game like a chess match, knowing what moves he will make well in advance of actually making them. He’s got the stomach for large, risky deals and has brought an adventurous spirit to the fast-evolving Hudson’s Bay Co. “He’s the kind of visionary who has his next actions already thought through. I absolutely love that. You want to be part of a path-breaking company,” says Storch.
A month ago, the Toronto-based HBC agreed to buy Galeria Kaufhof in Germany from Metro AG in a $2.7 billion deal that seemed to come out of left field. Yet similar to Saks, Kaufhof was on Baker’s radar for a long time. “It’s something we had been looking at and working on since 2006,” Baker says.
Through his decade-long buying spree of venerable department store nameplates — Lord & Taylor, Hudson’s Bay, Saks and now Kaufhof — Baker has emerged as a kingpin in the sector. But by growing up in his family’s real estate business, not retailing, and by virtue of HBC’s unique business model, Baker sits in a class of his own, outside the circle of retail giants like Terry J. Lundgren of Macy’s Inc. and the Nordstrom family — or even someone like Galen Weston, owner of Holt Renfrew, Selfridges and other chains. They manage retail corporations with traditional operations trying to evolve with heavily funded, omnichannel strategies, whereas HBC has been immersed in striking deals and integrating the acquisitions, and trying to catch up on the multichannel front. HBC’s blend of real estate maneuvers and retail deals paints a corporate identity that’s hard to label, though Baker explains it: “We are a global business that focuses on operating retail companies, acquiring and managing real estate, and mergers and acquisitions. It’s a company that has three major focuses.” Simple enough.
What’s more complicated is how to make money in fashion retailing when consumers’ spending habits are shifting to technology, traveling, entertainment and food.
The decision last December to bring in Storch as ceo to oversee the store operations has enabled Baker to focus on what’s he’s best at — acquisitions, creative financing and real estate — while detaching from much of the retail detail. Storch is the seasoned retailer that Baker very much needs at HBC, to not only run the company but also demonstrate commitment to the retail operations and deflect concerns that Baker is in it just for the real estate. Among other areas, Storch will be critical in accelerating HBC’s dot-com business and omni-initiatives — both underdeveloped — having launched target.com. “I have always been a big believer in the Internet. Anywhere I go, it’s the number-one priority. There isn’t any growth lever more important,” Storch says.
In their first joint sit-down interview, Baker and Storch, who became HBC’s ceo last December, reveal how they plan to grow the business they already have, while perhaps adding more to it. Baker, who gets restless in meetings that run more than 20 minutes, nevertheless seems relaxed, as does Storch, neither dominating the conversation. The flamboyant dealmaker who always draws media attention is clearly ready to let Storch share in it, doing some texting while Storch expounds on department stores. Though on a sensitive topic, like buying Germany’s Kaufhof, Baker assertively explains his view of the advantageous financials associated with the integration into HBC. They both make a case for why, when others have failed with department store conglomerates, HBC’s business model can work.
‘We are aggressively creating value in three key areas,” Baker says. First, “by running our operating companies better. Case in point, Saks Off 5th. Case in point, Hudson’s Bay. A second way to make money is the work we do with the real estate. Case in point: Buying Saks Fifth Avenue and its quality real estate. Case in point: Buying Galeria Kaufhof with that pool of real estate that we put into real estate joint ventures. Third is our ability to create value in synergies and opportunities that exist when we acquire and merge other companies.
“Those different features allow us to do things like spend $250 million to renovate the Saks Fifth Avenue [flagship]. It allows us to renovate our Hudson’s Bay stores in Canada, upgrade our systems, upgrade our online fulfillment. It’s that circle of value creation. We then take the value we create and invest it back into the business. That is increasing sales and the productivity of our stores because more customers are happier…We’re the oldest start-up in the world,” says Baker.
“Department stores were once written off as dinosaurs but that was before the Internet,” Storch adds. “The Internet has breathed new life into the department store model” rather than sucking it out, he contends. “Department stores, unlike focused specialty stores, have hundreds of brands, dozens of departments, thousands of stockkeeping units. The department store is the perfect localized distribution center for an Internet business. It’s a fantastic hub for the omnichannel model.
“We have a playbook for how to grow our department stores, while the old school would have said the department store is a stagnant business. We believe they can be significant growth businesses. We can grow in our existing stores. We can grow on the Internet.”
Even while growing rapidly, principally through acquisitions, HBC, at revenues of 13 billion Canadian dollars, or $10.54 billion, is still much smaller than Macy’s, Dillard’s, Nordstrom, Kohl’s or J.C. Penney. Asked if HBC is motivated for another acquisition in the near future to close the revenue gap, Baker replies: “I think we have a lot of exciting opportunities on our plate and we are very focused on running those businesses. We never have to buy another business in my opinion to have a lot of success and a strong future ahead of us, but having said that, one of our three core businesses is mergers and acquisitions. If we are in these businesses, why can’t we accumulate real estate? Why can’t we improve our operations? Why can’t we successfully execute mergers and acquisitions on a periodic basis?
“We don’t think about size. We think about return to our shareholders, and we think about being in a position to offer our customers superior service, product and pricing. All of those, to the customer, have improved dramatically. That’s what we are most proud about. Having said that, being bigger in today’s world is an advantage.”
In the wake of the Kaufhof deal, there is mounting curiosity over where Baker might strike next with his global M&A strategy. In private circles, he’s expressed interest in the Neiman Marcus Group, though that luxury retailer would be tough to buy considering it was purchased two years ago by Ares Management LLC and the Canada Pension Plan Investment Board for a hefty $6 billion and carries about $4.5 billion in long-term debt. Neiman’s filing a registration statement last week for a possible initial public offering at an unspecified date flags the debt situation. Belk has also been suggested, but sources said HBC won’t go there.
“We are focused on every single department store in the world and constantly evaluating and re-evaluating different opportunities,” Baker says. Regarding any aspirations for Neiman’s, he replies simply, “We don’t comment on other retailers.”
“We are already quite large,” Storch says.
At least for the time being, the duo is focused on digesting Kaufhof. The retailer, Baker says, was “a very attractive opportunity as the leading, better-priced, midtier department store in Germany” with “spectacular” owned real estate and “strong” management. Kaufhof operates 103 Galeria Kaufhof locations and 16 Sportarena stores in Germany as well as Belgium’s only department store, the 16-unit Inno chain. Baker and Storch emphasize that Kaufhof will take pages from the playbook used to grow Hudson’s Bay in Canada. Kaufhof is contained in HBC’s new international division, supervised by Don Watros, president of the division, along with Storch, while Olivier van den Bossche continues as the German firm’s ceo.
They also emphasize that it’s full steam ahead for expanding Saks Off 5th to a diversity of urban and suburban settings, and that Lord & Taylor, the oldest department store in the U.S., is modernizing by embarking on “robust” renovations at its best locations, and pursuing a higher percentage of exclusive offerings.
Saks Fifth Avenue, they say, is staying the course toward “elevating” the luxury experience despite the leadership change this year, and is on track to open two stores in Canada and three in the U.S. next year. The long-awaited $250 million renovation of the 640,000-square-foot Manhattan flagship, which has 340,000 square feet of selling space, has just begun. While sources familiar with the building say the renovation will cost more, Baker insists otherwise. When he first disclosed the $250 million two years ago, “we were forward enough to understand future dollars.” The $250 million figure is a gross amount, he stresses, meaning it includes vendor contributions to the project.
Within the HBC portfolio, Lord & Taylor is widely viewed as having limited expansion potential, as a regional chain catering to an older customer base, showing recent sluggish sales and with no new stores planned. Saks Fifth Avenue has been hanging in with moderate sales gains while lagging behind the competition in profitability.
On the other hand, the Hudson Bay department store chain in Canada has been performing well after years of merchandise improvements and renovations since Baker’s company bought the business in 2008. Recent results at the HBC department store group — which includes Hudson’s Bay and Lord & Taylor — stack up well against the competition. Last quarter, the group reported a 4.9 percent comparable-store increase, while Macy’s comps were down 0.7 percent. Last year, sales at HBC’s department store group rose 2.3 percent on a comp basis, while Macy’s came in at 1.4 percent.
Still, HBC’s fastest-growing segments are off-price and digital. Saks Off 5th, which reported 10.3 percent and 12.1 percent comp-store sales gains for the latest quarter and last year, respectively, is challenging Nordstrom Rack and other off-pricers for value customers. Digital sales rose 37.2 percent last quarter, and 63 percent last year.
But while all of these operational and structural improvements have been occurring, it is HBC’s real estate maneuvers linked with the retail acquisitions that have generated the most attention and underscored Baker’s adept dealmaking.
Among the shrewdest, Baker took out a mortgage on the ground portion of the Saks flagship in Manhattan leading to a $3.7 billion appraisal for the famous site, which is more than what HBC paid for the entire Saks chain, and he sold off Zellers in Canada to Target for $1.8 billion for the mass retailer’s ill-fated Canadian expansion, which paid for the acquisition of the Hudson’s Bay stores. He contends that the value of the Kaufhof-owned real estate is also more than what the purchase of the chain amounted to, having reported that HBC acquired Kaufhof for 2.4 billion euros [$2.7 billion] and is selling 40 or more Kaufhof’s properties to a joint venture formed with the Simon Property Group, in a package that will exceed 2.4 billion euros. Officials say the entire HBC enterprise has 11 billion Canadian dollars, or $8.92 billion, in real estate value, including Kaufhof, and generates an excess of 754 million Canadian dollars or $611.3 million, in adjusted earnings before interest, taxes, depreciation and amortization.
In the last two months, HBC closed on its joint ventures with the Simon Property Group and RioCan Real Estate Investment Trust. Since disclosing the partnerships in February 2015, HBC’s market capitalization has risen from 3 billion Canadian dollars, or $2.3 billion, to 5 billion Canadian dollars, or $3.84 billion, demonstrating the value of the real estate hadn’t really been reflected in the shares. Together, the joint ventures are seen generating more than $846 million in cash for HBC.
The Kaufhof deal is expected to close at the end of September. “We have a full strategic plan we are working on — for every aspect of the Galeria Kaufhof business,” Baker said. “The business plan is very elaborate. It goes through the opportunity to grow the existing business, to roll out Saks Off 5th, to roll out Saks Fifth Avenue, and to greatly improve the online business.”
And he’ll do it his way. Bloomingdale’s and other retailers, including Saks under previous ownership, have opened licensed stores abroad, but Baker says, “That doesn’t mean we agree with how they do them; I wouldn’t do it that way. We are not going to do it that way.” He says Saks Off 5th and Saks Fifth Avenue stores will open in Germany, converting some Kaufhof real estate.
“The German market in our opinion has a lot of similarities to the Canadian market. We’ve had a very successful business plan in Canada. We believe many features will translate into the German marketplace,” Baker says. For example, Hudson’s Bay on Queen Street in 2013 launched Canada’s largest shoe floor, a 30,000-square-foot space on the main floor, giving a trendy look to a once dowdy image. HBC will also grow Kaufhof’s shoe business. “When we bought Hudson’s Bay, women’s shoes were mostly self-serve. Today shoes at Galeria Kaufhof are mostly self-serve, and the amount of fashion available both in men’s and women’s is at a much lower percentage than what we would see in a U.S. department store. We have opportunities to make the same kind of advancements we made with Hudson’s Bay in Canada. The businesses are quite similar in that they have a middle-to-high positioning, they have large home businesses. We can bring all of our learnings to that [Kaufhof ] team; to look at areas of the store where we can enhance the business — categories — and to look to global vendors we already do business with.” Kaufhof stores are reminiscent of Macy’s as well as Hudson’s Bay, though a few that have been upgraded come across as contemporary.
While Germany is Europe’s largest economy, retailing there isn’t thriving, with the population regarded as being fashion-conservative and more interested in shopping for cars and technology. Growing Kaufhof will be challenging, though Baker and Storch think exposing the German consumer to products they haven’t seen before, at least locally, could spark the business. “There may be some toughness in sales in parts of the market,” Storch acknowledges. “But there is always room for great product. Some consumers are very forward. It’s very cool to bring one product from a different country to another country….One thing I have learned from operating multinational companies, sometimes vendors have difficulties entering new markets. You have to open an office. You need salespeople to go around to all the local companies to try to get them to buy your products. But they are always excited to have a partner who can place large orders from the outset without having to go through a costly start-up phase to enter a country. They can place large orders with us and we can sell product immediately.”
“We can deliver 100 doors overnight,” Baker asserts. “The Hudson’s Bay acquisition of Galeries Kaufhof increases the sales by 50 percent and gives us the opportunity to grow our business with our key vendors. We are already in full negotiations with all types of different vendors and partners to grow into Germany.”
As they do that — and continue all the other work on the group’s portfolio — Baker and Storch no doubt will be eyeing other acquisition opportunities. Given his methods, Baker may already have one in mind.
“We are company of adventurers, we say intelligent adventurers,” Storch says. “Who else would have gone off and found such a great opportunity in Germany? But it’s an intelli- gent opportunity that makes all of the sense of the world.”