Wednesday, June 17, 2015

Scaling Up: M&A Activity to Rise as Omnichannel Retailing Grows

Fish East iPhone animation
Get ready for some omni-deals.
Driven by a need to create a retail environment where online and in-store shopping are a seamless experience for consumers, retailers are expected to make “bolt-on” acquisitions of vendors and e-commerce providers beginning later this year and into next.
Retailers have no choice. The stock market is looking for faster growth at a time when major firms are at best eking out single-digit gains in same-store sales. And consumers’ rapidly changing demands are forcing companies to adapt, or fall behind.
Consolidation is one of the few options left.
Banking sources, analysts and industry consultants also see companies continuing to extend their retail brands — especially into the off-price sector. Macy’s and Bloomingdale’s are recent examples of department stores that are pushing into the off-price world, while Saks Fifth Avenue and Nordstrom are expanding further into the segment — the latter now has more off-price units than full-line stores. Several of these same retailers are also turning to overseas markets for expansion opportunities, while even overseas retailers are snapping up their international competitors — just look at La Rinascente recently buying Germany’s KaDeWe Group and Saks parent Hudson’s Bay Co.’s eager acquisition of Germany’s Kaufhof chain.
The shift into the off-price sector coupled with creating an omnichannel environment — which includes reconfiguring supply chains — is, by design, a way to better control inventories, reduce costs and maximize profits. Sources said layoffs and reducing total square footage with store closures will also likely occur. Macy’s Inc. and J.C. Penney Co. Inc. have already shuttered a number of units, and companies such as Ralph Lauren and J. Crew Group recently revealed workforce reductions. The latest is Gap, which just reported closing 175 of its 977 stores.
Regarding larger-scale retail consolidation in the U.S., sources say deals will still occur (recent examples include Staples gobbling up Office Depot), but the pace of activity will be modest. Belk Inc. is on the market, but suitors have failed to line up, for example. A more likely scenario is smaller-size transactions involving vendors that can help accelerate the omnichannel approach. But will any of this achieve the goal of moving the needle on share prices?
“That remains to be seen,” said Todd Antonelli, managing director at the Chicago-based Berkeley Research Group LLC. Antonelli agreed that organic growth has stalled for most retailers and the mergers and acquisitions activity recently seen in the tech and communications sectors is poised to occur in retail, “starting this year and then into next year.”
The nature of M&A activity moving forward will shift to more bolt-on acquisitions and brand extensions — such as what’s occurred in the off-price channel, Antonelli said. Macy’s acquisition of beauty retailer Bluemercury earlier this year is an example of the types of deals the market will see. Macy’s management said at the time that the strategy — which involves a whole new format in a business that it knows well — was to bolster its omnichannel efforts.
There will also be activity on the vendor and product brand side of the business. Recent examples include Procter & Gamble’s impending unloading of some of its beauty brands, which have attracted bids from both strategic players and private-equity firms.
“Overall, retail is ripe for M&A deals,” Antonelli said. “But it’s not going to be like what we’ve seen in the past. We’ll be seeing a consolidation [involving e-commerce] platforms and brands.” He said omnichannel retailing and convergence trends where the lines between online and in-store shopping are blurred will be the key drivers of transactions.
“Organic growth is not boosting shareholder value,” Antonelli added. “And retailers will only grow through acquisition.” To their advantage, Antonelli said retailers “own the shopping experience” and so he expects companies to acquire e-commerce vendors to make shopping — online and off — a seamless process.
Moreover, retailers can handle acquisitions. At the moment, many of those that are public have a lot of cash on their balance sheets and are in good standing with banks. Macy’s, for example, has more than $2 billion in cash with about $7 billion in long-term debt. Target Corp. has about the same in cash with about $12 billion in long-term debt.
“And many don’t have a lot of [activist] investors barking at them — at least for now — to spend that cash. But that will likely change,” Antonelli said.
Retailers can also increase dividends and expand share buybacks to add value for investors, which is what Target Corp. is in the midst of doing. With omnichannel the strategy-of-the-day, retailers need to have suppliers “closer to home,” Antonelli said, adding that he expects a portion of M&A deals at retail to involve them buying their U.S.-based suppliers, which would both boost their growth and enable them to expand their exclusive or private-label offerings.
Jodi Harouche, founder and creative director at Multimedia Plus with clients that include Coach Inc., Brooks Brothers, Grupo Cortefiel and Ardène, among others, said she feels “there will still be significant M&A activity as companies find a balance between online shopping and physical retail stores. Stores will focus on the ultimate in service and brand experience,” Harouche continued. “As M&A activity continues, the level of service and selection at the store level will increase, making shopping at the store a destination experience. M&A will be on the rise until this balance is found.”
Donna Reamy, chair of the department of fashion design and merchandising at the VCU School of the Arts, also expects omnichannel retailing to be the theme of M&A activity. “Consumers are smart. They not only want a product, but they want an experience when they shop. Therefore, retailers may close doors — brick-and-mortar — but will continue to push their product through Internet sites, pop-up shops, and stores within stores [with brands],” Reamy explained. “This will take the retailer global, which in turn will create a more competitive playing field, higher demand, lower supply and stocks will rise, based on economic theory.”
Andrew Tananbaum, executive chairman of Capital Business Credit LLC, said conditions in the financial market make the timing right for acquisitions. “Right now, growth is difficult to come by — there’s not a lot of inflation in wholesale and retail prices,” Tananbaum said. “It is easier to be strategic and buy than to build, and we’re in an attractive financing environment for acquisitions. Big names will cull through their brands and look for opportunities to acquire.”
He cautioned against acting too quickly or too boldly. Larger wholesalers “need to be cautious about brand valuations” and make certain that “they do not pay too much for a big brand,” he said, while department stores “need to be careful with strategic change because their customers may not follow their strategies.”
Kevin Ramsier, managing partner of Vesticor, an M&A adviser with a focus on exit planning, expects M&A activity to be “strong in the retail sector over the next 12 to 24 months.” There are several factors that will drive that activity, the primary one being “changing consumer preferences.”
“Consumers are certainly buying more and more goods online,” Ramsier said. “This shift has caused retailers to struggle when it comes to paying the expenses of real estate and personnel associated with traditional brick-and-mortar locations. An increase in M&A activity will likely increase this trend as companies will reduce redundancies in markets after they join forces. Mergers in this sector can offer huge cost savings by consolidating jobs and closing some locations.”
Ramsier noted that consumer behavior is shifting where shoppers spend less time at the mall, “and when they do go, they are spending a lot less time per visit,” he said. “Malls are being forced to fill vacancies with nontraditional tenants — children’s play areas, low-end nail salons, consignment shops. Acquisitions must be based upon this trend.”
There are also demographic forces at play. “Millennials, for example, are heavy online shoppers. [And] they tend to buy less traditional work clothes — more casual — and even shy away from some of the mainline brands that the Baby Boomers grew up on,” he said.
The M&A adviser said strategic buyers are “under massive pressure to find new ways to grow, and strategic acquisitions seem to be the best bet,” adding that private equity sources “continue to look for deals in this space that have built-in brand equity, even though recent exit strategies have become more difficult to execute upon due to very slow (or in some cases nonexistent) growth rates.”
Future deals will also likely shift from traditional combinations of two brands to transactions to boost omnichannel operations. “Keep an eye on major retailers looking for acquisitions in Internet platforms or other technologies that allow consumers to see clothing and accessories modeled online with people that are their size,” Ramsier said.
Al Ferrara, partner and national leader of BDO’s consumer business practice, also expects the omnichannel trend to drive a lot of deals going forward — and wouldn’t be surprised if private equity gets into the action.
“Retail is a great entry point for private equity,” Ferrara said. “Retail is a very transparent business where you can go into stores and see the business in action.”
Ferrara agreed that organic growth no longer brings value to shareholders. “But retailers — mature ones — still throw off a ton of cash, and are attractive to private equity for that reason,” he said, adding that he expects some retailers to exit the public market completely, which is another option instead of consolidation.
Jane Goldstein, M&A partner at Ropes & Gray, said there are a lot of advantages to going private. She said “in a private environment, management teams may have more ability to take risks and have a longer-term view where they are not reporting publicly on a quarterly basis. It could also be that they believe they have strong growth potential but need a financial boost to get there while retaining their brand.”
Rob Coble, KPMG deal advisory partner said from an economic perspective “falling commodity prices will benefit retailers in the short term…[and] along with relatively cheap debt, may help stimulate M&A activity in the U.S.”
That said, Coble sees broader challenges ahead for dealmakers. “The global outlook is unclear as geopolitical uncertainty and worsening economies will make the global M&A environment challenging,” he said.

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