Canadians have had a front-row seat to the alchemy involved in turning retailers’ real estate assets into investing gold. Empire Co. Ltd., the parent company of Sobeys, and Canadian Tire Corp. were among the first chains to stoke their share prices by spinning off store properties into publicly traded real estate investment trusts (REITs). This past winter, Hudson’s Bay Co. governor Richard Baker concluded two big deals to spin off U.S. and Canadian real estate and raise more than $1 billion in cash.
It’s now a motif for investors in retailers: Capture the swollen value of properties by selling them, then lease back the stores. Among the U.S. chains that have done it recently are Sears Holdings Corp., Bon-Ton Stores Inc. and Darden Restaurants Inc., owner of the Olive Garden.
Here, however, is a tip for investors intrigued by the idea: Be careful. It’s hard to separate the value of the buildings from the value of the business of selling stuff.
Macy’s is a fine example. The company has 885 stores and it owns about 575 of them. This past summer, analysts at the investment firm Cowen & Co. estimated that Macy’s properties were worth about $19 billion on an enterprise value basis, which includes the equity and debt in those holdings. (All currency in U.S. dollars.) They pegged the enterprise value of the entire company at about $30 billion. Flowing those numbers through to Macy’s common shares, the analysts concluded that there was a potential upside of 24% in the share price.
But selling properties would likely create problems for the retail business that remained. Management would lose flexibility to close or remodel stores. There could be financial headaches, too. Cowen analysts said that the company would “have to shift into long-term leases that would raise rent expense significantly and deteriorate the credit quality of the retail entity, putting Macy’s at risk for a credit rating downgrade.”
Of course, Macy’s could sell just a few stores—or even portions of them. In fact, it already has. This past summer, the company sold and closed its downtown store in Pittsburgh, and five of the nine floors in a store in Brooklyn. In October, Macy’s sold the top four floors of a store in Seattle for $65 million
Cowen estimated that three flagship stores in New York, Chicago and San Francisco are worth $6.2 billion. That means the rest of the chain’s 570-odd owned stores are worth $12.4 billion.
Moreover, as analysts look more closely at Macy’s operating results, many don’t like what they see. After setting aside Macy’s gain from the sale of its Seattle floors, analyst Joan Payson of Barclays concluded that earnings from “retail operations are weaker than expected.” The market agrees. Macy’s shares dropped from more than $70 in July to less than $50 in October. That gave it a market capitalization of about $16 billion —less than its real estate is supposedly worth.