Keeping Score is a column that will appear periodically by Digital Commerce 360 editor at large Don Davis, who has been covering ecommerce since 2007.
Activist investors are pressing some retail chains, including Macy’s and Kohl’s, to spin off their ecommerce units or sell real estate to raise cash. Some want those retailers to follow the lead of Hudson’s Bay Co., which separated the Saks Fifth Avenue physical stores from the online business, which is now known simply as Saks.
That strategy may be a way for hedge funds and venture capital firms like Insight Partners, which was involved in the Saks deal, to make a relatively quick buck. But I doubt it’s a formula for building a retail business that can survive in the Age of Amazon.
One flaw in the spinoff strategy is its assumption that Wall Street will over the long term assign a higher valuation to an online-only business than to one that combines physical and online stores. But investors ultimately will demand profits, and the online-only retailers that have gone public have not had a great record of producing profits. I’ll come back to that shortly.
The deeper problem is that consumers value the convenience retailers can offer when they operate both physical and online stores, including such services as in-store pickup and returning online orders to the store. Hudson’s Bay, which retains a stake in the Saks online business and still owns the Saks stores, says Saks shoppers will continue to enjoy those conveniences and won’t see any difference as a result of the separation.
But I doubt that will be the case for long if the Saks ecommerce unit goes public, which seems to be the end game. The publicly traded Saks would be under pressure to maximize its own profits, regardless of the impact of its actions on Saks Fifth Avenue stores. Inevitably, the needs of the two companies will diverge, and customer experience will suffer.
And, in the end, it is the customers that determine whether any retailer succeeds. That may not matter to hedge funds and venture capitalists whose business model is based on getting out of the companies they invest in as quickly and profitably as possible. But it matters a great deal to retailers who want to build a successful business for the long term.
Are retail chains better off splitting off their ecommerce units?
The debate over the spinoff strategy was well summarized in a recent Wall Street Journal article that presented both sides of the argument: the pro-spinoff side from Marc Metrick, CEO of the new Saks online business, Hubert Joly, who was CEO of Best Buy from 2012 to 2019, providing the contrary view. Joly now lectures at the Harvard Business School and sits on the boards of Johnson & Johnson and Ralph Lauren.
Metrick, who had been CEO of the combined Saks Fifth Avenue division of Hudson’s Bay before the separation, argued that an online-only business can attract more investor capital and digital commerce talent. He also noted that the 340 service agreements now in place between the Saks stores and its online twin merely formalized policies that had been in place for decades, including on how store employees are compensated for online orders. But 340 contracts sounds like a lot of red tape that can make a retailer less agile.
Joly argued that a combined business can respond more quickly to new business conditions. He pointed out, for example, that Best Buy was able to introduce curbside pickup of online orders in just 48 hours in April 2020 as the coronavirus pandemic forced many stores to close and consumers to stay at home. He doubted that two separate companies, and their respective lawyers, could have made that happen as quickly.
That’s a convincing argument to me. And, with Amazon taking an ever-larger share of retail, including through opening its own physical stores, I think retail executives would be well advised to assume that they will have to make many more adjustments in coming years to deal with competitive pressures that can be just as threatening to their survival as a global pandemic.
Wall Street and the future of web-only businesses
Metrick’s argument that an online-only retail business can attract more investor capital than one with stores is based on the assumption that the shares of online-only retailers will perform well on stock exchanges. If they do, venture capitalists like Insight Partners, which put $500 million into the new Saks business, can recoup their investment and more. But if online retailers don’t perform well in the stock market other investment firms will see that and drop this strategy, which could soon be a distant memory.
That raises the question: Can publicly traded online retailers turn the cash they acquire by going public into profitable, long-term businesses? Apart from Amazon—which makes most of its profit from cloud computing and not from retail—the results aren’t encouraging. Amazon is No. 1 in the 2021 Digital Commerce 360 Top 1000, a ranking of North American retailers by online sales.
We’ve seen some exciting web-only retailers such as furniture seller Wayfair (No. 7 in the Top 1000) and pet supplies retailer Chewy (Chewy parent PetSmart is No. 15) grow rapidly and dominate their categories online. But they struggle to consistently make a profit. The same is true for Stitch Fix (No. 48), the intriguing online seller of personalized clothing collections. None are clear winners for shareholders, at least not yet.
There is also the example of Blue Nile (No. 108), a pioneering online retailer founded in 1999 that built a solid business selling engagement rings at attractive prices. The e-retailer was consistently profitable, but not spectacularly so, and its growth stalled. That led in 2017 to private equity firms buying Blue Nile for $500 million and taking it private at a price that was well below Blue Nile’s peak stock market value at various times over the prior decade or so.
And then there is Overstock.com (No. 31), another early and initially successful e-retailer. It has suffered in recent years from competition, including from Wayfair, and the company has sought to sell off its online retail business so it can focus on its investment in cryptocurrency. That investment, at least, is working out for Overstock shareholders. Online retail, not so much.
Investors project growth for ecommerce companies
Despite this less-than-stellar record, it’s important to remember that investors look ahead. That’s why online retailers can be attractive to Wall Street, at least for a while. Analysts tracked by Yahoo Finance project negative growth for Macy’s and Kohl’s over the next five years, while predicting Wayfair, Chewy and Stitch Fix will grow by an average of nearly 13% over that period.
That accounts for the relatively high stock price for the online retailers, given their profit struggles, and the low prices assigned to shares in department store chains like Macy’s and Kohl’s. From the point of view of investors, the main value of Macy’s and Kohl’s may lie in the real estate they own. Indeed, Macy’s already has sold off some of the land underneath its stores and leased it back, while some investors are pressing Kohl’s to do the same. Kohl’s management has rejected that idea.
Department stores may well be outdated relics of retail days gone by, and perhaps they will disappear. But the broader question for other retailers that operate physical stores is whether they should split off their online business into a separate company.
I think they should not, mainly because those that have effectively combined their stores with their websites and mobile apps to better serve customers are making money—and faring reasonably well on Wall Street.
Take three of the most successful omnichannel retailers: Walmart, Best Buy and Target. The analysts surveyed by Yahoo Finance project they will grow on average by 10.6% over the next five years, far better than the estimates for Macy’s and Kohl’s. Walmart is No. 2 in the Top 1000, Best Buy No. 5, Target No. 6, Macy’s No. 14 and Kohl’s No. 19.
Even more telling is the price-to-earnings ratios of these companies. That compares the market value of each company based on its stock price to its earnings for the past 12 months. The P/E ratio for Macy’s and Kohl’s is about 10 in both cases, well under the S&P 500 average of just below 15.
But for Walmart, Target and Best Buy it averages nearly 25. And that’s despite Best Buy’s share price being depressed since a disappointing earnings report in November that drove down its P/E ratio to the level of Macy’s and Kohl’s. Walmart’s P/E ratio of 48.5 even approaches the level of Wall Street darling Amazon, which is trading at about 55 times its profits for the past year. (The P/E ratios of Wayfair and Chewy are even higher, but only because their earnings were so low; Stitch Fix lost money, so its P/E ratio is not meaningful.)
That suggests to me that an omnichannel strategy done well will allow a store-based retailer to survive in the face of competition from Amazon and other online retailers. As Joly’s example of the fast implementation of curbside pickup at Best Buy suggests, it’s hard to imagine that separating their online businesses would make them more agile—or attractive to consumers.
Can online retailers be profitable at scale?
That leaves the question of the road forward for retailers that establish a niche online. Should they raise venture capital in order to expand significantly, with an eye to going public?
I think they should be very cautious. Consider the sad story of vintage apparel merchant Nasty Gal, a high flyer a decade ago that overestimated the demand for its product, expanded beyond its ability to sell profitably and ultimately went out of business.
Online retailers can be profitable, and succeed for a long time. But it appears to be harder to do when an e-retailer faces the kind of quarterly scrutiny from Wall Street that publicly traded companies do. Investors want growth, and that often leads publicly traded companies and those that take large venture capital investments to take risks to demonstrate growth. Even those that don’t fail like Nasty Gal, may disappoint Wall Street when they go public, especially if they can’t turn a profit consistently. And that can lead to private equity firms buying them at a discount, as happened to Blue Nile.
That kind of outcome sees especially likely today when practically every retailer is competing with Amazon and with a growing array of venture capital-funded, direct-to-consumer startups.
Some online retailers are long-term ecommerce winners
That’s not to say the prospects are gloomy for online-first retailers. Quite the contrary.
Digital Commerce 360 has tracked many primarily online retailers that have thrived for many years. Among those that come to mind are car and home stereo specialist Crutchfield (No. 242), educational plaything retailer Fat Brain Toys (No. 714) and woven goods importer Peruvian Connection (No. 739). They stayed private, allowing their executives to make decisions without the pressure to show the kind of dramatic growth that appeals to Wall Street.
Most importantly, they provided value to their customers in ways competitors did not, and continue to do so today. “The customer is always right” has been the watchword of many successful retailers. Whether you sell primarily online, through stores or through many channels, your ultimate success will be determined by the customer.
It’s in that light that I look at financial plays like spinning off a retailer’s online business. Will they allow the retailer to better serve its customers? I don’t think so. That may not matter to hedge fund managers eager to make a quick profit, but I know it matters a lot to the many entrepreneurs I’ve interviewed over the years who have put their hearts and souls into building successful retail businesses that shoppers love.Favorite