BREWED AWAKENING
Inside the nasty battle for DavidsTea to find its sweet spot and become profitable again
DavidsTea Inc. chief executive Joel Silver is making an impassioned pitch for stability as the battle for control of the struggling tea retailer comes to a head this week.
Despite winning raves over the years for its range of creative tea products, distinctive packaging and airy, bright stores, the Montreal-based company has been grappling with a rapidly shifting consumer marketplace, poor financial results and all-too-frequent management upheavals.
DavidsTea has recorded losses in four of its past five fiscal years and posted three years of declining same-store sales, a key measure of retail stability. Since going public in 2015, the retailer’s shares have consistently traded far less than their US$19 IPO price, and have been floating in the US$3 to US$4 range while a proxy battle rages between the company’s co-founder and the current board.
“There has been so much conflict and so much turnover, the company hasn’t really been able to open up new (growth) channels and work on strategy,” said Silver, the former president of Indigo Books & Music Inc. who took over the tea seller a little more than a year ago.
“We have had 10 board members turn over since the company went public, and I was the second CEO in three years, though there was an interim one in between. How do you work on a three-to-five-year plan when there is so much turnover?”
Silver is defending his management team’s three-year turnaround plan that began last year, but he’s now staunchly opposed by Herschel Segal, the 87-yearold founder of fashion retailer Le Château Inc. and co-founder of DavidsTea, who believes the team has had more than enough time to fix the business.
“There is enough debate and I think we need to take action,” said Segal, who owns 46.4 per cent of DavidsTea’s shares through his Rainy Day Investments Ltd. firm.
After six years on the board, Segal resigned his seat in March, and is asking shareholders to jettison the current board at the company ’s annual general meeting on Thursday and replace it with a slate of seven nominees, including himself as executive chairman.
“The action is to take our stores in Canada and make them profitable again,” he said. “And you do that as a merchant would: You see what works, change it and try it … you don’t need any major strokes.”
Three significant shareholders — Porchlight Equity Management LLC, TDM Asset Management PTY Ltd. and Edgepoint Wealth Management Inc., which collectively own 36.5 per cent of the company — disagree with Segal’s vision. They support the current board and its proposed slate of six candidates, including Silver and a representative from each of their firms.
In theory, DavidsTea should have a far better chance of making a stable recovery since Teavana, its Starbucks Corp.-owned rival, has closed its 379 stores, including 56 in Canada, during the past year.
But DavidsTea is primarily a retailer of fresh tea blends and accessories, not a quick-service beverage seller, and online shopping is taking a toll on mall traffic and sales at its 240 North American stores.
To-go tea drinks account for less than 10 per cent of DavidsTea’s total sales — which reached $224 million in fiscal 2017 — and its customer traffic reflects it. You won’t see huge Tim Hortons-like lines of morning regulars jostling for a hot cup of Chocolate Chili Chai, nor is it trying to serve that market.
The retailer’s ability to rotate 40 seasonal teas from its assortment of 120 blends guarantees that loyal customers will regularly peruse its bricks-and-mortar locations to see what’s new. But orders for its 80 popular standby blends can easily be filled online: People don’t have to visit a store anymore to get their fix of premium loose tea.
Part of the romance customers have with the DavidsTea brand has been the ability to smell and sample new flavours from the store’s colourful “tea wall,” and the lion’s share of sales involve its associates, known as “tea guides,” scooping and packaging the product in front of customers. That process can result in long lineups at peak shopping times.
“The brand strength is strong, and I think they have a good loyalty following, but I think consumers have been frustrated with the model of always having to interact with the sales staff,” said Robert Carter, executive director of food service at market researcher NPD Group Inc. “If they are regulars, they might know what they want, but they need to keep expanding (online operations) and expanding the distribution model further to look at other ways to gain customers. Now that Teavana has disappeared, they have an opportunity to carve out a greater market share.”
Carter believes DavidsTea has suffered because of the upheaval at the top and so its turnaround plan needs time to take hold, especially since it’s a different strategy than the company had three years ago. Without that stability, he believes, it risks losing loyal customers while not attracting new ones.
But despite the polarizing proxy battle, it’s not clear that Silver’s and Segal’s visions are that far apart. Both stress the need to improve the Canadian business, grow e-commerce sales and develop new distribution channels such as grocery stores.
Silver said the first few months of his tenure involved strengthening the management team, upgrading the company’s digital capabilities and assessing the store network in both Canada and the U.S. He said the company was in more disarray than he anticipated when he took over last year.
“We (needed) a bigger turnaround than I thought,” he said. “The team was much more decimated than I thought.”
Though the board in December hired advisers to pursue strategic alternatives for the brand, Silver insists a sale is not on the table.
He is also optimistic about the performance of new-concept stores in Toronto and Calgary, which appear to mitigate the “throughput” problem — in other words, slow lines. Same-store sales rose by double digits at those locations, which allow customers to sniff tea samples from areas on the sales floor. The stores also stock more ready-to-go prepackaged containers of the most popular blends.
The firm will now test the model at five more stores, Silver said. “At an investment of $130,000 per store, the return on capital is great.”
Management also wants to expand e-commerce, which accounts for 12 per cent of sales but is growing quickly, and Silver is keen for DavidsTea to be offered as a premium product on grocery store shelves, where bagged tea accounts for 98 per cent of the category.
He believes the U.S. market, where DavidsTea has 50 stores, has renewed potential given the recent exit of Teavana, and notes leasing terms are far more favourable today than they were when it entered the U.S. market in 2011.
Segal, for his part, believes current management has spent far too long mulling over strategy rather than making the necessary changes to improve the business in Canada.
Segal co-founded DavidsTea in 2008 with his entrepreneurial young cousin, David, after whom the tea retailer is named. The elder Segal is certain he will get the required votes to oust the current board, which he suspects wants to sell DavidsTea and are too aligned with the desires of the retailer’s institutional investors.
Though he was on the company ’s board when DavidsTea began its store renovation program, he is not convinced a new store design is what the brand needs. He also sees room to improve the U.S. business.
“Whatever we have to do is going to be better than having confusion,” Segal said. “I think that it has to have one leader and I think I can do it, and I have done it, I have my money in there and I have no preconceived ideas. I just think it can be much better.”
Segal said the throughput problem could be remedied by any number of measures after testing, such as experimenting with the amount of prepackaged tea in stock, creating an express line or packaging products differently. “If you have a bottleneck in traffic, then you have to settle it, it doesn’t mean you have to re-engineer your whole store.”
The company, he said, could sell more tea bags, which account for less than 11 per cent of DavidsTea’s sales. “Our tea bags are 92 cents. People don’t pay that for a tea bag. Forty cents is reasonable, when you can pay 15 cents (elsewhere).”
On March 5, when Segal left the board, his Rainy Day Investments firm said it intended to present a proposal to buy out DavidsTea’s minority shareholders. A week later, that proposal was off the table and Rainy Day said it would instead submit a dissident slate of board nominees for election at the June AGM. David Segal, meanwhile, has no horse in the race, since he left the company in 2016 and no longer owns any shares.
Though Rainy Day’s large ownership stake suggests an easy route to winning the proxy battle, two large proxy-advisory firms — Glass, Lewis & Co. LLC and Institutional Shareholder Services Inc. — are advising shareholders vote against Segal’s proposed board and support the incumbent board’s nominees.
“We question whether further senior management changes would be advisable at this time given the relatively brief tenure of the current CEO and the company’s high management turnover in recent years,” Glass, Lewis said in a statement. “Given his influential role as a director of the company during a period of significant underperformance, as well as his age … we question whether it would be advisable to install Mr. Segal as the chief architect of a turnaround plan at this critical juncture for the company.”
ISS cited Segal’s performance track record at Le Château Inc. as a strike against the retail veteran’s bid to control store operations as executive chairman. Le Château, struggling to compete against fastfashion retailers such as H&M and Zara since they entered Canada more than a decade ago, shrunk to 170 stores at the end of 2017 from 212 at the end of fiscal 2007. The fashion retailer has posted 10 years of flat to declining samestore sales, and declared a net loss in each of the past five fiscal years.
Silver said the board had hoped to come to terms with Segal to avoid an all-out proxy fight, one he admits he has a low chance of winning. “Nobody wants this to be, but at this point, both sides want to air their case among the balance of the shareholders,” he said. “It’s expensive. It’s low chance. But we’ve got to fight for it.”
The action is to take our stores in Canada and make them profitable again. And you do that as a merchant would: you see what works, change it and try it … you don’t need any major strokes.