Amer­i­can re­tail: The next big short? The rise in on­line shop­ping is hav­ing a dev­as­tat­ing im­pact on bricks-and-mor­tar US re­tail­ers

Muscat Daily - - BUSINESS - By Robin Wig­glesworth

For a small band of hedge funds that slapped down pre­scient bets against the tot­ter­ing US hous­ing mar­ket, the fi­nan­cial cri­sis was the big­gest money-spin­ner in gen­er­a­tions. Some in­vestors think they have now found the next ‘big short’ in the re­tail in­dus­try.

The re­shap­ing of how Amer­i­cans shop by the In­ter­net is ac­cel­er­at­ing. The US re­tail in- dus­try faces a grow­ing headache, with ten com­pa­nies pushed into bank­ruptcy al­ready in 2017, ac­cord­ing to Stan­dard & Poor’s. Even Sears, a once mighty depart­ment store chain founded in 1886, is now tot­ter­ing.

“We think the mag­ni­tude of this short could be big­ger than sub­prime,” said Stephen Ketchum, the head of Sound Point Cap­i­tal, a hedge fund that man­ages more than US$13bn in as­sets. “Go to the Ama­zon web­site and type in ‘bat­ter­ies’. What you see is just the tip of the fu­ture ice­berg. And re­tail is the

The re­lent­less rise of on­line shop­ping is pos­ing a huge chal­lenge for US shop­ping malls, de­vel­op­ers and in­vestors who own shares and bonds in house­hold names. The core prob­lem is a dra­matic over­build­ing of stores, cou­pled with the rise of ecom­merce, Richard Hayne, Ur­ban Out­fit­ters’ chief ex­ecu- tive, told an­a­lysts on a con­fer­ence call ear­lier this year. “This cre­ated a bub­ble, and like hous­ing, that bub­ble has now burst,” Hayne said. “We are see­ing the re­sults: Doors shut- ter­ing and rents re­treat­ing. This trend will con­tinue for the fore­see­able fu­ture and may even ac­cel­er­ate.”

The im­pact is far-reach­ing. Credit Suisse es­ti­mates that as many as 8,640 stores with 147mn square feet of re­tail­ing space could close down just this year - sur­pass­ing the level of clo­sures af­ter the fi­nan­cial cri­sis and dot- com bust. The down­turn is hit­ting the largely healthy US labour mar­ket - the re­tail in­dus­try has lost an av­er­age of 9,000 jobs a month this year, ac­cord­ing to the Bu­reau of La­bor Statis- tics, com­pared with av­er­age monthly job gains of 17,000 last year.

Shut­tered shop­ping malls and strug­gling depart­ment stores are the most vis­i­ble exam- ple of what an­a­lysts have termed ‘the Ama­zon ef­fect’, as spend­ing mi­grates from bricks-and- mor­tar shops to the on­line realm dom­i­nated by the likes of Jeff Be­zos’s In­ter­net re­tail­ing gi­ant. But it is also likely just the first stage, with some in­vestors pre­dict­ing that ev­ery corner of com­merce is about to ex­pe­ri­ence a painful burst of cre­ative de­struc­tion as shop- pers mi­grate on­line.

“There’s a big shake­out in how peo­ple con- sume goods,” said an­other big hedge fund man­ager. “It will have a mas­sive eco­nomic im- pact . It is al­ready a bad year, and it feels like it has the mo­men­tum to be­come some­thing big­ger.”

When Ama­zon swooped for the Whole Foods Food fight gro­cery chain this sum­mer, it sent shiv­ers down the spines of many in­vestors. Tradi- tional supermarket chains like Wal­mart and Kroger in the US, Tesco and Sains­bury in the UK and Car­refour and Metro in Europe were long thought to be rel­a­tively in­su­lated from the on­line re­tail­ing wave, but their shares all slumped as in­vestors reap­praised that as­sess- ment in the wake of Ama­zon’s ac­qui­si­tion.

“Buy­ing pat­terns are per­ma­nently chang- ing,” said Wayne Wicker, chief in­vest­ment of- fi­cer of ICMA-RC, a pen­sion fund for US pub­lic sec­tor work­ers. “These things creep up on you, and sud­denly you re­alise there’s trou­ble. That’s when peo­ple panic and run for the exit.”

So far the S&P 500’s re­tail­ing in­dex has held its head above wa­ter, climb­ing more than ten per cent this year. But the only rea­son it is not do­ing much worse is be­cause Ama­zon makes up a third of the gauge, and its shares have climbed more than 33 per cent al­ready this year. The on­line gi­ant’s shares are now worth US$477bn, more than half as much as the rest of the listed US re­tail­ing world. With- out Ama­zon, the in­dex’s mar­ket cap­i­tal­i­sa­tion has largely flat­lined since early 2015.

“So far, gro­ceries have been very re­silient to digi­ti­sa­tion, but Ama­zon is try­ing to sys- tem­at­i­cally break this con­sumer de­pen­dence: Shift sta­ples to dig­i­tal; cre­ate a net­work of small brick-and-mor­tar stores to ser­vice per- ish­ables,” said Trevor Noren, an­a­lyst at 13D Re­search. “If Ama­zon or some­one else suc- ceeds, it will elim­i­nate one of the pri­mary rea- sons peo­ple still go to shop­ping cen­tres.”

Shop­ping malls and depart­ment stores are the big­gest losers from this shift, and the pain is wors­ened by a flurry of con­struc­tion in the decades lead­ing up to the fi­nan­cial cri­sis. PwC es­ti­mates that there is about 24 square feet of re­tail­ing floorspace per per­son in the US, com­pared with 11 square feet in Aus­tralia - the only other de­vel­oped coun­try that comes close to the US - and be­tween two and five square feet in Europe.

Bank of Amer­ica Mer­rill Lynch es­ti­mated that US re­tail floorspace is down ten per cent since 2010, while depart­ment store sales are down 18 per cent. “The depart­ment store in- dus­try I think is largely in a death spiral,” Bill Ack­man, the Per­sh­ing Square hedge fund man­ager, said at a con­fer­ence in May.

The pace is ac­cel­er­at­ing. So far this year, the shut­ter­ing of 76mn square feet of re­tail space has been an­nounced, ac­cord­ing to CoS­tar, a data provider - al­most as much as the eight-year high of 82.6mn dur­ing the whole of 2016. PwC es­ti­mated that at least 90mn square feet will be closed this year, but Credit Suisse es­ti­mates that based on cur­rent trends it could be a record-smash­ing 147mn square feet.

“It’s a slower bleed than the hous­ing crash, but that was a cycli­cal story. Re­tail is dif­fer­ent be­cause it’s slower, but sec­u­lar,” said Nadeem Meghji, head of North Amer­i­can real es­tate at Black­stone, the world’s big­gest in­vestor in prop­erty.

The con­cern is that this could cause col­lat- eral dam­age to the broader com­mer­cial and even res­i­den­tial real es­tate mar­ket, as shut- tered shops, malls and stores are re­de­vel­oped for other uses. Jay Sel­lick, se­nior man­ag­ing di- rec­tor of 13D, pre­dicted this will be the ‘next stage of this cri­sis’, weigh­ing on the US$4tn worth of mort­gages in the com­mer­cial real es- tate mar­ket, which al­ready ‘ap­pears over­built and over-in­debted’.

Yet the de­cline of the iconic Amer­i­can shop­ping mall is only the most vis­i­ble as­pect of a far broader revo­lu­tion that is up­end­ing the en­tire world of com­merce. On­line-only pur­chases ac­count for just over ten per cent of all US re­tail sales, but the share is grow­ing quickly, said Credit Suisse. Across the board, con­sump­tion pat­terns are evolv­ing, es­pe­cially among younger Amer­i­cans who are much more com­fort­able with an on­line-only expe- ri­ence than their par­ents.

Even ded­i­cated turn­round in­vestors are sit­ting on their hands. Pri­vate eq­uity firms and hedge funds that spe­cialise in cor­po­rate up­heaval - so-called dis­tressed debt in­vestors that snap up strug­gling com­pa­nies, tak­ing them over in a re­struc­tur­ing and hope­fully en­gi­neer­ing a re­cov­ery - are largely shun­ning tra­di­tional re­tail, wary of the im­mense chal- lenges, ac­cord­ing to re­struc­tur­ing ad­vi­sors.

Vic­tor Khosla, founder and se­nior manag- ing part­ner of Strate­gic Value Part­ners, a US$6bn dis­tressed debt hedge fund, said the list of trou­bled re­tail­ers his firm now moni- tors is ‘ex­traor­di­nar­ily long’, but he is stay­ing well away.

“Try­ing to fig­ure out the bot­tom is hard. We have spent a lot of en­ergy un­der­stand­ing these busi­nesses, and have con­cluded that the vast ma­jor­ity of them are un­in­vestable,” he said. “Many of these were great busi­nesses at some point in time, but the In­ter­net and chang­ing con­sumer habits have de­stroyed them.”

Some re­tail chief ex­ec­u­tives who have man­aged to build rel­a­tively suc­cess­ful dig­i­tal op­er­a­tions com­plain that their share prices are too low and are un­fairly pun­ished for the broader in­dus­try malaise. That may be, but “I re­mem­ber hearing home­builders say the same in 2006”, one hedge fund man­ager re- called, point­ing out that even for tra­di­tional re­tail­ers the shift will be painful, given that peo­ple tend to make less im­pul­sive pur­chases on the In­ter­net.

“A lot of in­ci­den­tal con­sump­tion doesn’t hap­pen on­line. Most peo­ple don’t wander the dig­i­tal aisles,” he said. A dol­lar spent in a shop in prac­tice only trans­lates to 80-90 cents on- line, even though costs are lower. Data re- leased re­cently showed that core re­tail sales in June fell for a sec­ond month run­ning for the first time since early 2015.

Some in­vestors are un­con­vinced that tra- di­tional play­ers have what it takes to com­pete with their on­line ri­vals, given the lat­ter’s ad- van­tages in tech­nol­ogy and data. “[In] what- ever area they are com­pet­ing for shop­ping dol­lars, it is like the old-world re­tail­ers are bring­ing a knife to the fight, and the tech com- pa­nies are rock­ing a heat-seek­ing mis­sile,” said an­other hedge fund man­ager.

Still, hedge fund man­agers stress that the ‘re­tail big short’ is go­ing to be fun­da­men­tally dif­fer­ent from the hous­ing down­turn - far more halt­ing and slow - which makes it hard to carry out any­thing other than tac­ti­cal, op- por­tunis­tic trades. More­over, it will not en­tail the global, sys­temic dan­gers that the sub- prime-trig­gered fi­nan­cial cri­sis did.

Some of the dam­age is al­ready priced into the bonds and stocks of re­tail com­pa­nies, and the slow­ness of the shake­out makes it tricky and ex­pen­sive to make out­right bear­ish wa- gers on what some an­a­lysts are call­ing a ‘re- tail-maged­don’.

“Be­cause it is such a slow bleed, it is im­por- tant to get both the di­rec­tion and the tim­ing right,” Ketchum said. “We are fo­cused on short­ing the com­pa­nies that have reached a tip­ping point for one rea­son or an­other.”

Some hedge fund man­agers are more scep- tical. David Tawil, pres­i­dent of Maglan Cap­i­tal, said: “Although it is a good short, I don’t think that, at this point, it is the short, nor is it a big short.”

In ad­di­tion, re­tail is not go­ing away, and as some chains go out of busi­ness the sur­vivors will pick up some of their cus­tomers. Most econ­o­mists ex­pect wage growth in the US labour mar­ket to pick up in the com­ing years, help­ing to sup­port con­sumer spend­ing.

“Web­sites can­not give you goose­bumps, and that is where phys­i­cal stores still have an ad­van­tage,” said By­ron Car­lock, head of PwC’s US real es­tate prac­tice. “I don’t see con­sumers shy­ing away from con­sum­ing. Good re­tail­ers will fig­ure it out.”

But what looks like a slow-mov­ing train wreck could speed up should Amer­i­can con- sumers - who at the mo­ment are en­joy­ing low in­ter­est rates and sub­dued un­em­ploy­ment - suf­fer an­other shock. For ex­am­ple, in the un- likely event that the Fed­eral Re­serve em­barks on ag­gres­sive rate rises and pushes the econ- omy into a re­ces­sion, re­tail­ers could be hit both by higher borrowing costs and con- sumers tight­en­ing their belts.

The im­pact of the re­tail sec­tor’s prob­lems on the fab­ric of the US labour mar­ket is likely to be se­vere. Gold­man Sachs es­ti­mated that ecom­merce com­pa­nies only re­quire 0.9 em- ploy­ees per US$1mn of sales com­pared with 3.5 for a bricks-and-mor­tar store, and the sec- tor is on course to lose about 100,000 jobs this year.

This may be small com­pared with the over- all re­tail econ­omy - which em­ploys al­most 16mn - but it is likely only the be­gin­ning of a broad, ac­cel­er­at­ing trend as even more shop- ping mi­grates on­line.

“The so­cial and eco­nomic con­se­quences are go­ing to be huge,” warned Meghji. “It’s a mas­sive sec­u­lar change to how our econ­omy and so­ci­ety op­er­ates.”

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