Welcome to the Re/Re/Recap. It’s the Fourth of July holiday weekend and we hope you’ve been able to take a break and relax a bit with friends and family. Today, we’re bringing you a special rambling about shopping malls.
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Lucky Brand Dungarees, Chapter 11, and the American Mall
It’s July 2020 and so the retail reckoning continues. This past week, Lucky Brand Dungarees’ balance sheet became the latest COVID casualty, entering into Chapter 11 proceedings with SPARC Group LLC as its stalking horse bidder.
You may know SPARC as the operating group behind Aeropostale and Nautica brands. Interestingly enough, SPARC is owned in part by Simon Property Group (a REIT that primarily owns and develops malls and premium outlets). Simon also is a partial owner in Forever 21, which filed for Chapter 11 protection in September 2019.
Which spun me up on a bit of a goose chase:
Why would Simon -> SPARC -> want to keep snapping up its tenants?
Boiling it down, Simon Property Group (SPG) makes money when Lucky pays rent.
So I checked out the Lucky CRO’s First Day Declaration and saw that Lucky’s “store locations are all leased and are typically located in traditional shopping malls” (SPG’s primary play). Rent and occupancy costs for the 200+ stores in the US and Puerto Rico were $66m in FY19.
Okay, but what’s the move here? Is SPG trying to protect its rental revenue? How much more is the value of a “limping-along” tenant than “no” tenant? Is this a move to further vertically integrate?
At first blush, it seems that SPG wants to get a bigger share of retail margins — above and beyond what it already gets as part of a store’s fixed costs. Clearly, it’s had some success with this model already with Aeropostale and Nautica and Forever 21. But then, I zoomed out.
And started thinking broadly about the business model of Modern American Malls.
The Modern American Mall
The Modern American Mall is, in my estimation, a sort of poorly-organized grocery store. The big anchor department stores (Dick’s, Macy’s, Belk, whatever) are the produce aisle and the snapback store and the middle-of-the-walkway hand-lotion hut are the People Magazines at the register. Heck, you could even argue that the department stores are their own messy grocery store ecosystems within the broader mall ecosystem.
Malls are all about alternatives, about enticing and trapping you in endless corridors of retail opulence. It’s about geographic concentration and simultaneous separation of near-identical items.
Let’s be honest with each other: you’ll take your teen to the mall for Abercrombie and walk out in Aeropostale. You turn down a hallway to head towards Dillard’s and find out you’re actually going towards J.C. Penney. You check out Polo and end up in Nautica. How?
Well, because the Gruen Transfer is a thing.
“In shopping mall design, the Gruen transfer (also known as the Gruen effect) is the moment when consumers enter a shopping mall or store and, surrounded by an intentionally confusing layout, lose track of their original intentions, making consumers more susceptible to make impulse buys.”
(Ironically, Gruen himself — the mall designer whose name got attached to this psychological quirk — claimed this was a “bastardized” consequence of his original innocent intent.)
The Gruen Transfer enables the Modern American Mall experience, capitalizing on the fact that — sorry, pure economists — people aren’t rational consumers. Also, when was the last time you went to a mall and went in one store, and one store only? Probably never.
And if you’re SPG, this is something you’re counting on. Let’s walk through the following, from the perspective of the Simon Property Group’s mall holdings:
People go to malls and buy things they don’t need from stores they didn’t intend to [Good for SPG: more spending means more tenants paying rent on time]
People can only buy from a store at the mall, if it’s, you know, at the mall… [Good for SPG: value-proposition for tenants]
It’s 2020, people are less likely to go to malls [Bad for SPG: less foot-traffic means less value-add for tenants, less spending, less on-time rent]
It may not make P&L sense for some stores to maintain mall presences, especially in a post-COVID world [Very Bad for SPG: a few key stores dropping out could trigger a “run on the bank” type of self-perpetuating avalanche of mass tenant exits]
Now here’s what’s fascinating to me: in 2019, in an interview with analysts after an earnings release, Simon Property Group CEO, David Simon, dropped this nugget of strategic insight when asked about SPG’s approach re struggling tenants:
“We’ll work together on other distressed situations. But we’re only going to buy into companies that we think have brands and that have the volume that is worth doing it.”
Key word: volume.
If you needed more convincing about how volume is life for SPG, reading their most-recent 10-K risk disclosure section is a “holy moly they’re screwed because every single one of these risks is happening right now” type of heart attack (emphasis my own):
“Some of our properties depend on anchor stores or other large nationally recognized tenants to attract shoppers and we could be materially and adversely affected by the loss of one or more of these anchors or tenants.”
Also, the understated:
“We face potential adverse effects from tenant bankruptcies.”
It’s ultimately why SPG is considering putting in a bid for also-bankrupt J.C. Penney.
When it comes down to it, SPG sees stores as volume magnets. You best bet they’ve got stats on per-visitor store entries and per-visitor average distributed spend. A dollar spent at Jamba Juice probably means another ten dollars spent at Express. And so on.
But with all these bankruptcies — both current and incoming — can SPG keep resuscitating its tenants?
The Modern American Mall of the Living Dead
We’re in a twilight-zone time where would-be-dead retailers are getting propped up by the very capital that had been previously extracted from them.
For SPG, keeping tenants alive and rent-paying as long as possible is of the utmost importance. With a business model that earns not only fixed rent, but variable rent based on store performance, every vacant storefront represents not only the total loss of that individual store’s revenue, but incremental loss of volume, which means overall less available revenue at other stores.
SPG had ~95% overall occupancy in their malls and premium outlet stores across America at the end of the 2019. But can it keep that up? The Marvelous Mx. Market isn’t sure: SPG’s stock has essentially halved since the beginning of COVID.
It’s clear that we’re in what is arguably the most-challenging retail economy since the Great Depression, and it’s no doubt the Modern American Mall is faced with a reckoning.
But just how many short-paying, cost-cutting, low-draw “zombie” stores will be kept in storefronts at malls across America for the sake of “volume” and “occupancy”?
And just how much financial necromancy will the market sustain?