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FEDERATED-MAY

Merger good for mall industry, landlords say

BY BRANNON BOSWELL

First it was Kmart and Sears. Now it’s Federated and May. Merger mania in the department store sector is speeding up the regional mall’s evolution cycle, and mall owners couldn’t be more excited about it.

An unprecedented amount of mall anchor space will be in flux over the next few years as stores close, brands disappear and space is freed for new uses. And that’s an opportunity to add lifestyle components, bring in a discounter anchor, or add restaurants and entertainment tenants, landlords say.

“You don’t get a mall, put it up, collect rent and then leave and go home,” Peter Lowy, managing director of the Westfield Group, said last month at a Lehman Bros. REIT conference in New York City. “We’re in a dynamic management business. If we can manage our properties correctly, we can deal with such events when they arise.”

As Federated Department Stores begins repositioning its store base next year, most of the focus will be on the 98 malls with overlapping Federated and May Department Stores Co. anchors. They are some of the highest-quality properties in the country, and 86 percent are owned by REITs, points out Merrill Lynch analyst Steve Sakwa. “Federated would not be looking to reduce their square footage exposure at many of the nation’s most productive malls, and those stores they do close would have considerable re-leasing options,” Sakwa wrote in a report to investors.

So if an anchor does close, it shouldn’t take long to line up suitable replacements. The Macerich Co., for example, has learned from experience that a closed department store at a quality mall usually translates into rental income and traffic growth once a new tenant is brought in, CEO Arthur Coppola said at the Lehman conference.

When Montgomery Ward closed its store at Macerich’s 2 million-square-foot Lakewood (Calif.) Center mall, Coppola said, the firm chose Target instead of Sears to fill the vacated anchor slot. That decision paid off in spades, he says. “Today that Target store is doing more business than any other department store in that particular center, including Macy’s and Robinsons-May,” he said. Sales per square foot and traffic are up there, he says, and Target is doing between $60 million and $65 million annually.

Macerich is one of the public REITs most exposed to possible store closures resulting from the Federated-May merger, according to Merrill Lynch. Of the 93 malls anchored by both Federated and May stores, Macerich owns 12. “There will be changes at those malls,” Coppola said. “But five years from now, they’re going to be more exciting places to shop and much more profitable.”

Though Lowy says he cannot imagine a mall without traditional department stores, he acknowledges that discounters are a profitable option. Wal-Mart is an anchor at Westfield’s Shoppingtown Parkway, San Diego. Westfield’s portfolio of malls includes 13 with overlapping Federated and May anchors.

Multitenant, open-air lifestyle spaces are another profitable option for malls with empty anchors. The CEO of one major REIT predicted recently that 50 percent of the vacant anchor stores at U.S. malls will convert to open-air liffestyle “tails” in coming years.

Macy’s mounting might
Mall owners aren’t just excited about the opportunity to bring in new anchors. They’re also optimistic about Federated’s chances at rejuvenating the department store with Macy’s new national power.

The sector could use the refreshment. Department stores’ share of general merchandise sales has dropped about 20 percentage points in the past decade, according to Bank of Tokyo-Mitsubishi figures.

But that could change once Macy’s becomes a coast-to-coast operator.

“It’s the first opportunity any department store chain has had a truly national brand to leverage,” said Stuart Kessler, president of Hillsborough, N.J.-based consulting firm Clear Thinking Group.

With new leverage to air television ads during such highly viewed events as the Super Bowl, something Target and Wal-Mart already do, Federated can reach a whole new genre of shoppers, Kessler says, especially younger consumers. Up until now, department store ads have been largely confined to newspaper inserts, he says.

And though one executive at a major department store chain says half of the new department stores built in the coming years will be in open-air centers, mall owners can rest assured that Federated won’t be driving that trend, at least not for a while. Instead, it will be spending the next several years improving its mall-based stores.

Converting May’s collection of regional brands to the Macy’s banner will significantly boost those stores’ sales productivity, said Federated CEO Terry J. Lundgren at a press conference the day after announcing the merger. He points out that Federated managed to grow same-store sales by 2.6 percent last year, despite the ongoing conversion of five regional brands and 184 stores to the Macy’s nameplate. The chain says it will spend $1 billion over three years on the May portfolio for store upgrades, name conversions, severance pay and the like.

Federated will also beef up its assortment of private-label merchandise in coming years, from 17 percent today to 20 percent. Macy’s private labels, including Inc. and Style & Co., have performed very well, Lundgren says, and have helped dispel the notion that all department stores sell similar merchandise. Federated is even putting money behind national ad campaigns for its private-label brands.

Another Federated objective is to hook young shoppers, for whom the department store model has become more and more irrelevant in recent years, Lundgren says. Mall owners would benefit from an uptick in youth traffic as well. Eleven percent of shoppers 18-24 currently buy their apparel at lifestyle centers, versus only 7 percent of the general population, according to a new survey from consulting firm Columbus, Ohio-based Retail Forward.

Even though Macy’s core customer is between 25 and 54, teen-agers are the brides and the core customers of tomorrow. Macy’s wants to woo them now. Convenience will be key in courting this demographic, Lundgren says.

The Macy’s credit card operation could assist in this effort, says Kessler. In conjunction with the conversion of the hyphenated stores to the Macy’s brand, Federated rolled out a national Macy’s charge card to more than 14 million customers. “Offering credit gets in the young people,” he said. Macy’s rival Kohl’s is aggressively pushing its private credit card to pull in more sales, he noted.

Federated dilemma
The only major unknown for mall owners at this point is how Federated will deal with situations where it has a Macy’s store in the same mall with more than one profitable May store, says John L. Bucksbaum, SCSM, chief executive of General Growth Properties, which has 18 of its 209 malls anchored by overlapping Federated and May stores. “How do you handle that? In almost all of General Growth’s affected malls, that is the case,” he said.

The 1 million-square-foot Christiana Mall in suburban Philadelphia, for example, is anchored by Macy’s and by two May brands: Lord & Taylor and Hecht’s. Two Macy’s would be overkill, closing the Hecht’s and Lord & Taylor stores would mean lost sales, and selling the space to a rival such as Nordstrom would erode market share, Kessler says.

Macy’s and Bloomingdale’s can share a mall because they are easily segmented into mid-tier and upscale merchandise. But with three May nameplates in one mall, one of the stores will likely go to another retailer, Kessler says. “And it would have to be a high-revenue producer to please the landlord, and a noncompetitor to please Federated,” he said.

That leaves several options, including Barnes & Noble and Dick’s Sporting Goods, he added. Long-standing reciprocal easement agreements between the landlords and Federated will also play a big part in how the stores are repositioned, because many of the malls in question are more than 30 years old and may be governed by agreements that give anchors a lot of say in the matter.

Regardless of the way the Federated-May merger plays out, it highlights the continuing importance of the regional mall in American commerce. “Retail business is obviously still being done in the malls,” said Kessler. “The trick for Federated will be drawing those specialty shoppers out of the small shops and back into the department stores.”