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NEW OWNER TRANS WORLD TRIES TO STAGE MUSICLAND REVIVAL

By Steve McLinden

The two waves of store closures generated by Musicland Holding Corp.’s January bankruptcy and resultant sale to competitor Trans World Entertainment Corp. will no doubt register as the biggest, but there are more ripples to come for the company and music and entertainment retailers, industry experts say.

For now, Minnetonka, Minn.-based Musicland, which operated about 800 stores a year ago under the Sam Goody, Suncoast Motion Picture and MediaPlay names, will emerge this spring with no more than 335 locations remaining — most of which are expected to be in second-tier malls and shopping centers.

Trans World’s bid to buy the foundering company was accepted by the U.S. Bankruptcy Court in the Southern District of New York on March 22. Of the 400 stores it is purchasing in the deal, Trans World has agreed to retain 335 of the better performing units, while turning over 65 others to two liquidating firms, Gordon Brothers Retail Partners and Hilco Merchant Resources, for going-out-of-business sales.

At the end of 2004, Musicland began facing serious liquidity issues. In December last year the company defaulted on a $300 million credit agreement, prompting its Chapter 11 bankruptcy filing in January. Musicland had already closed about 400 stores prior to Trans World’s purchase, including all 61 locations of MediaPlay, an outlet for CDs, DVDs, books, games and other digital media.

The continued shift in industry sales from specialty entertainment retailers to mass merchants, big boxes and nontraditional music sellers, and the legal and illegal downloads of digital media have taken a collective toll on Musicland, which leases retail space in many mid-level and upscale malls.

“The model to have these stores in expensive locations doesn’t work anymore,” said Steven H. Gartner, president of Metro Commercial, a Mount Laurel, N.J., retail brokerage and leasing firm. “But the real question is: What is the future of the category?”

Many fear it is a dim one. Musicland’s bankruptcy is just the latest in a succession of sour notes that have trumpeted the decline of store sales of recorded music in the past half decade. The category posted sale declines for four of the past five years. In 2002 the top five U.S. distributors of CDs and the three largest music retailers agreed to pay $143 million in CDs and cash to settle price-fixing charges. And in recent years music retailers such as Tower Records, Wherehouse Entertainment and CD World were also forced to seek bankruptcy protection.

Trans World, which reported a 7 percent decrease in comp-store sales for the five-week holidays sales season ending Dec. 31, 2005, and a total sales decrease of 11 percent in its 2005 fourth quarter, eventually bought Wherehouse and CD World.

Although sales have slumped, Trans World’s purchase of Musicland puts the company in an advantageous position to dominate the industry’s specialty-store niche in the future, according to industry analyst Joseph Gomes of McGinn Smith & Co., Inc. “This really leaves them as the only specialty entertainment retailer with a national footprint,” he said.

“There will always be a market for prepackaged music just like there will always be a market for checks. You may not need them to accomplish your objective ... but they are preferred by a lot of people,” Gomes said. The acquisition of the Suncoast concept also gives Trans World a more diversified product line that should help dilute its exposure to recorded-music sales, he added.

General Growth Properties and Simon Property Group had the greatest exposure to Musicland’s pre-bankruptcy portfolio, with 148 and 128 leases respectively, according to a report by KeyBanc Capital Markets analyst Richard Moore II. Next was Macerich Co. with 62 and then CBL & Associates Properties with 49.

For the most part, malls and REITs are happy to have these largely underperforming spaces back for retenanting, says Gartner. “Nobody in the retail real estate business is lamenting the loss of this category other than the retailer itself,” he said. “That said, the retailers should not get blamed for not staying current. They tried. Unfortunately, technology just passed them by.”

In all, the Musicland closings represent more than 4.5 million square feet of retail vacancy, according to the National Research Bureau, a retail real estate information service. General Growth and Simon each saw approximately 200,000 square feet of new vacancies from the closings.

At about 40,000 square feet per store, MediaPlay had the largest footprint of all three Musicland concepts. Music seller Sam Goody, which first opened as Musicland in Minneapolis in 1956, has an average store size of 4,700 square feet, according to Trans World. Suncoast, a seller of movies, movie memorabilia, posters, books, apparel and collectibles that debuted as Paramount Pictures in 1986 in Roseville, Minn., averages 2,400 square feet.

Neither General Growth Properties nor Simon officials would comment directly on the latest developments in the Musicland saga. But General Growth COO Robert Michaels said at the Deutsche Bank 2006 Real Estate Outlook Conference in January that Musicland’s bankruptcy, in addition to announced store closures by Toys ‘R’ Us and the recent divestiture of Federated/Mays stores, will cause some short-term pain but will eventually yield long-term benefits for REITs. “The good news in all of this, I think, is having watched these retailers for the past three or four years, most of [them] are on hold-over leases; they’re not paying much rent and they have fairly good locations. So that enables us to come in and remerchandise those spaces with much stronger retailers,” he said.

David Simon, CEO of Simon, said in his fourth-quarter 2005 earnings conference call that Musicland “will challenge the industry in 2006.” But in the same call, Simon CFO Steve Sterrett conceded that though Musicland’s woes were significant among the annual post-Christmas retail bankruptcies, the overall financial health of its retailers was still strong.

Eventually, only “marginal” shopping center properties are likely to house Sam Goody and Suncoast stores, says Howard Davidowitz, chairman of Davidowitz & Associates, a New York City consulting and investment banking firm.

Albany, N.Y.-based Trans World began aggressively renegotiating leases almost the minute their deal to buy Musicland was announced in late February, he says. “They’re saying, ‘Look, we’re in bankruptcy, and here’s what we can afford to pay,’ “ said Davidowitz. “But if the developer thinks he’s being asked to go below market rate [rent], he will negotiate nothing, because he knows he can get a better tenant. Sometimes, it’s a question of how the developer perceives his property.”

According to Davidowitz, in borderline scenarios, especially at higher-end centers, the balance could be tipped away from Musicland’s favor by another factor. “The developer might just say, ‘Why do I need this?’ — the whole business may not be viable.” Hence, more Suncoast and Sam Goody stores are likely to fall by the wayside as leases expire, he says. “It is a huge, huge move, closing all those bad stores in addition to renegotiating leases in existing portfolios,” he said.

The category appears headed for further fragmentation. Starbucks is in the process of rolling out its Hear Music Coffeehouse concept, where latte-nursing customers can burn their own CDs using the chain’s “media bars” containing up to a million songs. Patrons there, and at many conventional Starbucks, can also select from a carefully chosen line of prepackaged CDs that are tailored to regional tastes. Hear Music stores in Santa Monica, Calif., San Antonio and the recently opened 3,300-square-foot Miami Hear Music location precede a more extensive national rollout, the company has said.

Competition from mass marketers and downloading are huge issues. “Another problem is the fact there has been a lack of exciting music products in recent years,” Gomes said. “This is often overlooked in the big scheme of things.”

Meanwhile, other traditionally non-entertainment retailers, including electronics chains, bookstores and convenience stores, continue to expand their CD and movie assortments. The concept of buying a 12-song CD for only a few good tunes has become less and less popular “as the ability for consumers to sample and cherry-pick songs off Web sites, all from the comfort of their homes, increases,” Gartner said. “If you are buying CDs these days, you’re buying them in a commodity setting at a discounter or at Best Buy, which is probably not making a profit on them but still uses them to drive traffic.”

Of the 335 remaining Musicland stores, about half are Suncoast stores and the other half Sam Goody, according to a statement from Trans World, which did not comment for this story. MediaPlay, as well as Sam Goody and Suncoast, will continue to have a Web presence.

In the statement, Trans World’s chairman and CEO, Robert J. Higgins, said the firm looks forward “to quickly and efficiently integrating the acquired stores into the Trans World chain. This acquisition will increase our national footprint providing important operational and marketing synergies and we believe the acquisition will be accretive to our 2006 results.” He added that Trans World expects to leverage Musicland’s investments in its Replay Customer Loyalty Program, which he said has become a model in customer relationship management for millions of Replay members across the U.S.

Trans World, which before the purchase already owned about 800 stores under the CD World, F.Y.E., Coconuts, Planet Music, Spec’s, Second Spin, Strawberries Music and Wherehouse names, agreed to purchase Musicland for $104.2 million in cash and $18.1 million in assumed liabilities.