HBC/WeWork : True Mixed Use

It’s hard to miss the cadre of established companies tripping over themselves to secure mindshare and wallet-share from Millennials. There are few companies more ‘established’ than the Hudson’s Bay Company (TSX: HBC), 3 years short of its 350th birthday, and firmly one of the oldest companies in North America (if not the world). But if you take a walk through many of their retail environments, you can feel the age…and I don’t mean in the elegant, awe-inspiring sense, but rather in the worn-carpet, low dropped-ceiling-height, tatty metal racking sense. If you really want a sense of the difference, visit the Bay before a trip to London, and then nip into Selfridges (Canadian owned by the Westons) or Harvey Nick’s. Night and day. It’s not remotely a surprise to me, then, that HBC struggles with self-actualizing Millennials who prefer good service and far sexier shopping experiences like Zara, Urban Outfitters, etc. HBC’s website proclaims it ‘Canada’s Iconic Department Store’ – the middle two words are about as exciting to Millennials (like me) as the words ‘Fax Machine’.

ASIDE: If the might of the Millennial consumer interests you, Goldman has a great infographic overview for you.

Nevertheless, what HBC does have is AMAZING real estate. It’s stores in Vancouver, Calgary, Toronto, and Montreal are, as hockey-fans say, “centre ice”: fantastic locations, and great bones for just about any use (maybe save residential). Indeed when Richard Baker bought the Bay in 2008 it was ostensibly about the real estate. Though the Bay now joined the company of Lord & Taylor, and Saks Fifth Avenue, it was quite clear shortly after Baker acquired the Bay that the real estate may be worth more than he paid for the whole the company. 10 years later, as the conventional brick+mortar retail sector shrivels, that looks to have been extremely important, let alone shrewd.

But a quick walk through any of the Bay’s stores reveals a compounding problem. They’re way too big for the demand they serve, and most of the best locations are multi-storey (the flagship Toronto store is 6 storeys above ground…when was the last time you bought anything on the 6th floor of a building?). You don’t need much data to see that sales per square foot on the upper floors are awful. Just walk up there at peak non-Xmas shopping times (say a Friday PM in October) and count the shoppers (read: tumbleweeds). This under-use is really a travesty, not just for the Bay, but also for the cities in which these buildings exist.

This is why I love what HBC + WeWork have just announced.

The announcement centres on Rhone Capital – a partner and investor of WeWork – acquiring the Fifth Ave NYC Lord & Taylor store, but that’s just a real estate deal. WeWork is growing like a weed, has a huge amount of capital available to it, and is addicted to its home market of NYC. If WeWork is news to you (it will be to many in Canada), I suggest you see what Wired Magazine recently shared. HBC can use this deal to prove real estate values on its books (apparently, WeWork are paying c.35% more for that building than HBC investors were told it was worth).  But it’s the c.$100m that WeWork’s partner Rhone Capital will invest into HBC, and the relationship with WeWork that ensues that I find really interesting. WeWork will start to lease the underperforming upper floors at HBC flagships in major Canadian markets (and possibly it’s Berlin flagship of Galeria Kaufhof), and fill them with literally hundreds of Millennial co-working office workers, immediately above the stores. How better to revive a retailer’s fortunes than to place their ideal customers literally above their heads? And remember, it’s not just a few static consumers moving in above. The tenure of the average WeWork occupier is roughly 2 years, so there’s some great turnover that will result here for the Bay, AND, if they get it right, all of the investors, customers, advisors, tire-kickers, event participants, etc., that go to-and-from WeWork on a daily basis will be driving footfall at the retail stores conveniently located below. That traffic would be a major multiple of the actual ‘WeWorkers’ occupying upstairs.

How does this all help WeWork? The insatiable demand for growth to maintain a $20bn+ valuation is helped dramatically. During their 7-year romp around the world they have saturated favoured markets like London, New York, San Francisco, Boston, and even increasingly Shanghai. But their penetration in Canada has been pretty low. Indeed their first Toronto location just opened in August after a lengthy battle with liquor licensing to enable their free beer taps (I kid you not). Exclusive access to HBC upper floors immediately adds some of the most central, lively locations in the top markets in Canada, including Granville Island, Vancouver; Queen + Yonge Sts, Toronto; and St. Catherine’s Street; Montreal.

I’d think of the deal summary as follows:

WeWork gets:

1. An incredible new flagship building on Fifth Ave, NYC
2. Exclusive access to some of the most centrally located real estate in Canada in internationally recognized micro-locations
3. The addition of multiple relatively important markets in one fell swoop
4. An indirect ownership stake (through its investor, Rhone Capital) in what is probably an undervalued retail/property company

HBC gets:

1. The ability to repay over $1bn in debt (very imporant!)
2. A new deep-pocketed strategic investor
3. Reduced cannibalization/competition for its premier Saks Fifth Avenue store (by diminishing the presence of its Lord & Taylor store around the corner)
4. The expedient addition of Millennial consumers to the attics of its retail portfolio across Canada, Germany, etc.
5. Association with one of the fastest growing Millennial-oriented brands in the world
6. Direct investment to refurbish some pretty tired real estate by a company with its own in house design capabilities that can use data to optimize flows and potentially support the primary retail business at some point

Ok…you’re clearly a booster of this deal. What are the risks?

The new partnership has to get the buildings and refurbishment right. HBC will have to ensure that direct access through and to the stores are incorporated, in a way that doesn’t overburden stores with thru-traffic, but still captures the spend coming to the building every day.

The property folks reading this will note that leasing to co-working carries risk. In an economic downturn, all the start-ups and small businesses that occupy co-working are at risk, and thus the covenant of a co-working provider could be seen as dangerous. This is a discussion for another post (spoiler: I only partially agree), but I will say that it doesn’t feel like there’s a lot of downside here to HBC. WeWork’s inward investment will improve the space. WeWork tends to achieve occupancy day 1 of 70%+ (the Richmond St W location in TO opened >90% full given pent up demand, which is likely consistent with other HBC markets), and they tend to open quickly, so the benefits should arise soon. I’d also note that WeWork are pressing hard into what they call the enterprise market – basically flexible office space, on short lease terms for larger corporates like McKinsey, the Guardian newspaper, Pepsi, etc. that want more interesting space for Millennial staff, with less direct operating involvement. The large floor plates in the HBC buildings will probably accommodate this market nicely, so the Bay gets the right workers in the building, but with far better quality companies bringing them in (and WeWork grows a relatively high margin business for itself).

Finally…zoning. I haven’t read about how this will work, but I’d expect that each of these properties are zoned for retail and not office. It could be that the department stores have zoning flexible enough to incorporate other commercial uses, but that will be stipulated city by city. My expectation is that this is well thought through by the parties, and that the cities will want to see these buildings more productive, supporting businesses in their business districts, but it’s almost certainly a piece of work and delay risk.

Enough out of me…would love your thoughts.

Going forward, I’ll try to provide some more reading for you, for those interested in more of the details:

• Bisnow: “This WeWork Deal Could Breathe New Life into Struggling Departments Stores“, 24 Oct 2017
• Exchange of letters between HBC and it’s activist investor, Land + Buildings
  • HBC 24 Oct 2017
  • Land & Buildings 1 Nov 2017
  • HBC 2 Nov 2017 (response)