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Turnaround trap: Why it's so hard for companies to change course

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Saturday, June 15, 2019 – Page B1

Richard Baker's back is against the wall. Running out of options to revive Hudson's Bay Co., the real estate mogul has a new plan: Orchestrating a takeover to buy some time.

Eleven years after he took control of the iconic Canadian retailer, and nearly seven years after taking the company public, HBC's return to the market can be pronounced a flop. Buyers of its 2012 initial public offering have lost nearly 40 per cent of their investment. With losses piling up and $2.9billion in debt weighing on the balance sheet (plus some leases), many investors appear to have lost faith in Mr. Baker, who has cycled through a number of senior executives and is currently the company's executive chairman.

All of which helps to explain why Mr. Baker said this week that he is leading a group to take HBC private once again. Public markets, and the quarterly reporting requirements they bring, can be tough on a company trying to pull off a multiyear revamp, especially in an industry that is rife with disruption, as retailing is. A private company, he said, is a better structure for a company that needs "significant time and patient long-term capital" to improve.

The idea has merit. Yet there's also a reality that cannot be ignored: No matter the form of ownership, corporate turnarounds often fail.

Companies in turnaround mode sometimes get traction at first, then slide back.

Consider SNC-Lavalin Group Inc. of Montreal. The engineering and construction giant was in need of an overhaul after getting caught in a bribery and fraud scandal.

Like HBC, its board brought outsider CEOs - first Robert Card, then Neil Bruce - to inject new energy.

As with HBC, the SNC effort was making progress. But over the past nine months it has come apart.

The company failed to secure a deal with the federal government that would allow it to settle criminal charges and its mining and oil-and-gas businesses have run into trouble. SNC-Lavalin's stock now trades at a heavy discount to its net asset value, and this week the company announced that Mr. Bruce was out as CEO, immediately, with an interim boss taking over.

This trajectory is no anomaly. In 2018, Boston Consulting Group released a major study on corporate transformations and revealed a "pattern of frequent failure."

The consultancy also put a figure on the likelihood of turnaround success: 25 per cent.

Why are the results so poor? "It takes too long to act," Lars Faeste, the global leader of BCG's transformation practice, said in an interview.

"The longer you wait, the less likely you are to succeed, the more it's going to cost, and the longer the transformation is going to take," he said.

In business, human foibles often impede rational action. Ego is a major hurdle.

"It's very dangerous for managers to be too proud. ... . It's important to be alert and to start early," Mr. Faeste said. However, that requires accepting radical change is coming in your industry - or admitting failure. (He added that his comments were general, not specifically about HBC.)

The retail industry has been getting disrupted for the better part of a decade as online shopping alters consumer habits.

The industry is also splitting into two distinct segments, with global low-cost, fastfashion brands such as Zara dominating one end of the spectrum, and niche, highend brands holding the other. HBC is loaded with department stores that are trapped in the middle.

To counter HBC's exposure to the Hudson's Bay and Lord & Taylor chains, and to start building his dream retail empire, Mr.

Baker at first focused on acquisitions. This included the purchase of higher-end Saks Fifth Avenue in 2013, followed by a debtfuelled German expansion through the acquisition of the Kaufhof chain.

For the first few years, the strategy seemed to work, and HBC's stock rose from an IPO price of $17 to about $29 by 2015, partly on expectations that Mr. Baker would spin out the company's vast real estate holdings.

But a major deal never materialized, and investors started fixating on the company's debt load and the weak results from the stores. Before Mr. Baker made his privatization plans public on Monday, HBC's shares were trading for $6.37 apiece.

HBC got serious about restructuring in 2017 and made efforts to cut $350-million in annual expenses. The company also started to shrink, reversing the global growth Mr. Baker initiated. A year ago, the company sold Gilt Group, a flash sale fashion site, and in late 2018 much of the German business was unloaded.

This week HBC announced that the other half of its German arm is also being sold, meaning the European expansion is completely over - save for a small operation in Amsterdam.

Proceeds from these sales have been used to repay debt, so the burden is now more manageable. But investors haven't shown HBC much love.

In January, long-time shareholder Ontario Teachers' Pension Plan announced plans to sell its remaining stake in HBC for $9.45 a share. At that price, the pension fund would reportedly lose around $100million on its investment. (Teachers first invested in 2013 by providing US$500-million in equity to help fund the Saks acquisition.) The pension fund declined to comment for this story.

Will a new batch of patient capital help?

It could. But it also isn't the sole answer to HBC's woes.

Across all industries, it has become clear that a turnaround's success is not predicated on one form of ownership over another.

"You can do it in the public market, and you can do it in the private market," said Andrew Dooner, a partner at Strategy&, PwC's global corporate strategy practice.

The more important variable is the will to change, he said. "It comes down to conviction."

HBC has shown some lately. In early 2018, the company hired former CVS executive Helena Foulkes. She has cleaned house, overseeing the European exit, putting Lord & Taylor on the block and shutting the Home Outfitters chain. Her plan is to double down on the historic Hudson's Bay chain and on Saks.

But another human element is crucial to turnaround success, and it is often overlooked, Mr. Dooner said.

"We focus a lot when we're telling stories about transformations, good or bad, on the senior leaders who are shaping and driving the agenda - but often the difference between success and failure is an organization's ability to engage, inspire and mobilize a middle layer of people leaders who are quite often being asked to do some very new and very difficult things," he explained.

It is also hard to know what Mr. Baker has planned if the privatization goes through. He declined to comment for this story. HBC declined to comment as well.

There are some who believe that Mr.

Baker, a real estate developer, will find ways to extract hidden value in the company's properties.

Lately, though, that idea has grown a little stale. The company owns some very valuable real estate, notably the flagship Saks headquarters on Fifth Avenue in New York, which has a net value of $1.2-billion after adjusting for its mortgage. Yet even rating agencies who are intimately familiar with the financials believe the real estate can help only so much.

While the real estate holdings have significant value, "nonetheless, they still need to run a retailer in a very competitive environment," Moody's Investors Service analyst Christina Boni said an interview.

Because HBC still struggles to generate cash flow, its leverage ratio still hovers around eight times EBITDA (earnings before interest, taxes, depreciation and amortization), according to rating agency Standard & Poor's.

While the ratio could fall slightly after the latest European sale closes, rival department store chain Macy's debt amounts to 2.8 times its EBITDA, according to Moody's, because Macy's churns out significant free cash flow. The chain has an investment-grade rating from Moody's at Baa3, while HBC's has a junk credit rating at B3.

To succeed, HBC needs to get revenue growing again.

On Thursday, the company said overall sales slipped 2.1 per cent in the first quarter from the previous year.

There are some encouraging signs, particularly at Saks, the largest chain, whose same-store sales rose 2.4 per cent over the previous year.

In fiscal 2018, same-store sales at Saks also rose 5.3 per cent. But sales for Hudson's Bay stores open a year or more dropped 4.3 per cent in the first quarter, and it's the next-largest division.

Ms. Foulkes has talked candidly about just how many problems she inherited.

Technology is one: the Hudson's Bay's ecommerce site crashed for two hours on Black Friday in 2017.

The chain also was not surveying customers about their experiences. When it started doing so last year, there were complaints about there not being enough sales help in the women's-wear department, which is one of chain's most important.

"In many ways, we were building bright, shiny objects, while the foundation was not in place," she told The Globe and Mail in December.

Ms. Foulkes is highly respected in the retail industry, and she's proved she can halt the empire building that hurt HBC for many years. But her turnaround, if successful, might take years. On Thursday, she said HBC has "more work to do fixing the fundamentals and strengthening operations."

Associated Graphic

Hudson's Bay owns valuable land, but even rating agencies who are intimately familiar with the financials say real estate can help only so much.


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