GLG News by Kenneth Leonard

Implications: This analysis, as is the case with most of my analyzes for GLG News, could properly be classified under several different overly restrictive GLG News "Subjects".  It involves important impacts in "Retailing", "Finance",Stock Market Activity, and Shopping Center Real Estate(which as yet is not a separate category). Instead I chose to label it under the REITs category.  However, whichever category the GLG reader is interested in, the primary import of this article remains the same: ALL RETAILERS ARE NOT CREATED EQUALLY AND RETAILERS ARE NOT COMMODITIES! The author, who should know better but has been previously found guilty of spicing up headlines to increase her readership, treats the closing of a 1000 sq. ft. store in a strip center with the same import as the closing of a 150,000 sq. ft. department store anchor in a regional mall.  Therefore the meaning becomes garbled. I will attempt to clarify. 

Analysis: If Ms. Misonzhnik, the writer of this article, is to be believed, the closing of up to 6500 retail stores, or less than 1% of the total number of existing stores, is a major news story. However those of us who have been around the industry for more than a few years, see it in an entirely different light.

For one thing, most of the store closings that have been announced or that are rumored to be announced before the end of the year, are stores that have been losing money and/or market share for many years. Every single company now being written about, was overdue to go bankrupt at the first slowdown or increase in the cost of money.

For another thing, the article misses the most important impact that some of these store closings will have on large segments of the economy. For example 69 Goody's Family Clothing, Inc. are being eliminated. The impact that these anchor department stores (or in some instances, anchor Junior Department Stores) will have on the regional malls in which they have been operating for many years, will be enormous.  Not only will there be a serious drop in sales for the adjoining specialty stores but the likelihood of finding a replacement anchor anytime in the near future is negligible. 

The closing of these 69 Goody's stores, which is only mentioned in passing, is in my opinion, of far more import than the 200+ Linens 'n Things (most of which were in strip centers or free standing) or 200+ Sharper Image stores combined.

So I say to the astute GLG News reader,"Dear Reader, the sky is not falling. However, let me suggest you should start keeping track of the Mall REITS you may be invested in to watch which of them are most vulnerable to the continued closing of anchor department stores, particularly of the closings promised by Mr. Lampert and Mr. Dillard."

Implications: This article is important for at least three reasons. The first and most important is the "Domino" affect the restructuring or demise of Steve & Barry's will have on most, if not all, Mall REITs. The vast majority of their 270 existing stores are in former anchor stores that, if returned to their former vacant status, would have profound negative impact on the entire "wing" of the regional mall they would be vacating. The second and equally negative monetary impact will be on the bottom line of "inline" specialty retailers who have been depending upon the customer traffic generated by Steve & Barry's as a replacement for the vacant department store anchor. The third impact is the further verification of the "MYTH" of DEPARTMENT STORE REAL ESTATE VALUES". If the SHLD investors needed any additional proof that Messrs. Lampert and Ackman were totally misguided in their claims of between $15 & $20 Billion in real estate value, this is it. 

Analysis: As the article effectively points out "the forces pushing Steve & Barry's growth were not tied to end-consumer demand, but the needs of mall owners in a softening retail real estate market. Much of the company's earnings came in the form of one-time, up-front payments from mall owners. Those payments were designed to lure the retailer to take over vacated department store locations..."

This is a classic case of a "novice" retailer expanding where he can instead of where he should. It is also an excellent case study of how a so called "hot retailer" can lose sight of some of the basic principals of retail expansion. 

As any experienced analyst of the retail scene well knows, there is more to a successful new store than the availability of "free money", very cheap rent  and a bunch of cheap merchandize. Such things as well trained management, well trained supervision, carefully thought out distribution patterns, proven profitability and acceptance of the concept in each new market area, etc., etc. are all of equal or greater importance to the overall profitability of the retailer.

Even the most cursory look at the expansion strategy of any successful retailer reveals that Steve & Barry's was violating every known principal of retail expansion. There is simply not a single successful retailer you could find in business today, that expanded nearly as fast (from a percentage of store growth as well as the spread into new markets) as Steve and Barry's have tried to do. 

It is hard to tell just how much of the blame is to be placed on Steve Shore and/or Barry Prevor, two young guys who started slowly opening discount college apparel stores in 1985 and sold out half their company in 2005 for $170 million to T A Associates, or how much of the blame is to be born by T A. It is also hard to say how much of the blame is due to inexperience as opposed to just plain greed. 

Whatever the reasons or wherever the blame properly rests, the impact of a restructuring or bankruptcy will have repercussions well beyond the universe of Steve & Barry's investors. As the reporters correctly pointed out, mall owners gladly gifted each new store with millions of dollars of "Tenant Allowances" or outright cash gifts to insure that one of their empty anchor stores would again be able to generate customer traffic so that the nearby specialty retailers would continue to pay their rent. 

All of this "Irrational Exuberance" on the part of both landlord and tenant is now coming home to roost.

 

Implications: Sears stores sales down 9.8%, Kmart down 7.1%, and comp stores down 8.6%, all supposedly due to the price of gas and food. Q1:08 EPS -$0.53 v. consensus of +$0.15.   While the interim CEO, Bruce Johnson, blames outside events for the poorer-than-expected showing, he also makes a puzzling comment that he "expects higher EBITDA for the full year". This comment alone will provide fodder for the faith of all the SHLD supporters to hold onto until the next crisis. It will also provide some interesting commentary from observers like me who have questioned the veracity of almost every pronouncement  of Sears management since the merger with Kmart.

Analysis: As this article purports to show, Sears continues their downward slide at an increasingly faster pace.  They have gone from a disastrous 3rd and 4th Quarter of 07 to an even more disastrous 1st Quarter of 08. 

With little to offer except "more of the same" by their interim CEO, were it not for his comment about "higher EBITDA for the full year", it would be reasonable to begin speculating about when they stop circling and start going down the drain.  However, now that Mr. Johnson has made the comment, we simply can not let it go unchallenged or unexamined.

In order to achieve a "higher EBITDA" Mr. Lampert would have to find a way to either add 20% to gross profits or reduce the already skeleton expenses by 14%.

If he is able to pull this off over the next three quarters, even I will become a fan. If not, I see nothing on the horizon except the continued copy cat behavior of their "twin brother", Montgomery Ward!

Implications: This is a perfect example of my often repeated notion that what passes for news in today's 24/7 news-hungry environment is mostly just a rehash of old and obvious observations.   This WSJ reporter obviously was given the assignment to write something newsworthy about the annual shopping center industry's trade show currently being held in Vegas. In a failed attempt to address the various (and often conflicting) concerns that are voiced each year in this (and probably every other industry trade show since time began), this reporter tried to grab attention by crafting a catchy headline. Unfortunately the headline bore no relationship to the recycled information contained in the article.   In an effort to save the GLG News reader some time and effort I will allow my Commentary to summarize the essence of the trade show.

Analysis: For those of you who have not heard the news, the country is in the midst of a recession.  For those of you who do not know what happens in a recession, the WSJ reporter wants to alert you to the news that people spend less money.  He also wants you to know that when they spend less money, the retailers have lower sales and profits. When retailers have less profits they have less money with which to build new stores.

Now that I have summarized the important news in this WSJ article that GLG believed to be newsworthy enough to suggest it needed further analysis, let me point out some issues that a more knowledgable reporter could have turned into a very newsworthy event.

There were three themes that ran through almost every conversation and presentation at this year's ICSC convention.
 
The first was the complaint that cheap, easy money has dried up and now the developers were forced to develop only projects that made economic sense and that retailers really needed and wanted. 

The next theme was that the entire mall industry was worried about some of the major anchor department stores closing underperforming units and what that would do to the rest of the malls affected by the closed stores.

The last was that despite a major PR effort to counteract the obvious decline in attendance and foot traffic on the convention floor, the convention sponsors went to great lengths to create a "cover story" for the press that all was well in the shopping center industry.

There was not one word about the supersaturation of almost every trade area in the country. Not one word about the numerous retailers who have managed to avert bankruptcy for several years by relying upon unrealistically cheap money. Not one word about the need for a major "thinning of the herd" to allow the stronger members a better chance of prosperity. In short, there was not one word uttered by any "official source" about any meaningful topic that will be impacting this very vulnerable industry for years to come. 

Implications: While I realize that the Title is somewhat provocative and the Subject somewhat misleading, both are well deserved.   As my Commentary will show, those analysts who have been following SHLD and singing the praises of Eddie at every opportunity, are finally becoming disenchanted with his efforts. However they continue to blindly repeat their mantra about the stock having an "intrinsic collateral value" based solely upon some uninformed and ludicrous calculation of leased and owned real estate values.

Analysis: As GLG News readers will remember, numerous articles have been written over the past two years that totally debunked the myth of SHLD's real estate values. 

While some of my recent articles have focused on the silliness of ascribing billions of dollars of value to SHLD's leasehold interest in 1200 K-Marts and 300+ Sears stores, it appears that either they have been ignored or totally discounted as the ramblings of a madman.

The same can be said for the 500+ owned Sears stores, most of which are located in regional malls. Several of this writer's articles have clearly focused upon the use restrictions contained in the REAs and the fact that the demand for empty department store space in "B" & "C" level malls is non- existent. There are several other equally important reasons for the lack of meaningful value of department stores in malls but the two mentioned above have been sufficient to persuade any reasonably bright hedge fund analyst. Those I have talked to about this have all agreed but none of the bank analysts seem to understand.

What this latest round of Eddie's baloney tells me is that the love affair with "the next Warren Buffet" is so compelling that it provides a reason for otherwise hard nosed professionals to
overlook what has long been obvious to every experienced real estate professional in the department store or regional mall development business.

Readers of the GLG News who have been convinced of the minimal real estate value of SHLD's portfolio, should congratulate themselves for their due diligence prowess and ability to avoid the cult-like belief system that has blinded so many of their brethren. 

Implications: Eddie Lampert came up with about a half dozen excuses for lousy performance that in 40 years of listening to retailers use excuses about the weather, fashions, the weather, early or late holidays, the weather, and many other tired cliches, I had not heard before. While in this annual meeting he almost sounded as if he knew something about retailing, he spent most of his time backpeddling on comments he had made in previous meetings.   I found it facinating that he seemed to take some comfort in the fact that many of his competitors had added debt to their balance sheets in order to modernize their stores and add new units. Eddie on the other hand was pleased that they would not modernize their stores or take on more debt so that they could "weather any financial storm that comes our way". 

Analysis: By continuing to refuse to upgrade his stores and continuing to look for the "big ideas to put our capital behind" Eddie is at least being consistent.  However with same store sales falling for the past eight quarters and likely to soon fall for the ninth, his reluctance to do more than "look for big ideas" is a bit puzzling.

What is less puzzling but even more bizarre is one of his largest shareholders and former critic, Mr. Ackman, offering only mild criticism of SHLD's lack of transparency and then claiming the stock is "undervalued"! After all this is the same guy who said SHLD's real estate alone is worth $20 billion in collateral value, so he must know what he is talking about.

Between Messrs. Ackman and Lampert, (not exactly the J.C. Penney and Stanley Marcus of retailing) using their best retailing knowledge to try to turn around what some of the best retail minds in America have failed to do in the last ten years, it now appears that we need only wait until after the current recession to see some positive results from all the brilliant work these two great minds have been putting into the turnaround effort.

I do not plan to hold my breath while waiting for the "big ideas" to work their magic.

Implications: Another hedge fund-owned retailer bites the dust! As readers of GLG News know by now, this writer has a thing against retailers using deceptive PR practices to deflect blame from lousey management. This is not a recession related bankruptcy!  In an effort to provide a more realistic context for GLG News readers to interpret this latest retail bankruptcy, and to counteract some of the recent hysteria about how the current recession is devastating the retail world, my commentary will provide a brief historical perspective.

Analysis: Since the dawn of the shopping center age Linens 'n Things (L&T) has been an excellent niche player. They knew their industry and their customer and closely geared their expansion strategy to maximize sales at the lowest possible occupancy cost. For many years their real estate expansion strategy was as well conceived and executed as any national chain store. They relied heavily on opportunistic deals and less expensive strip centers.    

They were highly successful "doing their thing" aided in part by the fact that they had their niche pretty much all to themselves. The few other competitors that came and went were generally more narrowly focused and clearly not of the same caliber as L&T. 

Then along came Bed, Bath & Beyond (BB&B). Not only was BB&B bigger, prettier, more appealing to a broader customer base and taking more prominent and expensive locations, but their management was more energetic and creative while L&T's management was growing old and tired.

By the time BB&B opened their 100th store, knowledgeable industry observers knew L&T's days as the dominant retailer in this category were numbered. To make matters worse, as the result of the phenomenal early success of BB&B combined with the growing housing bubble, Target and Wal-Mart woke up to the opportunity to capitalize on this formerly dreary old category and started expanding their departments.

This combined attack on their market share forced L&T to respond. They decided to "out BB&B BB&B by taking larger, more prominent and far more expensive locations. The Mag Mile store that is being closed and that precipitated the above headline was an excellent example of the major change in direction.

Again, most industry observers quickly recognized this as a desperate and ill-fated reaction to combat BB&B. Within two years after opening the Mag Mile store was quietly being offered for sublease at a steep discount in rent but with no takers.
 
To make matters even worse, in 2006 L&T was acquired by Apollo Management whose record as a turnaround player in the retail field is less than stellar. They may have been inspired by the unbelievable job Eddie Lampert was doing turning around SHLD. Regardless of the reasons all Apollo added to the mix was more debt and management fees which did little to help the ailing L&T.

So now dear reader I hope you have a better perspective in which to understand today's headline about how the current recession is continuing to devastate the retailing industry.

Implications: I think this article is important because it spreads a false sense of what is really happening in the industry. While I realize that many reporters exaggerate their premise to make for more interesting reading, this article crosses the line. In my opinion it is irresponsible to dress up an old hag that has been hanging around for over 40 years and pretend that she is a brand new lady worthy of our attention.  The uninitiated reader or analyst could be easily misled and this article could serve to "add fuel to the fire" of the speculation about the extent of the trouble supposedly surrounding commercial real estate.  

Analysis: If the GLG reader closely examines the reporters own numbers they will immediately see that this lead article in an important trade magazine is badly overstated. For example, the article shows the following list of store closings by year: 
2001---7041
2002---5950
2003---4973
2004---6303
2005---4269
2006---4730
2007---4607
2008---est.5770
So, in fact the store closings estimated for 2008 represents the mean or modal number over the last eight years, hardly anything to write home about!

There are two other significant internal contradictions. The reporter indicates that the increase in store closings "...might force landlords to start lowering rents and offering retailers to stay in place".

In the very next sentence she reports "...retail vacancies will rise 50 basis points in 2008, slowing effective rent growth to 2%"...  Well an increase of 2% is what is expected by all the national retailers and is generally built into leases as the base increase for each option period.  This is hardly a condition that could cause serious panic or dislocation in the commercial real estate sector.

However, I have saved the best quote for last. After four pages of whining and complaining about the terrible conditions in the commercial retail real estate markets, the reporter quotes a well respected national brokerage firm that says "What happens in markets like these is that everyone gets scared, and even if retailers start doing more transactions,THEY WILL DO THEIR DUE DILIGENCE AND ONLY OPEN STORES IN GOOD LOCATIONS"!

Maybe it is a good thing to force retailers to do what they should have been doing all along. Maybe it is a bad thing to be so bloated by low interest and easy money that retailers open stores without doing their necessary due diligence.

Implications: I have (had) many friends working at Sears' Hoffman Estates headquarters,(most now gone) and to the man, (or woman) they have some of the scariest horror stories I have ever heard, about the conditions that prevail under Mr. Lampert's leadership. This latest round of layoffs is just one more indication of how desperate conditions have become. It was revealed in this latest article that the three most important departments required for a successful turnaround, bore the brunt of the layoffs. Operations, Store-Support and Logistics have historically been Sears "neediest" areas. Store management and trade journal writers  have long compared these areas unfavorably to the superior workings of comparable departments at Wal-Mart. Most observers in the Chicago area, many with close ties to Sears or to Sears employees, are unified in their belief that not only has Eddie started cutting into the muscle, but is actually now cutting the bone.

Analysis: Even the most aggressive retail managers know that cost cutting is a game of diminishing returns. It can make you look heroic for a short while but after the first year when the remaining headquarters staffs doing two or three jobs of their fallen coworkers, layoffs start costing far more than the salaries saved. 

I watched the same pattern emerge at Wards when they started "circling the drain".  In fact, the similarities between the desperate behavior of Mr. Lampert and and his exact counterpart, Mr. Brennan, is remarkable.

For those looking for a template of how fast and how steep SHLD's downward spiral is likely to become, I can think of no better "bathroom reading" than to look up the articles about the last two years prior to Ward's demise.

Implications: One of the major reasons for Carrefours success thus far is about to become its biggest lability! By keeping its' occupancy costs low through ownership of many of its' locations, Carrefour has managed to pass along the benefits of below market rents to its' shareholders in the form of increased profits.  Now under the plan of the private equity group called Blue Capital, the rents will rise to "market rates" and the "spread" between the market rate rents and the below-market occupancy costs determined by conservative family management, will go toward a front end payment to the Blue Group and other stock holders at that time. Who wins and who loses from this new arrangement?

Analysis: Whenever a private equity group takes a stake in a retailer with lots of owned property, the temptation to try to monetize the owned real estate and pocket the "profits" looms very large. 

Actually the outcome is really no different than any private equity group taking control of any public company and loading it up with debt. This debt is then siphoned off through "management fees" and "special dividends" and the private equity group then unceremoniously dumps the debt-laden company back on the unsuspecting public. 

The only difference in the case of Carrefour is that due to the amount of owned properties, loading the company up with substantial debt will be easier and faster.

I want to alert the GLG News reader to be aware of this pending transaction so that if they can not get in on the action and enrich themselves very quickly, to avoid any involvement with the company after the debt load has been placed.  It is my firm opinion that any investment made AFTER the Blue group has "raided the coffers"  will be the same as betting on a great racehorse who has been burdened with an unreasonable handicap and yet will be touted to win the big race against Wal-Mart and others who are not so handicapped.

Implications: With extensive anecdotal evidence from retail real estate  brokers around the country who are bemoaning their lack of action, this article attempts to depict what's behind the almost moribund market for retail properties.  As usual, this reporter who frequently writes for one of the industry trade journals, gets it wrong.  Instead of pointing a finger at the true underlying cause of the virtual halt in investment sales, she simply collects and echoes the complaints of brokers who look no further than the last excuse they heard from their prospective buyer or seller.   Consequently the article does little to help the GLG News reader understand what is really going on in the industry.

Analysis: It should be no surprise to regular readers of GLG News that many industry insiders have long believed that there was far too much "dumb money" at unbelievable interest rates, chasing far too few deals. 

The credit crunch has dried up the flood of low interest dumb money and those who took advantage of this "once-in-a-lifetime" flood of money are now having difficulty adjusting to a more normal set of market conditions requiring reasonable amounts of equity, reasonable rates of interest and reasonable rates of return. 

The article does a pretty good job of pointing out that institutional sellers are quicker to realize that they have to expect discounts.  These sellers of class-B and class-C properties are experiencing a rapid increase in cap rates from the unrealistically low 5 to 6% to upwards of 7% on freestanding single tenant properties and over 9% on strip shopping centers in smaller markets.

The problem with the market seems to be that these institutional sellers are the ones who, for the most part, do not have to sell and can comfortably hold onto their overpriced , low return properties till they can decide how best to proceed. It is the private investor, who has trouble meeting their debt obligations and/or planned on a quick refinancing to somehow make sense of the ridiculous prices or exceptionally low cap rates they bargained for, that is the cause of all the moaning and complaining about the lack of a fluid market to bail them out. 

If this sounds similar to the complaints rampant in the single family housing sector, it is because the same rules of basic economics are at work in both arenas.

This writer expects to see many more articles in business publications talk about the mysteries of the disappearance of an orderly market for retail real estate.  Readers of GLG News will be able to congratulate themselves for having seen the "big picture" and will be able to ignore them, secure in the knowledge that they read the real reasons here first. 

Implications: There are two glaring problems with this New York Times Article.   First of all, its' headline is very misleading and designed to stir up controversy, while the body of the article is a well reasoned and evenhanded analysis of a far less disturbing trend. One could almost finish reading this with a positive feeling about the sudden realization of certain lenders that they should think twice about lending lots of money to people that could not pay it back!  Next, while it further verifies what readers of GLG News have been reading about for many weeks; that the real reason behind this wave of bankruptcies has less to do with the current recessionary economy than with the ridiculous levels of debt that these bottom tier retailers have been carrying, it only deals with this issue "in the fine print" at the end of the article.

Analysis: Reading the list of retail companies that have recently filed for bankruptcy and/or reorganization creates the impression that the depression is upon us. Is this alarmist journalism just trying to sell newspapers or is there some basis in reality for its' urgent tone? 

Linens 'n Things, Levitz, Sharper Image, Fortunoff, Lillian Vernon, Harvey Electronics, Bombay, BombayKids, Domain & Wickes reads like a list of impressive retailers who have earned the right to survive were it not for the big, bad, recession.

Not so, says I!

A closer look at every one of these companies shows a sharp decline in operating profits in recent years combined with an equally sharp increase in debt loads.

Even great companies file for bankruptcy when they are saddled with an unreasonable debt loads. One needs look no further than the late 80s and study how Federated Department Stores (now Macy's) was the leading department store organization in the world when it was acquired by an inexperienced Canadian homebuilder with the help of some fee-hungry investment banks. In the blink of an eye they went bankrupt , reorganized and freed from the ridiculous debt loads placed upon it, quickly regained its' position as the worlds best department store group.

If I may be allowed a biblical reference, the natural order of things have frequently experienced "7 good years followed by 7 lean years". We can also look to Darwin to better understand the notion of "survival of the fittest". I submit that this is no more significant an event than the normal and necessary "thinning of the herd". I also want to submit that the herd never needed more thinning than today after it had swollen in size from the constant feeding on cheap money and irresponsible lending practices. 

It happened in the residential sector and it is happening in the retail sector.  Furthermore, I submit that this is a good thing just like in nature where the healthy members of the herd will have a better chance to survive when not burdened by the weak and unhealthy members slowing it down. 

Implications: This WSJ writer and many like him are raising big red flags about the fate of the retail industry. They are seizing upon the rash of retail bankruptcies as either further evidence of the severity of the depression or the tightening of customer purse strings, or both. However, not one business writer I have found is talking about the "elephant in the room". The elephant is simply the fact that every one of the retailers recently declaring bankruptcy have been the target of a buyout by some private Investment Fund who overpaid for a long-troubled company and then promptly loaded the company up with debt to enrich their investors.

Analysis: Linens 'n Things is being singled out as one of the first major retailers to go bust in this economic downturn resulting from the credit crisis. Other less dramatic business writers also mention other recent buyouts such as Wickes, Sharper Image, etc.
However, upon closer examination, none of these recent bankruptcies are really the fault of the current recession.  They (and the several others yet to come) are a product of only two things.
 
Thing one is that they fell victim to stronger competition.  Many have become weak or were never strong, dominant, retailers to begin with. Alternatively (as was the case with Linens 'n Things), they were once reasonably good but became complacent and allowed themselves to be overtaken by newer, better merchants that eventually "done them in".

Thing two is that they were all overburdened with lots of new debt placed upon them by their financially savvy new owners to help pay for the buyout and provide immediate riches to their investors.

The current recession is but a minor cause of their troubles. Any slowdown (or lack of a miraculous sudden sales and profit increase at the hands of the new "merchant genius owners) would have hastened their demise.

Those of you old enough to remember the Federated Department Store debacle of the late 1980s when a Canadian homebuilder managed to convince several fee-hungry investment banks that he was worthy of acquiring FDS, will immediately see the similarity to today's craziness.

FDS was (and remains so today under the Macy name) the preeminent department store group in the world.  Because they avoided debt and were conservative operators who owned most of their hard assets free and clear, they were inviting targets of the overleverage crowd.  They were bought at a huge premium and were immediately burdened by horrendous levels of debt that could only be met by (this twice- committed for "nervous breakdowns" and convicted bigamist )Canadian being able to immediately increase profits by 25%. Naturally he was unable to do this. FDS could not meet its' debt load and went bankrupt within 20 months.

The former management took over and, free from some of their less successful stores, picked up exactly where they left off before being rudely interrupted by the unholy alliance of Canadian homebuilders and New York bankers.

That is exactly what is happening today with many of these retailers. However, most do not have the staying power and successful track record that FDS had prior to the takeover so they will have little choice but to fall by the wayside as they would have done anyway if left to their own devices. 

GLG News readers should not be deceived by the drama and controversy the 24/7 business media tries to create when they think they see a pattern emerging and want to announce it to the world to show how smart they are.  It is simply business as usual in response to too much debt being placed upon weak businesses!

Implications: This article is important because it provides an early impression of what is happening around the country  to vacancy rates,  asking rents and effective rents.  Obviously if true, this limited survey by Reis Inc., could provide an early indicator of a growing problem in the shopping center industry However, based upon my experience in this industry over many years and many economic cycles, I suspect that not only is the information rather shaky, but that it needs much more in the way of careful analysis to be meaningful for use in making investment decisions.

Analysis: Although the article tries hard to impart an aura of credibility by pointing out that this survey supposedly shows a drop in "asking rents"from 0.9 in the first quarter of last year to 0.4 this year and a supposed slowdown in "effective rent increases" from 0.8 last year to only 0.9 this year.

My first instinct is "where the heck do these figures come from?" and "who the heck has the time or money to maintain such a survey accurately"? I suspect our gentle GLG News reader should take these numbers with a large "grain of salt".

First of all I suspect that no effort was made to categorize the surveyed centers by quality of anchor tenant, or age, or condition, average size of vacant space, or competition or anything else that might allow for a better understanding of what is really happening in the industry.

As with many surveys of this type, a few phone calls to some of the larger brokerage firms with retail specialties, constitute all the "due diligence" needed for sending out a press release and trying to get some free publicity.

Retail brokers and leasing agents are notorious for voicing their opinions based upon nothing more than last month's commissions. Rarely do they ever make any distinctions for such important factors as the vacancy rates of these types of centers before the recession took root, and/or how much new competition had to do with the increased vacancy rates of older centers.

Before this minor survey becomes the gospel and starts a whole series of articles in the news-hungry trade and business journals, I would suggest that someone take a careful look at the strip center REIT's and see which of them are reporting higher or lower rents or vacancy rates. My hunch is that the quality REITS will report only very slight differences from past patterns while the REITs owning the lower quality centers such as Centro, will report a continued (and expected) slowdown in results.

Implications: ASistema is the largest Telecom company in Russia and together with its' construction subsidiary, Sistema Hals, (listed on the London Stock Exchange with a first 9 months turnover of $9.6 billion), is making their first ever investment outside of Russia and the CIS. With so much opportunity to make profitable real estate development investments in Russia and the CIS, the question arises as to what is Sistema thinking about going so far afield to get involved in a high risk real estate venture? This analysis will look at some of the possible answers.

Analysis: As a rather recent observer of Sistema and several of its' subsidiaries including Sistema Hals, I have been impressed by how this recently formed company has been able to make so many deals, in so many different industries, in such a short time. Upon closer examination I came to realize that at its' heart it is really just a Telecom company that has managed to acquire enough different companies in enough different industries to become a conglomerate virtually overnight.

It is interesting to note that it justified many of its' investments outside the telecom industry by talking about the possible synergy and benefits these investments would bring to its' telecom business.

All this sounds very familiar. I can recall a recent era in American business when Conglomerates were all the rage. Every new acquisition was hailed by the press as having potential synergy to the main business.

Remember ITT? Remember ITT/Sheraton Hotels? Remember ITT/Sheraton Hotels/Wonder bread?  SAME THING!

I have frequently heard that Russia is considered to be 50 years behind the US in its' business and financial activities.  It would seem this effort by Sistema to be all things to all people in all countries, is further evidence of them embarking on a program of conglomerate building that was discarded almost 50 years ago as being unworkable and unwieldy by some of America's best business minds.

My advice to GLG readers is to be careful!

Implications: With debt of of roughly $17 billion and $3.4 billion in short term debt due to be paid or refinanced by April 30, can even the most ardent suitors expect to be able to do the necessary due diligence to come up with any kind of a rational offer within the next 3 weeks? Alternatively, is this another Bear Sterns $2.00 a-share-type buyout? It is my belief that the outcome of this bidding process will reveal a great deal about whether or not the retail real estate bubble has really burst or if investors have learned anything about valuing troubled and over-leveraged REITs.

Analysis: Citadel Investment Group is the only suitor named thus far . None of the other suitors or values of the bids have been revealed as yet. However it is interesting to try to understand what is going on behind the scene and, even though GLG News readers have pulled in their horns about making new investments, I suspect that there are several clients that consider Centro too tempting a target to pass up.

What we have here is a failure to communicate.

Centro was a very small Australian-based strip center landlord in 1998. Today they are listed as one of the largest landlords of strip centers in the world. While this was happening no one seemed to notice or care that they were growing by first overpaying for mediocre properties and then over-leveraging those properties expecting the real estate and debt bubbles to continue indefinitely.

When they got caught everyone seemed to be amazed that such a thing could happen to such a large REIT in an industry that was supposedly "recession proof". 

I suspect that the same people who bid the price of Centro's shares to $9.10 last year, will be circling the carcass  with thoughts of grabbing a real bargain. I submit that the true value of this company is much closer to the $1.00 level the current market has set than the $9.00 level the over heated retail real estate market set last year.

Implications: As a veteran of 40 years at the highest levels of the corporate retail real estate industry and as a close observer of Circuit City's real estate efforts since their inception, it is my opinion that Mr. Schoonover is simply using the real estate as a coverup for his bad decisions. Mr. Schoonover has said that one of their biggest challenges is that "400 of their 654 stores are too big, outdated, or in suboptimal locations, or all of the above".  He has said some other equally ridiculous things about other parts of his operation but since this writer's credentials are primarily based in real estate, I will leave the merchandizing and financial comments to others. 

Analysis: Let's take a look at each part of Mr. Schoonover's attempt to blame his operational problems and bad decision making on Circuit City's real estate.

First of all he says "the stores are too big". As the CEO of the second largest appliance and electronics retailer in the world, he should be aware of the constant changes in prototypes that both Best Buy and Circuit City (as well as most other retailers of every type) have gone through over the past 25 years.

Most good merchants are clamoring for MORE SPACE and always have ideas about how they could make more money if they just had the room to display more merchandize. Over the years Circuit City's size has varied both up and down with each new technological advance or merchandizing whim. Trust me when I tell you that I have sat in endless meetings listening to merchants argue with the CFO over store size and which departments will stay and which will go.

Next he says they are "outdated". I submit that this is a meaningless term that could be used to mean anything from being in need of a paint job to a complete overhaul.  Either way it is a problem that can easily be solved by increasing the capital expenditure budget.

Finally he says they are in "suboptimal locations". This is probably the silliest remark of the whole bunch.  Circuit City has long held the reputation of having one of the smartest bunch of real estate people in the industry. When the Wurtzel family fan it, Sam's son took particular interest in making sure each new location was the best it could be. The fact that Best Buy has now entered every market that Circuit City formerly had pretty much to themselves and located stores in equally prominent, but obviously newer strip centers, is the real culprit.  

It is also interesting to note that neither the "size" argument or "location" argument are capable of near term solutions so if these are truly the reasons for the sudden drop in profits,  the likelihood of a turnaround within the next 5 to 10 years is highly unlikely. Either Mr. Schoonover is correct in his assessment and the matter is hopeless, or Mr. Wattles is correct in demanding his ouster.

I suspect the latter is the case.

Implications: With eight major investment funds taking very large positions in Circuit City immediately after their highly publicized turn around effort failed badly, things look bleak for the new management and , if the track record of these investment funds are any indication of the type and quality of retail management they provide, even bleaker for the investors in the investment funds. So what is to become of the former innovator and powerhouse that was Circuit City? This was the company that not only  invented the appliance and electronic catagory as a  national chain, but virtually invented the entire concept of "big box Catagory Killers".  Today instead of reaping the benefits of their past innovations and leadership, their very survival is in question.

Analysis: As readers of the GLG News will remember, this writer commented on the incredible incompetence of Circuit City's leadership when they announced they were replacing 3000 of their best (and highest paid) salespeople in order to cut expenses.  It is my firm belief that this action alone accounts for the "modest loss" they just announced while the street was awaiting a promised upturn due to their highly touted turn around plans.

As might be expected, the vultures immediately started circling. Wattles Capital Management, Wellington Management, TCW Group, Maverick Capital, D. E. Shaw, HBK Investments, First Pacific Advisors and Royal Capital Management are all taking larger stakes and starting to actively lobby for an entire new Board and management group.

As a long time friend of the founding Wurtzel family that created the company when it was still known as Wards Appliances in Richmond, Va, I am saddened by how quickly so called "professional management" can ruin a great company by incompetence. It is not that Best Buy has been so  much smarter and better retailers, it is really just plain old lousy management decisions that caused Circuit City's near demise.

I will be watching with interest how well these financial Gurus do in developing a survival plan. One thing for sure, this is one instance where the financial folks can't do worse than the retailers.

Implications: In a rare moment of candor, Henry Kravis, Alan Bond, Hamilton James and David Rubinstein confess at the Super Returns private equity conference, that the private equity market is simply a "proxy for the credit markets".  They also agree that the private equity buyouts are "now recognized as reality triumphing over hope" and are seen to "count for very little". The retail industry was a major target of private equity buyouts and have come to an abrupt halt with the onset of the credit crisis. The big question is whether the buyouts that did occur will end up working out?

Analysis: As reported in several previous GLG analysis by this writer, Several of these highly leveraged buyouts have started to unravel. The largest of which is Sears (SHLD) but the recent bankruptcy of one of my former clients, Wickes Furniture, is another very appropriate example of how silly and out of hand the buyout bubble had become.

As the FT article indicated and Warren Buffet observed, "when the tide goes out we see who has been swimming without their shorts". In 2006 Citibank published a report showing that "returns could exceed even the best historical private equity returns by simply leveraging basic stock market indices by three to one".

Within weeks of that report, the private equity market was AVERAGING a leverage rate of over five to one!

So let us be candid. the deals of recent years are leveraged buyouts.  Simple financial engineering made possible by easy monetary policy and lax credit conditions. The fact that they generated enormous fees for placing a heavy debt burden on troubled companies is, in my opinion shameful.

Private equity should not be just about debt. The folks who have lost their jobs and/or their investments by this "clumsy trick" of financial engineering will hopefully learn that there is no such thing as a free lunch.

Implications: For almost the entire history of JCP's store expansion, they have been recognized in the industry as having one of the most conservative and highly selective programs of any major chain.  Suddenly they are starting to take locations in secondary, troubled strip centers and paying premium prices for the privilege. What is happening? For almost the entire history of Wal-Mart's relocation and superstore expansion program they have been noted for their willingness to dispose of their old properties at near giveaway prices. Suddenly they are hanging on to vacant old stores for two or three years in an attempt to obtain higher prices. What is happening?

Analysis: What I believe is happening is a unique juxtaposition of disparate interests.

This article is further evidence of the rumored increased emphasis JCP is putting on their effort to "hedge their bets" on their mall department store locations. Due to management pressures to meet their goals of a certain number of strip center locations for the year, they are forced to take mediocre locations in distressed centers and pay premium prices to do so on a "fast track" basis.

The article also provides further confirmation of Wal-Mart's new program of not disposing of unwanted real estate until they receive an offer closer to their own appraised value. Part of the reason for this newfound desire to discontinue their "firesale" of unwanted properties, is their success in reducing their inventory of vacant old stores so that now they are more able to handle their disposition program in a more orderly fashion. 

Finally, by mentioning the fact that this is a Simon REIT-owned strip center, and outlining the several other anchor tenants that have left this center for better locations, it confirms my belief that no one is immune from the ravages of time and competition by newer and better located shopping centers.