Strategies for Surviving the Retail Apocalypse

To see how changing consumer habits are disrupting the retail world, you can drop by the Florida Mall, an upscale complex in Orlando owned by mall giant Simon Property Group. A few years back, with traffic declining at its “anchor” department stores, the shopping center converted a Lord & Taylor store into three separate, smaller shops. Then, three years ago, a Nordstrom was repurposed as a Dick’s Sporting Goods after its lease expired, while a former Saks Fifth Avenue became a food court.

Robb Paltz, a structured-finance analyst at Moody’s Investors Service, sees the Orlando complex as a case study in the evolution of shopping. “Department stores do not create the same draw as anchors that they did 10 to 15 years ago,” Paltz wrote in a recent note. And places like the Florida Mall are looking to other retailers to fill the vacuum. It is no secret that brick-and-mortar retail has been struggling. The S&P Retail Select index has been anemic for three years, falling an average of 1% annually. Over 2017 through mid-December, even as total bankruptcies fell 37%, eight big retailers, including Toys “R” Us, filed for Chapter 11, according to BankruptcyData. And despite a holiday shopping season in which spending rose sharply, 2018 could be worse, says Garrick Brown, a retail and real estate analyst at Cushman & Wakefield—with department stores high on many pessimists’ watch lists.

Conventional wisdom depicts this slump as the result of a zero-sum contest between online and in-person shopping, where Amazon and its ilk unstoppably siphon money away from stores. The reality is more nuanced. In-store shopping is hardly disappearing—Forrester Research estimates that 87% of retail sales in 2017 took place in stores. But shoppers are shifting their loyalties, seeking out retailers who can compete for their time with low prices and online options in the era of Jeff Bezos’s “everything store.” Those trends are creating daunting challenges for retailers—but they offer opportunities for investors who take a chance on what are now some very inexpensive stocks.

Just because a retailer is profitable today, however, does not mean it is poised for success. Department stores still produce a tremendous amount of cash, enabling them to endure for “decades as a zombie retailer,” says Bill Dreher, an analyst at Susquehanna. Macy’s, the nation’s largest department store chain, runs that risk. This fall its stock jumped after the chain reported that it had boosted free cash flow 26% through the first nine months of the current fiscal year. But it obtained those results in part by arranging to close about 100 stores—15% of its total fleet—in the face of a long-term sales decline. And Macy’s balance sheet could become the tinder that burns down its clearance racks. The chain has a 27% debt-to-sales ratio, high enough to pose problems if its revenue decline accelerates. Citi analyst Paul Lejuez says the company will likely need to cut its dividend—it currently yields 5.85%—in order to pare down that debt. Industry analysts see a relatively simple formula for identifying survivors: Companies that have low debt, that are growing their omni-channel presence (the term that is used to describe retailers’ ability to serve customers either in-person or online), and that did not expand too fast during the mall boom of the 1990s and 2000s.

By these measures, Seattle-based Nordstrom looks competitive. It is one of the few retailers still growing store count, through its off-price brand Nordstrom Rack, which is helping it reach discount-conscious shoppers. The chain currently has 117 full-size stores and 216 Rack stores. Nordstrom has also aggressively invested in online shopping. E‑commerce now accounts for more than 20% of sales companywide, giving Nordstrom an “opportunity for a future,” says Dreher.

The stumbles of department stores are creating openings for the giants that anchor strip malls. Five years ago, investors were not sure electronics retailer Best Buy would survive. But after cutting prices, beefing up its omni-channel presence, and reducing expenses, it has become an investor darling. Although its growing reliance on e‑commerce has eaten into margins, its stock is up 75% over the past three years. Best Buy offers a good blueprint for other struggling retailers, says Citi analyst Kate McShane. It recently laid out plans to increase revenues 9% over four years—which counts as a robust pace in bricks and mortar.

Target has looked sluggish compared with Walmart, in part because of its slow growth in fresh groceries. But its online sales have risen nearly 30% annually over the past two years. Target has also been focusing on wooing the customers nearby malls lose. It is remodeling stores and building smaller, easily navigable ihops in densely populated neighborhoods, and it has scored wins with in-house brands like kids’ clothing line Cat & Jack. McShane says she is waiting to see store traffic grow at a steady, sustainable pace before buying in, but she sees Target making the right moves for the new retail era. “They’re very focused on being the right omni-channel retailer for their customers,” she says.

Citations

1. http://for.tn/2BUYo5v – Fortune
2. http://bit.ly/2DYCj8g – Barron’s

Casinos Look to New Games to Attract Millennial Gamblers

One of the big dilemmas facing the $70 billion U.S. casino industry is how to get people in their 20s and 30s to play slot machines as much as their parents or grandparents. Generations raised on video games and smartphones do not have the same interest in sitting in front of screens when they are out on the town. In Las Vegas, the percentage of visitors actually gambling is down, while the share going to nightclubs and other attractions is up. The total number of slot machines in Las Vegas is off 23% from its 2001 peak—these machines make up the majority of gambling revenue in the U.S.

That is why Eric Meyerhofer, an electrical engineer who previously ran a company that made ticket printers for slot machines, co-founded Gamblit Gaming, which builds millennial-friendly gambling devices. The products of the Glendale, Calif.-based company look more like arcade games than slot machines and have been out on the floor of big casino operators such as Caesars Entertainment Corp. and MGM Resorts International for almost a year. They have opened a window into what young players like and do not like about gambling, Meyerhofer says. One thing is clear, it is not going to be an easy sell. “This will take years to evolve,” he says.

Skill-based slot machines—some made by Gamblit, others by rival startup GameCo Inc. and established manufacturers such as International Game Technology Plc and Scientific Games Corp.—make up about 500 of the roughly 982,000 gambling devices in the U.S. and Canada, according to market research firm Eilers & Krejcik Gaming LLC. But casino operators say they will add the games because they are luring new customers. “We believe that these are the games of the next generation,” says Rick Hutchins, a senior vice president for slot machine strategy at MGM. While the games require some skill—Gamblit’s Into the Dead, for example, involves seeing how many zombies you can blast—the size of the cash prizes is determined randomly, much like traditional slot machines.

Meyerhofer’s original vision, back in 2010, was to file patents for interactive gambling devices that he could then license to big manufacturers. The idea was to create skill-based slot machines where players could be rewarded in part for their brains and dexterity and not simply by dumb luck. Manufacturers, however, were slow to embrace his ideas. So in 2016, Gamblit started making the machines itself. Employing about 90 people and with revenue of less than $5 million last year, Gamblit is still experimenting. Another early notion was that its games would work best in bars, where young people hang out. Instead, its devices on the casino floor generate three times as much revenue.

One of Gamblit’s signature games is a video poker table where up to four players compete to see who will be the quickest to grab cards that pop up in the center. The devices have proved popular with groups of strangers. “People enjoy it better when they’re playing against people they don’t know,” Meyerhofer says. Couples gravitate to Gamblit’s single-player games, such as Smoothie Blast, where players match fruits to make a smoothie, and Lucky Words, where the goal is to find words hidden on the screen. The games have been so popular with couples that Meyerhofer is adding benches to his devices instead of single seats. Borrowing from a strategy of traditional slot makers, Gamblit has secured the rights to well-known brands. The company later this year will put out machines based on the classic arcade game Pac-Man and the game show Deal or No Deal.

Because Gamblit’s games take longer to play than slot machines, there is a slower turnaround of bets, 45 seconds for Gamblit vs. about six seconds for a typical slot machine. There have been regulatory issues as well. While skill-based games have been approved in gambling markets such as Nevada and New Jersey, regulators nationwide are still catching up. Caesars removed a Gamblit Poker game from its casino near San Diego, for example, because California regulators considered the four-person device four separate slot machines and state rules limit the number of devices some casinos can operate.

Meyerhofer says he is certain regulators will come to better understand the devices. As many as 70% of Gamblit’s customers were not in the casinos’ customer databases before, proving his machines are doing what they are designed to do, he says. “The youthfulness of the player, that was an unknown one year ago today,” he says. “I have no lack of confidence that this is going to work.”

Citations

1. https://bloom.bg/2nejzX9 – BusinessWeek
2. http://bit.ly/2DVJHgC – PokerCentral.com

The Good News Is . . .

• Nonfarm payrolls grew by 200,000 in January and the unemployment rate was 4.1%, while wages saw their biggest jump since the end of the Great Recession, the Bureau of Labor Statistics said. In addition to the solid payroll growth, average hourly earnings were up 0.3% for the month, matching estimates and reflecting an annualized gain of 2.9%. That was the best since mid-2009 as the two-year economic slump was coming to a close. However, the average work week fell two-tenths to 34.3 hours.
• Boeing Co., a global aerospace and commercial aircraft company, reported earnings of $5.18 per share, an increase of 100.0% over year-earlier earnings of $2.59 per share. The firm’s earnings topped the consensus estimate of analysts by $0.17. The company reported revenues of $25.4 billion, an increase of 8.9%. Management cited reflecting record commercial and military aircraft deliveries strong operational performance, and benefits from the recent tax reform act as reasons for its strong revenue and earnings results.
• Keurig Green Mountain announced a takeover of Dr Pepper Snapple Group for $18.7 billion. With the bid—one of the biggest ever for a beverage company—Keurig and its majority owner, JAB Hodings, are betting that they can create a beverage giant with an estimated $11 billion in revenue, and brands such as Keurig’s single-serve coffee pods, Dr Pepper, 7Up and Snapple. The deal is the latest attempt to consolidate in the food and beverage industry, as companies focus on building size and scale. Under the terms of the proposed transaction, Keurig would merge with Dr Pepper Snapple, creating a company called Keurig Dr Pepper. Shareholders in Dr Pepper Snapple would receive a cash dividend of $103.75 per share.

Citations

1. http://bit.ly/2iYbHWM – Bureau of Labor Statistics
2. http://cnb.cx/2lwnm3s – CNBC
3. http://bit.ly/2EAm2n6 – Boeing Co.
4. http://nyti.ms/2GIczL0 – NY Times Dealbook

Planning Tips

Guide to Using a Family LLC for Estate Planning

A limited liability company (LLC) lies somewhere between a corporation and a partnership. A family-owned LLC is a powerful tool for managing your assets and passing them along to your children. You can maintain control over your estate by assigning yourself as the manager of the LLC, while providing significant tax benefits to both yourself and your children. Because estate planning is very complex, and the regulations governing LLCs vary from state to state and evolve over time, always check with a financial advisor before formalizing your LLC plan. You should also work with an estate planning lawyer with experience in tax law to advise you on whether this strategy is right for you.

What is an LLC? – An LLC is a legal entity recognized in all 50 states, although each state has its own regulations governing the formation, running and taxation of the company. Like a corporation, LLC owners (called members) are protected from personal liability in case of debt, lawsuit or other claims, thus protecting personal property such as a home, automobile, personal bank account or investment. Unlike a corporation, LLC members can manage the LLC in whatever fashion they like, and are subject to fewer state regulations and formalities than a corporation. Like a partnership, members of an LLC report the businesses profits and losses on their personal tax return, instead of the LLC itself being taxed as a business entity.

Why Use an LLC for Estate Planning? – You have worked hard to earn your wealth, and you probably want as much as possible to stay in your family once you are gone. Establishing a family LLC with your children allows you to effectively reduce not only the estate taxes your children would be required to pay on their inheritance, it also allows you to distribute that inheritance to your children, during your lifetime, without being impacted as much by gift taxes. All of this while providing the ability to maintain control over your assets. It is a win-win for you and your children. If you are looking to avoid estate taxes, it is important to note that as of 2018, the feared 40% estate tax only takes effect if an individual’s estate is valued over roughly $11 million. Estates worth less than this are considered exempt from the tax. Gift taxes, however, go into effect after $15,000 is transferred in a single year if unmarried (if you are married and each spouse makes a gift, you can jointly give $30,000). This total resets each year, and the taxes are owed by the person giving rather than receiving the amount. This limit applies per recipient. Also keep in mind: If you exceed the $15,000 per year annual gift tax exclusion limit, there is a lifetime cap of $10 million (before taking into account the necessary inflation adjustment). After that, the gift tax becomes 40%. Before you reach the cap, each amount given over the $15,000 limit is deducted from your lifetime cap, bringing you closer to the 40% tax rate. Considering this, the benefits of transferring wealth between family members with the use of an LLC starts to become more appealing.

Control of a Family LLC – In a family LLC, the parents maintain management of the LLC, with children or grandchildren holding shares in the LLC’s assets, yet not having management or voting rights. This allows the parents to buy, sell, trade or distribute the LLC’s assets, while the other members are restricted in their ability to sell their LLC shares, withdraw from the company or transfer their membership in the company. In this way, the parents maintain control over the assets and can protect them from financial decisions made by younger members. Gifts of shares to younger members do come under the gift tax, but with significant tax benefits that allow you to give more, plus lower the value of your estate. Here’s how it works.

Transfer of Assets Using an LLC – After you have established your family LLC according to your state’s legal process, you can begin transferring assets. You then decide on how to translate the market value of those assets into LLC units of value, similar to stock in a corporation. Now you can transfer ownership of your LLC units to your children or grandchildren, as you wish. Here’s where the tax benefits really come into play: If you are the manager of the LLC, and your children are non-managing members, the value of units transferred to them can be discounted quite steeply, often up to 40% of their market value. This discount is based on the fact that without management rights, LLC units become less marketable. Now your offspring can receive an advance on their inheritance, but at a lower tax burden than they otherwise would have had to pay on their personal income taxes, and the overall value of your estate is reduced, resulting in an eventual lower estate tax when you pass away. The ability to discount the value of units transferred to your children also allows you to give them gifts of discounted LLC units, thus going beyond the current $15,000 gift limit without having to pay a gift tax. For example, if you wish to gift one of your children non-management shares of LLC units that are valued at $1,000 each, you can apply a 40% discount to the value (bringing the value of each unit down to $600). Now, instead of transferring 15 shares before having to pay a gift tax, you can transfer 25 shares. In this fashion, you can give significant gifts without gift taxes, all while reducing the value of your estate and lowering the eventual estate tax your heirs will face. Be sure to consult with your advisor before doing this. Some courts have held that gifted assets that are subject to restrictions (like the restrictions on control and transferability that give rise to valuation discounts) disqualify gifts of interests in business entities from the annual gift tax exclusion.

What You Can Transfer Into an LLC – You can transfer just about any asset into an LLC, and then pass those assets along to your children and grandchildren.
Typical assets include:
• Cash – you can transfer money from your personal bank accounts into the LLC, and then distribute it amongst the LLC members.
• Property – you can transfer the title to land and structures built on that land into your LLC. Check with any mortgage holder prior to such a transfer, however, as you might need their approval.
• Personal possessions – you can transfer ownership of automobiles, stocks, precious metals, artwork or other significant belongings into your LLC.

Citations

1. http://bit.ly/2nyiMkz – LawInc.com
2. http://bit.ly/2EbEjZU – LegalNature.com
3. http://bit.ly/2DUyeO5 – Investopedia
4. http://bit.ly/2GDWcz7 – LegalZoom.com
5. http://bit.ly/2E6hsiD – DigitalCommons.com