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  Hudson's Bay

BENJ GALLANDER and BEN STADELMANN

Monday October 19, 2015

When you invest in the markets over a long period of time, you're going to have some stumbles and disappointments. Sure, you want to limit them in the first place, but the key is not to dwell on them. Sometimes it is worthwhile to re-examine one of those odd ducks as a constructive exercise.

For us, a mallard that quacked on Golden Pond was Hudson's Bay Co.

Mind you, it wasn't a stumble — which has strong overtones of a loss — but a letdown in that we liked the company, imagined being longer-term holders and instead got bought out at a lower-than-anticipated positive return.

It was in January, 2003, when we bought shares in Canada's oldest company at $8.50 a share with an initial sell target of $19.04. Almost three years later, a serious offer was made for the company at $15.25. We tendered our shares and the company went private. The bid was from American Jerry Zucker, the corporation's largest shareholder, of Maple Leaf Heritage Investments. There had been an interesting game of corporate chess between MLHI, Onex Corp. and the private investment firm Cerberus Capital Management, but Mr. Zucker's offer was the only serious one. The return on investment was 79.4 percent plus a healthy dividend, but still we felt cheated. This enterprise, to our way of thinking, was worth more.

At the time we were surprised by the inferiority complex shown by Canada's business elite. There was a lot of pandering to the likes of Wal-Mart Stores Inc. and specialty retailers. Catcalls claimed that department stores such as HBC were dinosaurs and nostalgia counted for nada. Even with HBC losing money and having high debt payments, we noted it had a hidden gem in its real estate. Plus, the credit card business and retail store network could not easily be built from scratch. We thought that with the right marketing, and the unique history and iconic status of the company, this outfit could be turned around into a small fortune. We saw the same value in one of our country's oldest institutions as a guy from South Carolina with a lot of chips on the table.

Mr. Zucker died in 2008 at the relatively tender age of 58, and the company was sold to New York private equity group NRDC Equity Partners. They took the company public again in 2012. This was pivotal in the strategic makeover of HBC into the upscale, fashion-forward, home and accessory specialty retail conglomerate that it is today. Their main competitors are now Holt Renfrew and U.S. player Nordstrom. Zellers is long gone, as are the sports, toys, records, electronics and pet-supply departments. Even the pinball machines placed near the pay phones so your mom could shop in peace have disappeared. Now HBC has banners such as Hudson's Bay, Lord & Taylor, Saks Fifth Avenue, Saks Fifth Avenue OFF 5TH, Home Outfitters and now German department store chain Galeria Kaufhof. By combining these brands, there have been demonstrated cost savings.

But what really has Wall Street, Bay Street and Main Street taking notice are the two real estate joint ventures, with initial public offerings to come. The deals were made with two established REITs: U.S.-based Simon Property Group and RioCan Real Estate Investment Trust. The transactions are valued at $1.8-billion and $2-billion, respectively, and will cut HBC's debt by $1-billion as it contributes real estate in sale and leaseback transactions. This unlocks the value in the properties that we always knew were underappreciated.

It will be interesting to see how all of this financial and retail engineering plays out over the next half-decade or so. There could be tremendous appetite for the IPOs and the market for urban upscale retailers could keep growing, as the world's premier cities become playgrounds for those who have money and like to spend it. As investors with experience in this space, we've seen some clear cycles and noticed how much of retail is about innovation and creating excitement.

HBC is definitely far from the turnaround we spotted in 2003 and not on our menu given our investing criteria. However, we can see how other investors might decide to take a gander at the company.


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