Why I think Nordstrom Should Go Private / Or Is a Buy

I have never held a position in this company. But I first started researching the company on a very adhoc basis during my time in Chicago between 2016 and 2018 when I was bored out of my mind during free time at business school, and comparing and contrasting it with other departmental stores around the area (Ross, Macys, TJ Maxx, Neiman Marcus etc.). Nothing came out of it. I remember reading though that Leonard Green had tried taking the company private but couldn't agree on a price with the management, so that had given me the impression a de-listing was something that management would be open to.  

I cannot recall exactly what was the catalyst now, but Nordstrom suffered a price-drop around August 2019, and frankly it doesn't seem as if it has stock has recovered since then. While preparing for some private equity interviews, I decided to do some further research on this company and see it made sense for it to go private now. Again, my thesis that I am about to share was based on what I thought was going in the world around then, and I haven't updated it since then. But the company is still very undervalued IMO, and here is why I think it would be a buy: 

  1. As much as people love to bark about e-commerce being the next in-thing and eventually taking market share from brick-and-motor stores, having physical presence will ALWAYS remain relevant. It helps lead to lower customer acquisition costs. Think about how many companies started as pure ecom players, and eventually transitioned to having a brick and motor presence: Casper; Warby Parker; and Amazon (via acquisition of Whole Foods and setting up stores otherwise). Also, people want to go in-store and check something out before they eventually buy -- this really holds true for relatively high-value merchandise. I Am Really Not in that Camp, as I know my size and know what I want, but folks love window-shopping.  

  2. Most of Nordstrom's outlets are located in high quality malls that experience good foot traffic and will remain relevant. Millennials might not enjoy it so much, but families love going to malls. It's a field day out. And Nordstrom, if you compared it pre-2020 with its comps, had industry-leading productivity measures (evident by its revenue / square feet).  

  3. If you've ever been to a TJ Maxx store, you'll notice how awesome their supply chain management is and their ability to provide customers with the goods they're looking for. Nordstrom is/was differentiated in that through its Rack business line that I felt would be driving bulk of the growth going forward for the company. It's e-commerce sales (as a % of total sales) had already been on the higher end vs. comps, but frankly, I really couldn't care less, because having a strong digital presence is so table-stakes right now that it's just a must-to-have rather than a true differentiator. However, none of these other off-price retailers have a full-price store

  4. There were clear levers to improve the business even more, which would have made it attractive to a private equity player, because I had felt that the stupid market wasn't giving the business enough credit for its growth prospects and its "moat". These levers had included: expanding into emerging markets, which weren't as oversaturated as the US (in terms of retail space per capita) and thus had higher margins; culling unprofitable locations that weren't still as bad as some of the others (for instance walking into Macys in downtown Chicago would make you realize how horrendous the store was in so many ways, including customer experience and the depth of inventory), and maybe putting an end to initiatives like Nordstrom Local, which I had felt was a waste of real estate, because people could just go to the store and check it out/do pick-ups. I am not sure if these initiatives are in-place at other JWN locations in the US, but for instance here in Toronto, more recently, I feel that Barverde and Habitant are really not too value-additive (the staff says occupancy is low because of the pandemic, but there's no need IMO for them as there are usually enough restaurants/dining areas in the mall itself for families to go to and enjoy themselves, while these seem like pretty excluded areas with high cheque sizes (if I am already paying on average $100 at your store, why would I want to spend another $100 or something for food); I cannot remember now if Barverde and Habitant were around in Chicago). Obviously, the more important one would be expanding the range of your partnerships/brands and trying to go as exclusive as you can (exclusivity is awesome!)....Also, in case shit ever hit the fan, since Nordstrom was an anchor tenant in most of its malls, it would have had reasonable leverage to negotiate/cancel/amend leases..

And so that I would say was the crux of it all. I remember when the pandemic hit around Feb 2020 and nobody had any idea how long this entire shit would last, with retail and all being shut down, I felt that this would obviously have impacted the business even more, and the market might punish Nordstrom (which it did), so the management should seriously consider taking the company private (rather than waste time with silly analysts and be explaining stuff quarter to quarter), but I am shocked that they never did. 2 years on, we're still at the same level, and it immensely puzzles me that how can a company so good be so cheap. This to me just indicates that the markets aren't efficient and take a more short-term view on things/companies that don't fit their expectations of being high-growth (Think Tech and All)...How the fuck are companies like AMC and GameStop trading at such high levels just points to cracks in the system. That's it. 

Comments (16)

  • Intern in IB - Gen
Mar 20, 2022 - 12:32pm

Great write up. As a college student, really cool to see some quality discussions/pitches on this site lately.

  • Prospect in RE - Comm
Mar 21, 2022 - 10:36pm

^ agreed. It is great to see something not along the lines of "how do I talk to a girl" or "help I'm sleeping with my MD's daughter what do I do"

Mar 20, 2022 - 7:34pm
Frybird101, what's your opinion? Comment below:

Makes sense. Always gotta play devils advocate tho- what do you think the top three risks to your thesis would be?

Haven't looked into it but maybe rates rising may crimp their profits or something.

  • Investment Analyst in HF - Other
Mar 20, 2022 - 8:20pm

1. Store / region concentration
2. Brand Concentration 
3. Something to do with cybersecurity given rising e-com sales and so they have personal details of customers on account
Macro-events (recessions and all) obviously impact stuff / consumer purchasing patters (retail spending is a deferrable expense) but that's where the rack business line comes in play. TJ Maxx and Ross, I think, have been relatively recession-resilient 
 

Mar 20, 2022 - 9:18pm
Frybird101, what's your opinion? Comment below:

I don't know how relevant those risks are though.

1&2 - they have like 100 stores listed on their website and hundreds of brands. I may be misunderstanding what you meant by these two points tho.

3- that's definitely a risk that management faces but it's more of a general risk that any company with online operations faces, not one specific to Nordstrom or their sub-industry. I think from my portfolio management classes that means it's a firm-specific risk (terminology may be wrong) and you'd just want to be diversified.

One risk may be the Nordstrom rack performing slower than comps. and diluting the brand name if they invest too heavily. They seem to have a strong position operating at the high end and the cheap end. From a quick look at their financials, it seems if they can hit 2018/2019 avg NI levels, even if the PE drops from 25 rn to 15 it'll be worth like ~75% more. maybe look into the 2021 figures to see why NI was so low.

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Mar 20, 2022 - 10:44pm
m_1, what's your opinion? Comment below:

To your first first point...

Apparel is one category where having a physical presence is hugely beneficial because returns rates on DTC purchases in apparel are nuts. For most of the niche brands popping up, they'll never be able to justify physical stores themselves outside of a few large metros.

The return issue thing used to be less of a problem when CAC was insanely low, but now that CAC is $25 - $40...DTC margin is not really better than traditional retail.

Assumption is that most of them will only be able reach scale + profitability via retail and Nordstrom is "the" retailer to be selling through. Nobody comes close if you're an apparel brand.

  • Investment Analyst in HF - Other
Mar 20, 2022 - 11:07pm

Maybe I should have expanded on the first point, but anyways...

Yes I agree that having physical presence is hugely beneficial in Apparel, but I wouldn't say it's a function of the return rates. As I pointed out to the previous commentator, return rates are an action, not a cause. Causes are that people like trying apparel (esp if it's reasonably expensive, maybe a ticket size of $30 or above) in-person before they buy it, hence having physical presence becomes important to facilitate that. On the contrary, if you order something cheap from an online-platform, let's say, Amazon, for $2-5 (hypothetical example for the sake of one), you wouldn't really care too much if your order got screwed up. Yes, it would suck, but you might not be inclined to go through the hassle of returning it. Maybe that's just me, but that's how I think. I don't spend my time chasing pennies. 

For niche brands, it doesn't make sense to justify physical presence in the beginning when they lack any significant brand awareness, so better to be selling stuff through Amazon. (not even sure if there's an alternative to Amazon, maybe there is, but if it's not the first or second thing that comes to your head, it implies it's not really relevant), but beyond a certain point, once you've attracted a high enough user / cult following (meaning your CAC is trending down), you are better off either going to a  departmental store or DTC. DTC will only make sense once your LTV significantly exceeds the CAC, which in the case of selling through departmental stores represent "shelf-placement" costs. Most firms obviously have a hybrid approach (for instance Nike). Hope that makes sense

Most Helpful
Mar 21, 2022 - 12:20am
m_1, what's your opinion? Comment below:

I was agreeing with you but I think you misunderstood my post. To be fair, I did a shitty job in my first post. :)

Distilled:

1. Pre-2018, the attitude among DTC brands was that nobody really needs retail as DTC margin > b2b. Sentiment was that more brands running at scale and those not running at scale but growing would not utilize retail. Like what we saw with Footlocker.

2. Turns out Bonobos, Warby Parker and the other OGs needed physical retail to be profitable. Ad costs exploded after IOS14 + big brands jumping into digital post-COVID. 

3. DTC margin is not better than selling via b2b for brands. Therefore, they are more willing to work with retail. Lots of successful apparel brands running at scale used to tell retail "no" before. Now it's "yes please".

---

BTW no "brand" is really moving volume on Amazon. Not a good comp vs on-site for mid/high end brands. It's a rank & bank game but anything heavily branded is not. You would never try to push anything you find in Nordstrom on Amazon. You might use it to capture existing search intent, but not generate new demand. That is somewhat changing with AMS ad inventory/placements opening up, but still pretty rough for high end apparel IMO. 

The best comp is owned sites VS retail.

For color, back in the day ~2016 - 2018, digital CPA was maybe $5 - $10. Now it's $25+ where $25 is considered very good. You can see this all reflected in FB being annihilated by Apple's IOS14.5 update. There's no way digital CPM drops anytime soon either, especially now that a whole generation of marketers and entrepreneurs have an addiction to it. My friends brands running at scale and our own brands are now triaging retail > DTC because we're sick of volatility and ever-increasing CPM.

To give you an idea of how expensive CPM is. It's now cheaper for me to send you a catalog or postcard than to buy a click!

Mar 22, 2022 - 2:05pm
Luxo, what's your opinion? Comment below:

Former C&R banker here (actually worked in this situation back in late 2017).

Interesting thesis. My thoughts on what would likely happen if somebody tried to take JWN private below - still pretty much what happened back then.

  • It is extremely unlikely that the BoD would accept an offer at market, and given they were trading at ~$40.00 pre-pandemic, methinks that's your consideration per share floor; otherwise the board would not consider your offer
  • At that price level, you'd have to buy ~164mm shares on a fully-diluted basis, so you'd have to pay ~$6.6 billion for JWN's equity with an implied TEV of ~$9.1 billion
  • Now, to consider how much debt you can slap on the business to make for an attractive LBO, you have to consider ~$1.4 billion of capitalized lease liabilities that will just sit there and you cannot refinance (retail companies usually look at leverage as Debt / EBITDAR, inclusive of capital leases, and since IFRS 16 you can capitalize operating leases - so JWN looks at debt on a fully-loaded basis {see their 10-K})
  • Just for the sake of argument, let's assume you can bring leverage up to ~5.0x EBITDAR (which for retail might be a serious stretch; at least it was back in my day covering C&R) - that implies you have ~$5.3 billion in debt available between say, a Term Loan and Bonds.
    • Banks could maybe be willing to finance ~$1.0 billion of that (at a hefty rate, or lend significantly less), so you'd need to place ~$4.3 billion of retail notes in the market pretty much at par
  • Assuming you're able to place that much debt, you'd need to write an equity check of ~$2.4 billion, of which the Nordstrom family could roll ~$1.3 billion into the private company and so the sponsor would contribute ~$1.1
    • Not a problem at this valuation level, but worth noting that the family would most definitely NOT give control of the company to a sponsor, so that sets a limit to how much equity a sponsor could contribute
  • In conclusion (and I guess TLDR), it'd be hard to place that much retail debt in the market, and given you have an equity cap there's only so much you can pay to take JWN private
    • Back when LGP and the Nordstrom family tried to LBO the company, the need for bonds was ~$5.0+ billion and there was just no appetite in the market for near-par retail bonds when other peers were trading at a deep discount
    • At the same time LGP could not just cover the gap to a more hefty valuation because the family did not want to give out control
    • The above set a very hard limit to what LGP and the family could offer
    • At the end the BoD rejected the offer because it was low and not in the best interest of shareholders
  • Investment Analyst in HF - Other
Mar 22, 2022 - 3:29pm

Not really responding to anything you wrote, but commenting generally here. There obviously would have needed to be a significant enough premium to the share price around Aug - Oct 2019 level to make the offer worth considering for the BoD / Management, but at the beginning of the pandemic (with all media reporting doom day type scenario for the next foreseeable months, hence the market being hard on otherwise good businesses) it could have made sense for JWN management to explore this , as nobody wasn't sure how long would this situation last. That's what I was thinking back then. And had actually analyzed this situation from a LBO perspective. 
From a debt perspective, could have levered it up to 3x EBITDA, which is how I'd done it, and as I looked back at the presentation, it implied ~5BN of debt over the 2019 Q2/Q3 LTM EBITDA. I was being conservative with my debt capacity, growth assumptions, and exit multiples...Seemed like a home run to me if someone did executive it. The debt profile would have been on the lower end of what CPPIB and Ares did with their portco (Neiman Marcus) that spectacularly blew up. I think there the problem with Neiman Marcus was just the aggressive capital structure -- maybe when you were working on this JWN / Leonard Green transaction in 2017, that Neiman Marcus spectacle was fresh enough in the participants' mind, because of which you or whichever bank worked on this was going to have a hard time placing the debt   

Mar 23, 2022 - 10:46am
Luxo, what's your opinion? Comment below:

On your debt point, sure - quantum sounds about right, but multiple feels pretty low. We also worked on Neiman's big mess, and yes that's one of the reasons why investors weren't receptive to that much JWN debt trading at par.

You still have the equity cap from the family not wanting to give out control - that's probably the main problem as it's a permanent issue. 

Mar 22, 2022 - 8:46pm
resistance23, what's your opinion? Comment below:

I know that Hudson's Bay has been performing pretty poorly for the last few years, even well before the pandemic. Nordstrom is a pretty similar business, do you think they've somehow avoided the issues plaguing HBC?

  • Investment Analyst in HF - Other
Mar 22, 2022 - 10:51pm

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