Adapting to Amazon: Strategies forthe Changing Marketplace

AABANY FALL CONFERENCE:

1982 • Celebrating 35 Years • 2017

2

Contents

Retail Landscape

Valuing Retail Leases

Case Studies

Our Panel

Appendix

Current State of the Industry

Retail Is An Industry In Radical Transition

“Retailers are going bankrupt at a record pace – Department stores, electronics sellers, andclothing shops are most at risk” Bloomberg, April 24, 2017

In a little over three months, 14 chains have announced they will seek court protection, according to an analysis byS&P Global Market Intelligence, almost surpassing all of 2016. Few retail segments have proven immune as discountshoe-sellers, outdoor goods shops, and consumer electronics retailers have all found themselves headed forreorganization.”

https://www.bloomberg.com/news/articles/2017-04-24/retailers-are-going-bankrupt-at-a-record-pace

“Brick-and-Mortar stores are shuttering at a record pace” Wall Street Journal, April 21, 2017

American retailers are closing stores at a record pace this year as they feel the fallout from decades of overbuildingand the rise of online shopping. Just this past week, women’s apparel chain Bebe Stores Inc. said it would close itsremaining 170 shops and sell only online, while teen retailer Rue21 Inc. announced plans to close about 400 of its1,100 locations. There is no reason to believe that this will abate…

https://www.wsj.com/articles/brick-and-mortar-stores-are-shuttering-at-a-record-pace-1492818818

“Is American Retail at a Historic Tipping Point?” NY Times, April 15, 2017

The profound reordering of New York’s shopping scene reflects a broad restructuring in the American retailindustry. E-commerce players, led by the industry giant Amazon, have made it so easy and fast for people to shoponline that traditional retailers, shackled by fading real estate and a culture of selling in stores, are struggling tocompete. This shift has been building gradually for years. But economists, retail workers and real estate investors sayit appears that it has sped up in recent months.

https://www.nytimes.com/2017/04/15/business/retail-industry.html?WT.mc_id=SmartBriefs-Newsletter&WT.mc_ev=click&ad-keywords=smartbriefsnl&_r=0

Retail Bankruptcy Filings on Record Path

Nine retailers have filed in just the first three months of 2017. That equals the number for all of 2016. It also puts the industry onpace for the highest number of bankruptcies since 2009, when 18 retailers filed. See below for examples:

2016 bankruptcy filings:

• Aéropostale - after thirteen consecutive quarters of losses, Aéropostale filed for Chapter 11 bankruptcy on May 4, 2016, with assets of $354million. The company closed 509 of its 739 U.S. store locations.

• Sports Authority – planned to reorganize and close 140 of its 463 store locations but wound up liquidating and closing all of its storelocations.

• American Apparel – in the process of liquidating and closing all 110 store locations.

• Pacific Sunwear – filed for bankruptcy protection in April 2016 and was acquired by Golden Gate Capital after closing approximately 30store locations.

• Hancock Fabrics Inc. - had plans to close 70 of its 250 locations when it filed for bankruptcy protection in February 2016 but wound upliquidating and closing all of its store locations.

First quarter 2017 retail bankruptcy filings:

• Gordmans Stores – liquidation of its 100 stores is being conducted by Tiger and Great American. All stores will likely be closed as part of thebankruptcy filing.

• Gander Mountain – Operated 160 stores; 32 stores immediately closed and liquidated. Closures included stores in Alabama, Georgia, Illinois,Indiana, Minnesota, New York, North Carolina, Tennessee, Texas, West Virginia and Wisconsin. As of 4/28/17, the business is liquidating,with Camping World taking over 17 stores.

• General Wireless Operations (formerly RadioShack) - ongoing

• HHGregg - On March 6, 2017 hhgregg filed for Chapter 11 bankruptcy. The filing followed the decision to close 88 unprofitable locationsoutside of its core markets.[8] Troubles for hhgregg continued and it was announced on April 7, 2017 that it would close all its stores in thecoming months.

• Michigan Sporting Goods Distributors – filed for bankruptcy protection on February 14, 2017; liquidating assets at all 68 stores.

• Eastern Outfitters – purchased by UK company, Sports Direct for $101M. As part of the sale Eastern Outfitters agreed to shutter nearly 50 storelocations in April.

• Wet Seal – closed all of its 171 store locations as part of the bankruptcy filing.

• Limited Stores - closing all 250 of its store locations across the United States as part of the bankruptcy filing.

6

Contents

Retail Landscape

Valuing Retail Leases

Case Studies

Our Panel

Appendix

7

Valuing Retail Leases - Discounted Cash Flow Analysis

• Assuming Contract Rent is less than Market Rent, then DCF of Contract Rentvs Market Rent over term

• How is Market Rent derived?− Internal and external data sources of lease information− Local brokers− Real estate departments of other local tenants

• How is discount rate derived?− Derive the discount rate for valuing the leased-fee interest− Increase the discount rate (lower the value) to account for risk associated

with a lease vs fee-simple interest− Apply further discount to account for market conditions

8

Valuing Retail Leases - Market Condition Adjustments

• Relevant vacancies and market vacancy rates• Relevant new development and new leasing• Co-tenancies in shopping center or surrounding tenants in CBD• Visibility• Signage• Ingress/Egress (turning lanes, traffic lights)• Mass transit• Availability of parking• Demographic trends

9

Valuing Retail Leases - Relevant Lease Provision Adjustments

• Adjust based upon Relevant Lease Provisions (noting Bankruptcyimplications):

− Itemization of occupancy costs (base rent, scheduled rent escalations, percentage rent (amount and breakpoint), CAM, Taxes, Insurance,Merchant’s Association fees, Advertising fees, etc)

− Use Clause− Continuous operations clause− Alterations / Signage− Parking− Kick-out rights− LL recapture rights (premises and/or profits)− Etc.

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Bankruptcy Implications to Valuation of Leases

• To assign a retail lease in Chapter 11, among other things, the assignee must provide “adequateassurance of future performance” (See 11 USC Section 365(b)(1)(C))

• Bankruptcy Courts will disregard the “use” clause when a lease is not in a shopping center.

• Section 365(b)(3) provides, “adequate assurance of future performance of a lease of real property in ashopping center includes adequate assurance—

− (A) of the source of rent and other consideration due under such lease, and in the case of anassignment, that the financial condition and operating performance of the proposed assigneeand its guarantors, if any, shall be similar to the financial condition and operating performanceof the debtor and its guarantors, if any, as of the time the debtor became the lessee under thelease;

− (B) that any percentage rent due under such lease will not decline substantially;− (C) that assumption or assignment of such lease is subject to all the provisions thereof,

including (but not limited to) provisions such as a radius, location, use, or exclusivityprovision, and will not breach any such provision contained in any other lease, financingagreement, or master agreement relating to such shopping center; and

− (D) that assumption or assignment of such lease will not disrupt any tenant mix or balance insuch shopping center. (emphasis added)

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Leases as Collateral

• How perfect a security interest in a lease?

− Record a leasehold mortgage for each lease in the filing office for each county vs DIP Financing Order

− Need leasehold mortgage friendly provisions in the lease:

• Landlord consent to the filing of a leasehold mortgage

• Subordination, non-disturbance and attornment agreement (SNDA)

• Mortgagee right to receive default notices

• Mortgagee right to cure defaults

• Mortgagee right, upon foreclosure of leasehold mortgage, to take over tenancyand not violate continuous operations clause

• Mortgagee right to assign or sublet the premises following a foreclosure of theleasehold mortgage

• Subordination of the landlord’s rights to the tenant’s personal property kepton the leased premises such as FF&E and inventory

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BAPCPA Affect on Leases

Before Reform

• Debtor has sixty (60) days after thebankruptcy filing to make decision as towhether they should assume or reject anunexpired lease.

• The Court could, and often did, extendthis period “for cause,” regularly occurredwhen multiple locations involved.

• No limit to number or length of extensionsthat the Court could grant.

Post Reform

• Debtor has one hundred twenty (120)days from the filing date to determinewhether they are going to assume/rejectan unexpired lease. 11 U.S.C §365(d)(4)(A)(i).

• Ninety (90) day extension available onlyonce for cause unless the landlord agreesto additional extensions. 11 U.S.C §365(d)(4)(B)(i).

• Total limit is two hundred and ten (210)days after filing and the judge has noauthority to grant further time unless thelessor has agreed in writing to anysubsequent extensions. 11 U.S.C §365(d)(4)(B)(ii).

The Bankruptcy Abuse Prevention and Consumer Protection Act of2005 (BAPCPA), enacted April 20, 2005

13

Affect of Code Changes on Lease Sales/Designation Rights

Before Reform andRecession• Unlimited time to make

about lease

• Retailers had the opportunity toextend their restructuringthrough a holiday season todecisions

After Reform and BeforeRecession• Limited time to make decisions

about lease• Retailer might not have the

opportunity to use a holidayseason to determine if theybe a stronger company,The economy was still strong soretailers could utilized storehistory and sale trends as apredictor.

• Chance for restructuring andrecovery

After Reform andRecession• Limited time to make decisions

about lease• Retailer might not have the

opportunity to use a holidayseason to determine if theybe a stronger company.

• Higher chance of liquidation vs.recovery

14

Contents

Retail Landscape

Valuing Retail Leases

Case Studies

Our Panel

Appendix

Lease Restructuring – Blockbuster

Situation Solution Outcome

Blockbuster, a Fortune 500 retailer was theleading provider of home movie and videogame rental stores across the United Statesand 21 other countries.

In 2009, in advance of a substantial bondpayment, Blockbuster initiated a majorrestructuring effort that included reducingits retail occupancy costs.

Blockbuster retained Keen as an outside realestate team to work both independently ofand in coordination with its internal realestate team, thereby preservingBlockbuster’s ongoing relationships with itslandlords and delivering a single clearconcise message about their then situation tothe marketplace.

Keen had direct access to Blockbuster’scomputer systems, which allowed us toview detailed information at the store level,draft store action forms once a tentative dealwas reached and present those deals toBlockbuster for consideration on a weeklybasis. This process allowed Keen tomaintain negotiating momentum withlandlords.

Through multiple projects that continuedthrough mid-2010, Keen renegotiated rentson over 2,500 locations, resulting inoccupancy cost savings of over $73,000,000.

Lease Restructuring – Rotech Healthcare

Situation Solution Outcome

Rotech Healthcare Inc. (ROHI) is anationwide leader in home medicalproducts and equipment headquartered inOrlando, Florida with approximately 450operating centers in 48 states.

The company was saddled with over 500million in debt as a result of its 2002 spinofffrom Integrated Health Services.

Rotech filed Chapter 11 bankruptcyprotection on April 8, 2013.

Keen-Summit approached RotechHealthcare with a proposal to run a rentreduction project.

Once retained, Keen worked closely withRotech’s real estate department and theirrestructuring advisor, AlixPartners toidentify target properties to approach.

The initial project focused on 16 locationsranging from 5,745 to 20,130 square feetwith outsized rental obligations.

The success of the initial rent reductionproject led Rotech to expand the scope of theproject to an additional 53 locations.

Rent concessions were achieved at 13 of theinitial 16 locations (81%) resulting inapproximately $1 million in savings in lessthan 4 weeks.

Successful negotiations were completed on32 of the Round 2 locations (60%),generating an additional $900,000 insavings, once again in a highly compressedtime frame.

17

Contents

Retail Landscape

Valuing Retail Leases

Case Studies

Our Panel

Appendix

Our Panelists – Doug Greenspan / Keen-Summit Capital Partners

Education, Licenses & Certifications• BA (Economics), University of Colorado, Boulder,

Colorado

• MBA (Real Estate and Finance), George WashingtonUniversity – School of Business, Washington, DC

• New York Real Estate Salesperson Licensed

Professional and Industry Experience

Prior to joining Keen-Summit Doug received his BA from theUniversity of Colorado, Boulder and an MBA from GeorgeWashington University. He has published multiple articles in theJournal for Corporate Renewal including the recent article titled,“Downsized Footprints May Help Retailers Adapt to RapidlyChanging Marketplace.”

Client engagements include the sale and disposition of real estateassets in and out of Bankruptcy, and supporting client and marketingactivities by conducting extensive industry and company research.

Representative Clients

Lease Restructuring• Payless Shoes• Blockbuster Inc.• Rotech Healthcare, Inc.

Real Estate Dispositions• Seaboard Realty portfolio• Plaza Continental Shopping Center• Cordillera Golf Club, Inc.

Corporate Finance• Nirvana Water Company• Aziz Gas and Convenience Stores• New Dawn Assisted Living

Keen-Summit Capital Partners handles M&A and real estatetransactions in bankruptcy, workout and restructuring situations.We have likely run more bankruptcy real estate sales and leaserestructuring projects than any firm in the country.

Doug focuses on developing and implementing strategic realestate plans for his clients involving property analysis, acquisitionsand dispositions.

Doug also concentrates his practice on lease-related servicesincluding negotiation, modification and termination of leases, aswell as real estate financing and sale/leaseback services.

• 646.381.9218

Douglas Greenspan• Manager

• dgreenspan@keen-summit.com

Our Panelists – William Hao / Alston & Bird

Representative Experience• Counsel to debtor hospital in its Chapter 11 bankruptcy

proceedings.

• Represents major financial institutions in their capacitiesas RMBS trustees in numerous Chapter 11 bankruptcycases and litigation matters.

• Represents lenders and special servicers in connectionwith distressed commercial real estate matters.

• Represented the official committee of unsecured creditorsin the Chapter 11 cases of MSR Resort Golf Course LLCand Grubb & Ellis Company.

• Represented the official committees of unsecuredcreditors in the health care Chapter 11 cases of St. FrancisHospital, Sound Shore Medical Center, Interfaith MedicalCenter, Saint Vincent Catholic Medical Centers, Our Ladyof Mercy Medical Center, Cabrini Medical Center, VictoryMemorial Hospital, CHA Hawaii LLC (Hawaii MedicalCenter), Forum Health, and North General Hospital.

• Represented international shipping company in its cross-border Chapter 15 ancillary bankruptcy proceeding.

Education• St. John's University (LL.M., 2007)

• St. John's University (J.D., 2005)

• University of Michigan (B.A., 2001)

Admitted to Practice• New York

William HaoSenior Attorney

212.210.9417

william.hao@alston.com

New York | 90 Park Avenue |15th Floor |New York, NY 10016

Litigation | Bankruptcy & FinancialRestructuring

William Hao is a senior attorney in the firm’s Bankruptcy & FinancialRestructuring Group. Mr. Hao is experienced in a wide range of bankruptcy,litigation, and out-of-court restructuring matters. He has representednumerous creditors’ and equity committees in complex Chapter 11 cases in avariety of industries that include healthcare, consumer products, and luxuryhotels and resorts. Mr. Hao has represented secured creditors, trade creditors,lessors and lessees, and other parties-in-interest in all aspects of bankruptcyproceedings such as avoidance actions, claims litigation, and the assumptionand rejection of contracts and leases. Mr. Hao has also advised majorfinancial institutions in their capacities as trustees and master servicers forresidential mortgage-backed securities trusts in connection with Chapter 11proceedings. Additionally, Mr. Hao regularly represents professional servicefirms with respect to bankruptcy retention and fee matters.

Mr. Hao is a member of the American Bankruptcy Institute, the TurnaroundManagement Association, the New York City Bar Association, and theNational Asian Pacific American Bar Association. Mr. Hao is also a co-chairof the Commercial Bankruptcy and Restructuring Committee for the AsianAmerican Bar Association of New York.

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Our Panelists – Jonathan Jung / Innovative Cosmetic Concepts

Jonathan Jung is General Counsel for Innovative Cosmetic Concepts where he is responsible for global legalaffairs including corporate, litigation, intellectual property, labor & employment, regulatory, international trade,advertising, marketing and privacy in the Americas, Europe, Africa, the Middle East and Asia. He provides seniormanagement with effective advice on company strategies and business development, manages daily operation oflegal department and oversees the work of outside counsels. Previously, he was General Counsel for iLuvCreative Technology. Prior to joining iLuv Creative Technology, he practiced in private law firms and worked invarious government agencies. He is a graduate of Binghamton University with dual degrees in History andPhilosophy and a law degree from Georgetown University Law Center. He is the Chair of Intellectual PropertyPractice Group at the Association of Corporate Counsel Greater New York Chapter.

• Jonathan Jung

• Innovative Cosmetic Concepts

• General Counsel

Our Panelists – Teresa Lii / Reorg Research

• Teresa Lii

• Legal Analyst

• Reorg Research

Teresa Lii is a Distressed Debt Legal Analyst at Reorg Research. Prior to joining Reorg

Research, Teresa was an Associate in the Restructuring Group at Kirkland & Ellis LLP. Teresa

received her J.D. at Columbia Law School and her undergraduate degree at Columbia

University, where she majored in biology and history. She is fluent in Mandarin.

Our Panelists – Spencer Ware / AlixPartners

• +1 201 232 3970 (m)

Spencer Ware

• Director

• sware@alixpartners.com

Spencer is a business leader with over 15 years of experience indeveloping comprehensive business solutions in retail restructuringsand reorganizations. As a leader of domestic and international teams,he has represented, and negotiated with, diverse key stakeholdergroups, including corporations, joint ventures, boards, seniorexecutives, and creditors ranging from lenders to suppliers

He is currently a lead on the Gymboree restructuring where he isfocused on liquidity management and the bankruptcy process

He holds a BA in economics from Haverford College and attended theLondon School of Economics. Spencer has served in a number ofindustry and non-profit leadership positions ranging from Haverford'sAlumni President to Global Trustee for the Turnaround ManagementAssociation. He is a frequent speaker and author on the topic ofcorporate restructuring, and was awarded the Future Leader of theYear Award by the New York Institute of Credit

Spencer’s retail experience spans a wide range of clients includingapparel, big box retail, consumer goods, grocery, restaurants, jewelry,luxury apparel, payday lending, and specialty retail

Representative clients include Bob’s Stores, Eastern Mountain Sports,Fairway Market, Freidman's, General Growth Properties, Gymboree,JCP Penny, Krispy Kreme Doughnuts, Staples, and Toys “R” Us

His engagement experience has included:

• Chief Restructuring Officer of Eastern Mountain Sports and Bob’sStores

• Identifying profitability enhancement opportunities by analyzingrevenue and cost at the corp. and customer levels,

• Analyzing store footprints and operationalizing closures, includingrelated lease negotiations, exit planning, and overheadrationalization,

• Developing and implementing strategic business plans andfinancial forecasting tools,

• Assisting with debt refinancings, loan extensions, forbearanceagreements, and other recapitalization efforts,

• Reviewing and re-packaging business plans for lender andstakeholder conversations,

• Developing bottom-up processes and models for forecastingfinancial statements and 13-week cash flows

Relevant Experience

SPENCER'S EXPERTISE COVERS: Restructuring, retail, crisis management, orderly liquidations, strategic planning, businessplanning, liquidity forecasting, contingency planning, & overhead rationalization

AlixPartners

Alston & Bird LLP

Innovative Cosmetic Concepts

Keen-Summit Capital Partners

Reorg Research

Thank You.

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Appendix – Relevant Articles

JA N U A RY 2017

R E TA I L

Closing time: pruning underperforming stores in a competitive retail environment

In early January, we saw a rash of store closure announcements from household names. Macy’s and Sears collectively announced 218 store closures across the United States.1 And The Limited announced it would close all of its 250 US stores, assuring customers that all of its products would still be available online.2

Once taboo, store-closing programs are now becoming more and more popular among retailers struggling in a competitive environment. Brick-and-mortar retail has been under attack for some time, with rising labor

costs and the shift to e-commerce putting heavy pressure on its margins. Yet here in the United States we have more than five times more retail space per person than any country in the world (figure 1), a figure that outgoing Macy’s CEO Terry Lundgren once called “ridiculous.”3

Retailers used to shun talk of store closures because they saw it as a sign of weakness, but they’ve now become far more receptive. Some are integrating store closure programs into their overall strategies by trimming the fat so that they can refocus their efforts on propping up more-profitable storefronts. Even robust brands like Starbucks and Target are regularly pruning underperforming stores. Starbucks has closed almost 500 stores in the past three years, a strategy that has contributed to a stronger remaining portfolio that continues to show increased average ticket size and increased same-store sales.4

1 www.businessinsider.com/store-closures-wreak-havoc-on-shopping-malls-2017-1.2 www.fortune.com/2017/01/08/thelimited-closing.3 www.cnbc.com/2016/08/11/macys-finally-starts-addressing-the-overstored-retail-landscape.html.4 Starbucks 10-Ks.

2 / Closing time: pruning underperforming stores in a competitive retail environment

Identifying which stores to close and determining how deep to cut requires looking at a business through a different lens from the one most retailers use day to day. The usual approaches—like relying on four-wall earnings before interest, taxes, depreciation, and amortization (EBITDA) and other traditional key performance indicators (KPIs)—can leave huge savings on the table and even lead to closing the wrong stores.

Although store-closing programs may no longer be uncharted territory for retailers, they remain a tricky business. Retailers should carefully unpack allocations, accurately quantify reverse cannibalization effects, skillfully forecast trajectories, precisely identify the structural elasticity of support functions, proficiently develop informed lease-negotiation strategies, and correctly segment closure decisions. When building a store-closing program, knowing when to challenge conventional perspectives can be the key to unlocking tremendous value.

Having worked through a number of store closure programs, we have put together some key steps that we will explore below.

G O B E YO N D F O U R-WA L L E B IT D ABefore diving into the steps, let’s first flag a common pitfall: making store closure decisions based purely on four-wall EBITDA. Four-wall EBITDA can be a useful KPI for measuring individual store performance and comparing managers, but retailers shouldn’t rely on this metric to pin down which stores aren’t doing well and should be closed. Instead, breaking down individual store expenses by type and source can help identify which costs truly end with the store’s closure and which are structural costs.

Because the goal is to close only stores whose closures will add value to the overall company, it’s very important to determine which profit-and-loss (P&L) lines are correlated directly to store count and metrics, which are contractually fixed, and which have high or low elasticity. Retailers should keep in mind that many P&L line items that influence a store’s four-wall EBITDA will stay behind in full or in part when that store closes.

Source: International Council of Shopping Centers, Knight Frank Research, General Growth Properties’ September 2016 Investor Presentation

Square feet per capita Retail sales per square foot ($)

FIGURE 1: Retail sales and square feet per capita

US Australia UK France Germany China

$11,687

$8,560 $8,104 $8,056 $7,167

$2,238

–

2,000

4,000

6,000

8,000

10,000

12,000

14,000

–

5

10

15

20

25

30

Retail square feet per capita Retail sales per capita

3 / Closing time: pruning underperforming stores in a competitive retail environment

S T E P 1: S T U DY T H E N E T W O R K E F F E CTIf you’re thinking about store closures, the first step should be to examine the network effect, which means figuring out how a specific store closure would affect sales within a network of similar stores. For that kind of analysis, you’ll have to cast a wide net. Include both your own stores, whose openings could cannibalize your adjacent locations, and competitors’ openings that also detract from your store’s top line.

Your store operation teams should already have on hand weekly sales trend data for the past several years. They can use that information to identify weekly sales impact from a competitive opening or identify the lift from a competitor’s closure. An understanding of those impacts should inform assumptions around reverse cannibalization, or what percentage of sales would be retained in-network if a competitive store closed. In dense markets, especially among specialty retailers, we’ve forecast and experienced as high as 40% sales transfers from closings of nearby stores.

S T E P 2: D I S T I N G U I S H B E T W E E N D I F F E R E NT T Y P E S O F C O S T SThe next step is to separate directly variable costs (DVCs), structurally variable costs (SVCs), market-variable costs (MVCs), and fixed costs.

• DVCs seem simple on the surface. These are costs that should go away if a store gets closed. Yet the trick is to understand when and where allocations may be skewing DVCs and to then determine when you should “re-pack” an allocation. A common example is evenly allocated distribution costs. For instance, a store 1,000 miles from the distribution center is much more expensive to supply, and so, you should reallocate costs such that each store’s distribution charge is more in line with the actual cost to supply it. Such a reallocation would ensure you have more-realistic DVCs when making closure decisions.

• SVCs. These represent the most nuanced part of a store-closing program. They frequently involve corporate support functions like payroll processors, legal support, and accounts payable. Capturing and addressing unallocated SVCs can generate meaningful savings not otherwise in the scope of a store closure program. For instance, if your analysis determines that you should close only 2% or 3% of stores, you’d likely see minimal impact flow through to the SVCs. But in a 10% or more program of

closures, the aforementioned departments could perhaps be reduced by 7% or 8%. Those savings opportunities can be meaningful—or meaningfully overstated if the analysis didn’t factor in elasticity correctly. It’s important to recognize that capturing those savings will require proactive measures that reduce corporate or regional support functions.

• MVCs. The main cost we see with MVCs is the cost of advertising. Eliminating one store in a designated market area serves to only shift that burden to the remaining stores, which could lead you to decide to exit a whole market or to keep certain stores if the marketing burden cannot be eliminated.

• Fixed costs. In general, these are the easiest to isolate. They include contractual obligations such as leases covering a specific store. We revisit these costs later, in step 4 on lease negotiations, because there are even techniques to influence so-called fixed costs.

S T E P 3: S E G M E NT S TO R E S TO TA K E A CT I O N Once you’ve determined a store’s true cash contribution, you’re ready to start making closure decisions. But rather than simply rank-ordering stores and closing the ones below a certain threshold, it’s usually helpful to segment stores.

The main reasons for segmenting have to do with commitment and psychology. Typically, your partners in a closure analysis are teams from store operators and real estate—the very people most personally or emotionally invested in each store. They could have deep relationships with the staff. They might have transferred a manager to the store in question. They might even have chosen the site. The closer these people are to the decision, the more likely they could find one-off excuses to keep certain stores open.

Our rationale for segmentation calls to mind the old adage, “When eating an elephant, take one bite at a time.” In this case, it means big projects and bad news are often best digested in smaller pieces. Retailers should try to gain commitment on segments that are harder to refute, leaving fewer decisions up for debate.

4 / Closing time: pruning underperforming stores in a competitive retail environment

While segmentations never look the same, typically, we develop a matrix with profitability bands along the top and decision or consideration bands along the side. Above is an indicative chart on how this segmentation might occur (figure 2).

S T E P 4: S E E I F L E A S E N E G OT I AT I O N S C O U L D H E L P

Once you’ve identified potential stores to close, it’s always worthwhile to calculate the level of rent reductions a current closure candidate would need if it were to remain open. Between cotenancy provisions and the increased frequency of retail liquidations, tenants are now gaining leverage in the renegotiation of leases, and sophisticated landlords are more willing to offer concessions.

But you should not examine and negotiate each store in total isolation. Instead, group stores by landlord and devise a cohesive negotiation strategy for each landlord. You should also be willing to offer concessions of your own such as offering to extend leases with more-profitable stores so as to obtain lease reductions on your less-competitive stores.

When all is said and done, you also have to be willing to walk away from a lease if your needs cannot be met. The ability to know when to walk away from negotiations and leave a store dark can be a powerful negotiating strategy when seeking concessions.

FIGURE2: STORE SEGMENTATION CHART EXAMPLE

Profitability and return on investment bands Other decision groups

Closure category Gro

up 1

Gro

up 2

Gro

up 3

Gro

up 4

Gro

up 5

Gro

up 6

Gro

up 7

Gro

up 8

Subt

otal

Excl

ude

Clos

ure

appr

oved

Dir

ect o

ppor

tuni

ty

prof

its

mor

e th

an

$150

,000

Tota

l

Store closure segmentation

Discussion categories

Stores for closure

a. Close ASAP 8 18 – 7 1 2 – 5 41 – – – 41

b. Close at lease expiration 9 3 – – 9 1 2 – 24 – – – 24

c. Close at YE 2 – 1 – 8 4 4 – 19 – – – 19

Total 19 21 1 7 18 7 6 5 84 – – – 84

Other categories

d. Marginal – monitor competitors 1 2 3 39 6 4 22 159 236 – – 18 254

e. Lease migration before closure 2 – – – 1 1 – 6 10 – – – 10

f. Market closure decisions 4 – 5 – 4 – 30 15 58 – – 24 82

g. Further analysis required – – – – – – – – – – – – –

Total 26 23 9 46 29 12 58 185 388 – – 42 430

Close or not for discussion

h. Approved for closure (develop plan) – – – – – – – – – – 217 – 217

i. Do not close; remove from list 1 2 1 2 2 3 2 6 19 3 – 10 32

j. No closure category yet – – – 1 – – – 5 6 24 – 2,602 2,632

Total 27 25 10 49 31 15 60 196 413 27 217 2,654 3,311

Note: The data in this segmentation matrix are fictional and for demonstration purposes only

5 / Closing time: pruning underperforming stores in a competitive retail environment

Contact the authors: Holly Etlin and Spencer Ware.

F O R M O R E I N F O R M AT I O N, C O NTA CT: Holly Etlin, Managing Director at hetlin@alixpartners.com or +1 212 297 1594.

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STEP 5: FOCUS ON INVENTORY TRANSFERSWhen thinking about the liquidity impact of these closures, it’s also important to keep in mind how much inventory could be transferred to existing locations or could be liquidated at a steep discount. It may be helpful to review your previous store closures so you can fine-tune your assumptions about which products and how much of your overall inventory are worth transferring. Another technique is the monetizing of excess and obsolete inventory by pushing through going-out-of-business sales at closing locations. That technique can help offset the costs of store closures.

S T E P 6: C O N S I D E R C LO S I N G C O S T S Retailers cannot afford to ignore closing costs, which typically include two to four weeks of rent and labor, with a small offset for liquidation of property, plant, and equipment. It’s important to have a tactical execution plan because each closure requires focused corporate- and store-level resources to help exit the property efficiently. Those teams of resources should lead the transition and hire temporary help if needed. The most important trap to avoid here involves distracting your key operators from focusing on their go-forward business.

Another important part of the execution is the downsizing of centralized support functions, whose savings informed your closure decisions.

We recommend performing additional diligence and developing a tactical plan for more-material or more-suspect savings targets from centralized services to make sure you can realize these savings.

E V E RY T H I N G M U S T G OWe have just walked through a tool kit to use when considering a store closure program. Not all of the things in the tool kit may apply to your company’s situation, and some of them should be explored more fully. And there are also other factors we haven’t fully addressed here such as how to handle oligopolies, understanding market rents and prices, dealing with liquidity concerns, and thinking about whether a potential bankruptcy could enable you to reject leases—or credibly threaten bankruptcy without concessions.

Overall, the key is to ensure that you carefully weigh everything above that applies to your business. As store-closing programs become the new normal, you should challenge conventional thinking, focus resources on more-impactful assumptions, and segment the results, making sure all of your stakeholders are fully on board long before you close the doors.

6/22/2017 Downsized Footprints May Help Retailers Adapt to Rapidly Changing Marketplace | TMA

https://turnaround.org/jcr/2017/06/downsized­footprints­may­help­retailers­adapt­rapidly­changing­marketplace 1/2

By Harold Bordwin, Principal & Doug Greenspan, Manager, Keen-Summit Capital Partners LLC

In 1Q 2017 and into 2Q 2017, news of retail store closures and bankruptcy lings had become commonplace, with no signof abating. Shifting consumer shopping habits and competition from fast-fashion retailers and e-commerce have led to amore competitive marketplace and, in general, decreasing pro t margins for retailers. To survive this market, retailersneed, among other things, an articulated real estate strategy to use their footprint more effectively and to mitigate thecost and distraction of unproductive stores. 

After retail sales in 2009 sustained their largest decline on record and, concomitantly, consumers increased their savingsrate, a May 2010 JCR article pondered whether the prerecession consumer spending highs were sustainable. In fact, theywere: U.S. consumer spending returned in a big way, reaching an all-time high of about $11.66 billion in 4Q 2016.Nevertheless, while overall spending has returned, how and where consumers are spending their dollars has, in fact,changed. 

Online sales account for a larger percentage of consumer spending every year, and the rate of growth is increasing fasterthan many expected. The National Retail Federation recently predicted that online and nonstore sales will grow between 8 and 12 percent in 2017 as compared to a projected growthrate of 3.7 to 4.2 percent for the retail sector as a whole (excluding auto, gas stations, and restaurants).  

As a result of these rapid changes, almost every retail business has too many stores. Historically, retailers were pressured by Wall Street to grow their store bases as a way to increasetop-line revenue growth. Opening new (as compared to good) stores was easy when a retailer nancially incentivized its real estate department and real estate brokers to do so. 

In addition to having too many stores, many retailers are nding that their stores, individually, are too big. Retailers were also historically incentivized to create big box category killersso they could take advantage of economies of scale and complex distribution networks to drive down marginal costs. Examples of this include Barnes and Noble and Borders book stores;Circuit City, Comp USA, and Best Buy electronics retailers; Staples, Of ce Depot, and Of ce Max of ce supply stores; Linens & Things and Bed Bath & Beyond home goods stores; etc. It islikely that this trend has reached the end of its life cycle.

Retailers are reimagining what their retail brick-and-mortar store portfolio should look like and with this, there is a shifting mentality toward doing more with less. One way to increase aretailer’s nancial metrics is to reduce square footage. All things being equal, store performance on a per-square-foot basis increases with a smaller footprint. 

Developing a Plan 

For discussion purposes, the following serves as a hypothetical case to examine some of the challenges a retailer may face and its restructuring options. A specialty retail chain has 200shopping center stores, with an average store size of 6,000 square feet. Its average base rent is $40 per square foot, and average additional rent is $25 per square foot. Average annualstore total occupancy cost is $390,000. The chain’s average store sales are $275 per square foot, or $1.65 million annually. Average occupancy costs as a percentage of sales are 24percent. On a four-wall basis, 40 stores (20 percent) lose money, 120 (60 percent) make less than $50,000 per year, and 40 stores make more than $50,000 per year.

For most specialty retailers, there’s no way to make money when occupancy costs are 24 percent of sales. To improve this ratio, this portfolio of stores needs to grow sales and/ordecrease occupancy costs. For purposes of this hypothetical, it is assumed that the retailer is doing everything that it can to grow sales and is now looking at its occupancy costs.

This set of facts raises the following questions and observations which, as answered, can lead to the development of a restructuring plan: 

How much are the 40 money-losing-stores losing? When do these leases expire? Are there any kick-out rights tied to sales or co-tenancies? Can a lease termination agreement benegotiated for less than the losses? Is money available to pay landlords for lease buyouts? Are these losses signi cant enough to push the company into bankruptcy? Is the tenanton the leases the operating company or are any leases signed by single purpose entities?

What’s the trend for the 120 marginally pro table stores? Can they be stabilized? What’s the growth potential? What would be the impact of negotiated occupancy cost savings?When do these leases expire? Are there any kick-out rights? 

What’s the optimal store layout?

How many stores can physically be demised to the prototype layout, and at what cost? Is there suf cient lease term remaining to amortize the costs of:

demising the space (demising wall, new frontage, split utilities and HVAC, new bathrooms, loading dock access, etc.), and

carrying the space while vacant, paying a brokerage commission, and providing the replacement tenant with a market level of tenant improvements and free rent?What do the leases say about the tenant’s rights to alter the premises, signage, change of use, and percentage rent? What approval rights does the landlord have?

Are there any reasonable store-within-a-store options? What will be the leasehold implications as they relate to signage, percentage rent, use clause, etc.?

When considering store closings, what are the revenue transfer possibilities? What are the impacts on SG&A, advertising budgets, distribution centers, and regional managers?

Downsized Footprints May Help Retailers Adapt to Rapidly Changing Marketplace

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6/22/2017 Downsized Footprints May Help Retailers Adapt to Rapidly Changing Marketplace | TMA

https://turnaround.org/jcr/2017/06/downsized­footprints­may­help­retailers­adapt­rapidly­changing­marketplace 2/2

What is the nancial health of the operating entity? Is it making or losing money? What are the revenue and EBITDA trends? What is the company’s debt burden, and is itsustainable? Are any balloon payments coming due? What if maturities are forthcoming? What covenants are at risk of default? 

What is the nancial health of any entity that guarantees the lease obligations?

What security deposits are in place? How many are letters of credit, and what would be the nancial impact if they were drawn upon?

A real estate advisor can help a retailer ask pertinent questions and, based on the answers, develop and execute a lease restructuring strategy.

Renegotiating Leases

While considering the needs of the tenant, it cannot be forgotten that all lease restructuring strategies (other than closing stores and rejecting leases pursuant to Section 365(d) of theU.S. Bankruptcy Code) require a landlord that is open to negotiations. Landlords are not in the business of reducing rents or of letting tenants out of leases, and they have to account totheir own equity holders and lenders. Thus, a key factor in determining the success of a lease restructuring project is the tenant’s negotiating leverage and messaging.

Whining to a landlord that rent is too high or that the shopping center is not generating suf cient traf c will not persuade a landlord to compromise its position. The single biggestelement of tenant negotiating leverage is the legitimate risk that the retailer will le bankruptcy.

In the context of a bankruptcy threat, the landlord faces the possibility of leases being rejected and being stuck with a vacancy and a capped claim, pursuant to Section 502(b)(6) of theBankruptcy Code, that may be paid at cents on the dollar at the end of the bankruptcy proceeding. Faced with that risk and the costs of rerenting vacant space—down time during thererental process, tenant improvement allowances, brokerage commissions, free rent, etc.—the legitimate risk of bankruptcy frequently is suf cient to convince a landlord that it’s in itsbest interest to negotiate rent concessions and lease terminations.

In addition to using the risk of bankruptcy as negotiating leverage, tenants should undertake a market study to determine whether their rent is at market or above- or below-market.Landlords are much more amenable to taking back space if it’s a strong market with little vacancy and the rent in the lease being terminated is a below-market rent.

Moreover, landlords are very sensitive to co-tenancy clauses, which allow tenants to reduce their rents and/or terminate their leases if certain anchor tenants vacate the shopping centerand/or certain overall occupancy rates are not maintained. When tenants have co-tenancy clauses, landlords are typically more motivated to negotiate lease modi cations to keep atenant in place rather than risk losing the tenant and triggering co-tenancy clauses in other retailers’ leases and experiencing a cascading effect of rent reductions and/or vacancies. 

Without a Chapter 11 or other negotiating leverage, a tenant is in an arm’s-length negotiation in which there is little incentive for a landlord to compromise unless it is getting signi cantprotections. For instance, it is common for a landlord to hold out for a lease extension in return for a rent reduction (also known as “blend and extend”). Where a tenant (without a threatof bankruptcy) is seeking to close a store and terminate a lease, it is common for a landlord to hold out for what it considers to be a risk-free settlement— i.e., payment of all of itsanticipated costs associated with terminating a lease. A skilled real estate advisor may be able to help a retailer avoid such a costly settlement.

Staying Competitive

Given the highly unusual state of today’s marketplace, retailers have what may be a once-in-a-lifetime opportunity not to “let a good crisis go to waste.” Amid this signi cant marketuncertainty, retailers should review their retail store footprints. A real estate advisor can help them understand business trends, identify lagging locations, study leases and markets, anddevelop and implement a strategic lease restructuring plan. Finding ways to create value from a retailers’ store footprint, while mitigating leasehold liabilities, is one of the best ways fora retailer to stay competitive.  

1. See tradingeconomics.com/united-states/consumer-spending (http://tradingeconomics.com/united­states/consumer­spending)2. See digitalcommerce360.com/2017/02/08/online-will-grow-three-times-faster-retail-industry/ (http://digitalcommerce360.com/2017/02/08/online­will­grow­three­times­faster­retail­industry/)

About The Authors

Douglas Greenspan is a manager with Keen-Summit Capital Partners LLC and provides transaction advisory services, as well as marketing and disposition of realestate for healthy and distressed companies. He also focuses on lease-related services, including negotiation, modi cation and termination of leases, real estate

nancing, and sale/leaseback services. Greenspan holds an MBA from George Washington University and a bachelor’s degree from the University of Colorado.

Harold Bordwin is a principal and managing director of Keen-Summit Capital Partners LLC and is responsible for all aspects of Keen’s advisory and transactionalbusiness. With nearly 30 years of real estate and corporate nance experience, he develops and implements strategic real estate and corporate nance plans for hisclients. Bordwin was a recipient of the 2016 Transaction of the Year Award for a Mid-Size Company by TMA Global.