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Retail Newsline: The Urge to Merge

By Garrick Brown, Vice President, Research – West Region

Puppy_Lab-resized-600This past week has been crazy. Tons Puppyof retailer growth news… not a big surprise. ICSC San Diego was last week and we see a spike in store announcements typically around the time of the big conferences. But it was a big news week as well.

The biggest news of the past week was that the Fed didn’t raise interest rates. This really didn’t take anyone by surprise considering the recent market volatility. That’s not to say I actually think it would be a big deal were they to raise rates. The economy can take it. In fact it could have taken it on September 17th and it probably could have taken it a couple of months ago. We are, after all, talking about just a .25% bump here. However, while the underlying fundamentals of the economy could take it there is the chance that investors couldn’t. No doubt that when the Fed does tick rates up, we will see some erratic behavior on Wall Street. Actually, erratic behavior on Wall Street is something of a given. But there is always that chance that an overreaction builds momentum and then spins into something out of control. I don’t even think that would have happened had they raised rates last week. In fact there is a school of thought that if they just got it over with, the markets would calm down to a certain degree… after all certainty is what the market wants. Of course, that is kind of like finding out you have cancer and then hoping the doctor tells you it is terminal because at least then you know exactly what you are in for.

OK, maybe that’s a bad example. I don’t see interest rate hikes as being anything that scary. But the fact is that the Fed’s credibility is at stake with this next hike. So they just can’t risk being wrong and they can’t make any move that they might have to go back and correct. Since they stated a target inflation goal of 2.0% and inflation is currently near zero… well, they have an out. And they took it. And even though there has been some chatter from the St. Louis Fed President that October hikes aren’t off the table, it is just that… chatter.

Now if we have a solid holiday sales season in the works come December could we see hikes then? You bet. Next week I will be sharing with you my annual holiday sales season forecast but either way if interest rate hikes are keeping you up at night I think you might be stressing out over the wrong things.

ICSC San Diego was great this year. I’ve gotten conflicting numbers from different sources but attendance was at least 4,000 people and may have hit 5,000. And then I know a couple of cheapskates that just set up shop across the street so the impact of that conference goes beyond who actually shows up in the convention center hall.

We have an updated “Who is Doing What” update this week. Click here to check it out. Actually I am working through about 80 pages of notes still and that section of the Newsline is going to be pretty full for the next few weeks.

But like I said, this past week had a slew of news. You’ve got plenty of reading ahead of you with this week’s issue of the Newsline. But before I let you go, I want to share with you what I think might be the most important story of the week… at least in terms of bricks and mortar retail real estate.

News broke last week that Petco and PetSmart may be in the early stages of merger talks.

Marketwatch ran with a story yesterday as to why such a merger might not work; A PetSmart-Petco merger might not add up. The takeaway from that piece is that many analysts believe that such a move might not result in a new super “PetSmartCo” in which the whole was greater than the sum of its parts. The case against the merger is that the new entity would have a huge amount of debt and it wouldn’t solve some of the problems that each retailer individually faces. For one, such a merger might mean that PetSmart (who many analysts believe needs to improve its e-commerce platform) may get diverted from improving its e-commerce platform (something many analysts believe is critical) as it goes through a complicated merger process. Meanwhile, the synergies it would create might be limited. Petco generally has higher pricing than PetSmart and a slightly different consumer experience. In this case, a merger might cause confusion with branding for the chain.

And the deal would also have to hold up to FTC scrutiny and many analysts believe a merger would have a 50% chance of not being approved.

But that also means that such a deal would have a 50% chance of going through. I personally think it would sail through. It might hit some slight snag like the Family Dollar/Dollar Tree merger. If you remember, back in July they were told they needed to sell off 330 Family Dollar stores to make it happen. Guess what? Against a combined store count of roughly 22,000 stores… that’s nothing. That’s basically the FTC saying, “We don’t see any potential monopoly issues here as long as you divest yourself of a paltry 1.5% of your store base.” So what’s that tell you? It tells you that if your favorite pet supply companies have the urge to merge, the FTC isn’t likely to spray them with a garden hose. They’re not going to step in unless there is a clear argument of a competitive monopoly and even combined, the new entity would still account for less than 30% of the pet supplies marketplace.

But one thing is for certain; such a move would result in store closures and probably a lot of them. As of the close of Q2, Petco operated just over 1,400 stores throughout the US and Mexico. The average size of a Petco store is about 13,500 SF. PetSmart has about 1,300 stores. The average size of a PetSmart store is about 10,000 SF. But in the US, 50% of all Petco stores are within a three-mile radius of at least one PetSmart. If you expand that radius to five miles that number increases to 72%. That basically means as many as 1,000 stores between the two chains might potentially be viewed as redundant within any given trade area.

I don’t think we will see 1,000 closures if a merger happens. But let’s throw out a conservative number of 500 stores. It is entirely possible, if not likely, that a new “PetSmartCo” may seek to close underperformers, redundancies and locations that are cannibalizing each other and that we could see 500 closures most likely over the course of a few years. I would assume most of this would be done by simply not renewing leases as they expire so the hit to the marketplace would be staggered. But keep in mind that depending upon the stores being closed, 500 locations would translate into anywhere from 5 million to 6.75 million SF of space being returned to the marketplace.

Now this deal is far from done and who knows if it will even happen. But something landlords, investors and market players in general need to keep in mind is that we are at a point in the economic cycle where we are going to see increased merger and acquisition activity all around us… at least until the next downturn. And in most cases that means space being returned to the marketplace at least during the first phase of a merger. The good news is there is a pretty decent well of tenants working in that size range and looking to grow. Additionally, both Petco and PetSmart typically are in marketable real estate. But that doesn’t mean that such a move won’t cause some pain, especially with new construction levels rapidly escalating and new projects soaking up an awful lot of the demand that is out there. There is a good supply of tenants out there but not a great one.

This post is commentary from the latest weekly edition of our Cushman & Wakefield Retail Newsline, which you can subscribe to for free by e-mailing garrick.brown@cushwake.com.

garrick-brownGarrick joined Cushman & Wakefield (formerly DTZ / Cassidy Turley) in October 2010. He serves as Vice President of Retail Research for the Americas. He speaks frequently at industry events and has been a keynote speaker at symposiums, conferences and market forecasting events for groups like the Appraisal Institute, Urban Land Institute, CREW, ICSC and PRSM. He is also a member of Lambda Alpha International, an invitation-only land use society for those who are involved in the ownership, management, regulation and conservation of land, but also those who are involved in its development, redevelopment and preservation.

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