Merging Interests

Karstadt owner’s gamble

Kaufhof will Karstadt übernehmen
Stronger together, or simply waiting to die? Source: DPA.

If there is one thing to be said for René Benko, the Austrian investor and owner of Karstadt, it is that he is truly persistent. He has failed twice and remains undaunted. After unsuccessful bids in 2011 and 2015, he is now making a third bid for the department store chain Galeria Kaufhof, and is reportedly willing to pay around €3 billion ($3.5 billion) for the company. Real estate makes up the overwhelming majority of the company’s valuation and Mr. Benko is likely to view the business operations as dead weight that he is forced to acquire as part of the deal.

At first glance, the deal makes sense. After a takeover, the investor could merge Galeria Kaufhof with Karstadt, which he owns through his company Signa Holding. This would finally make Deutsche Warenhaus AG, which has been the subject of industry speculation for years, a reality. If Mr. Benko merged the management of the two companies, he would likely reorganize in order to increase efficiency and there would be significant advantages in areas like purchasing and IT. The merger would also eliminate a direct competitor.

But does a merger of Karstadt and Kaufhof really solve the fundamental problems facing the two department store chains? In many ways, the plan has the feel of two sick patients lying down in one bed, hoping to recover together. Retail businesses face such deep-seated challenges that a merger of two essentially medium-sized players is most likely not a solution.

Both Karstadt and Galeria Kaufhof have significantly more retail space than they can manage profitably. And like the entire industry, they face the predicament that sales are increasingly shifting to online shops. At the same time, the construction of new shopping malls is increasing rather than decreasing total retail space; this problem is even more pronounced among department stores. Experts estimate that of the approximately 180 stores the two companies operate, no more than about 120 are viable in the long term.

Shopping at Karstadt or Kaufhof is about as attractive for young customers as going to the dentist.

A merger would not change anything in this respect. It further aggravates the situation, especially since Karstadt and Kaufhof branches are often located across the street from one another. Creative concepts, which provide alternative uses for a department store, need to be implemented. This is easier said than done. Kaufhof’s parent, the Hudson’s Bay Company, will soon lease entire floors of its department stores to temporary office space providers. Both Karstadt and Kaufhof are bringing retail partners into their stores and these partners will manage large swathes of area on their own. Food service establishments, movie theaters and hotels could attract new customers.

The biggest problem, however, is that regardless of whether they decide to spruce up for customers or convert the space for completely different purposes, the necessary modernization costs billions. This is money that department store operators with narrow margins simply do not have. The Hertie chain bankruptcy is a prime example of just how difficult it is to find a new owner and purpose for department store properties, especially in smaller cities. Many of the Hertie stores have been empty for years, blighting the downtown landscape, and hardly any are still in use as department stores.

Realistically speaking, a merger would not change the competitive situation. Customers have migrated to online shops and to successful fast fashion providers, like H&M and Zara. The department store operators would have to lure them back with modern retail lines, new services and memorable shopping experiences. But it’s almost too late for that. Shopping at Karstadt or Kaufhof is about as attractive for young customers as going to the dentist. The brands have lost all appeal.

The only effective strategy is to take many small steps, as opposed to trying to do everything at once. Relatively unprofitable stores in smaller cities must be downsized, and others abandoned altogether. In that case, being a tenant and not the owner of a department store chain is more advantageous. Branches in big cities will have to gussy up their merchandise to lure back customers, and everything will have to be closely aligned with customer preferences and intelligently linked to online shopping. Even so, there is no guarantee of success.

In Mr. Benko’s bid for Galeria Kaufhof he is making a different bet: It is ultimately real-estate speculation rather than a retail concept. In view of sharp and sometimes absurd increases in real estate prices in the downtown areas of major cities, it seems that Mr. Benko hopes that skillful marketing of prime properties will justify the high purchase price. Locations that no longer work would then be liquidated piece by piece.

If anything, a merger of Karstadt and Kaufhof would not brighten the future of the department store chains, but instead accelerate its demise.

To reach the author: kolf@handelsblatt.com

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