Hedge funds smell blood in the malls.
Several long-short equity hedge fund managers have been shorting retailers that have run into trouble, or those they think may hit hard times in the future, as a growing number of retail chains have filed for bankruptcy or shuttered large numbers of stores over the past few years.
In just the past year alone, The Limited, Sports Authority, Aeropostale, and Radio Shack all have gone bankrupt. Macy’s, Sears Holdings, and others have announced hundreds of store closings.
Meanwhile, in late September Fitch Ratings warned that seven major retailers have a high risk of going bankrupt within the next two years. They are Sears Holdings, Claire’s Stores, True Religion Apparel, Nine West Holdings, Rue21, 99 Cents Only Stores, and Nebraska Book Company.
Most of them will be liquidated rather than reorganized, the credit rating company stressed in a report.
Many long-short managers anticipated this trend.
For example, Stephen Mandel Jr.’s Lone Pine Capital has been going long a number of industries and companies for several years that it deems to be disrupters in the new economy, especially Amazon.com, the e-commerce disrupter of all disrupters.
At the same time it has been short a mall full of retailers. We don’t know which ones exactly.
This trade did not work out as well last year as in 2015, when it played an especially profitable role in the fourth quarter of that year.
“The impact of the internet is resulting in the permanent and ongoing dismantling of longstanding economic models in advertising, media, retailing, technology and travel, among others,” the hedge fund firm told clients in its fourth quarter 2015 report. “This informs a significant portion of our short portfolio.”
Another fund that has been short retailing is Lansdowne Partners’ Lansdowne Developed Markets Fund. In its first quarter 2016 report, the hedge fund told investors it added a couple of new U.S. retail shorts “in companies felt by the market to be immune from disruptive online and offline competition that we feel is having an increasingly clear impact.” Again, it did not name names.
Meanwhile, in November 2016, when Horseman Global, headed by Russell Clark and managed out of London-based Horseman Capital Management, lost 12.64 percent for the month, some of its few gains came from shorting the discount retailing sector, according to its monthly report.
Another hedge fund that has been aggressively shorting retailers is Firefly Value Partners, launched in 2006 by Ryan Heslop and Ariel Warszawski and backed by Greenlight Capital founder David Einhorn. Since at least 2014 Firefly has been shorting what it describes as middle-of-the-mall apparel retailers that are struggling to survive. It pointed out in a recent report that over the past couple of years, five of six retailers it shorted have declared bankruptcy, while the sixth is well on its way. “Shorting each of these companies has added to the returns of the partnership,” Firefly wrote.
The retailers’ business model was under assault from two forces, the hedge fund firm explained: “the inexorable decline of mall traffic and the disruptive rise of fast fashion retailing,” a trend that involves quickly bringing new styles to market. Also, all six companies had “rapidly dwindling cash balances and few strategic options,” Firefly adds in the letter.
“No traditional mall-based apparel retailers are immune to the two forces,” the firm stressed.
In the firm’s third-quarter letter to investors, Firefly said it was short another six middle-of-the-mall clothing retailers “whose fortunes have deteriorated enough that we consider their survival unlikely.”
Its most recent short is Ascena Retail Group. This is the U.S. retailer formerly known as Dress Barn, well-known among women for its apparel, shoes, and accessories under a variety of names, including Ann Taylor, Dressbarn, Lane Bryant, Loft, Lou & Grey, and Justice.
Maverick Capital is another firm that is shorting retailers, noting it is the firm’s largest short theme in 2017. “The short retail debate has clearly been won by the bears,” the fund, headed by Lee Ainslie III, states in its fourth quarter 2016 letter.
It stresses that while the factors supporting its view, such as traffic challenges and cost burdens facing bricks and mortar retailers, are well apparent, “valuations do not appropriately discount our view of the rate and/or inevitability of decline in fundamentals and our conviction in the endgame is unwavering.”
Maverick stresses that investors must be selective in the companies they single out for doom. “It is not about a simple assessment of the ecommerce vs. bricks and mortar Battle Royale,” it explains. “Some ecommerce players have identified the merits of having a physical presence in select locations. Some bricks and mortar retailers have invested heavily to increase their online presence,” noting some of them have meaningful online businesses.
Maverick singles out six criteria it looks for when deciding whether to short a particular retailer, including ecommerce sensitivity, whether it has low-cost competitors, and whether it is suffering from declining traffic.
Maverick tells clients it has “a number of opportunities” that go beyond checking the box on each of the six criteria. Of course, it offers no names.
