Change is coming to department stores – whether they like it or not.

This week, two investment groups made moves to buy the American chain Kohl’s: a consortium of investors backed by hedge fund Starboard Value LP put in a $9 billion offer, and private equity firm Sycamore Partners is reportedly plotting a competing bid.

Even before the potential buyers emerged, Kohl’s was already the target of activist investors, Engine Capital and Macellum Advisors, which are pressuring the Wisconsin-based company to sell off its real estate and spin off e-commerce operations. The idea is that offloading some properties will generate cash flow for the company, and then the retailer would rent its most profitable stores instead. With digital separation, creating an independent online entity is a tactic to attract new capital.

Kohl’s isn’t the only department store operator faced with the prospect of being sold off in pieces. Retailers in this field have long struggled to grow sales and keep pace with new rivals both online and at the mall. That’s led some investors to see their true value in the land and buildings they occupy, or their brand name, rather than their ability to sell clothes, handbags and shoes. These investors have plenty of cash at the ready to test that theory.

Richard Baker, owner of Saks Fifth Avenue, sold Lord & Taylor for $100 million in 2019 while retaining the chain’s real estate assets. A year later, the retailer was sold once again in a bankruptcy auction to investor Saadia Group, which continues to operate its website.

Baker is also behind the trend of e-commerce spinoffs, where stores are split off from their websites. In a deal announced March 2021, Saks.com became the main Saks entity and received a $500 million investment from private equity firm Insight Partners, while Saks’ 40 brick-and-mortar stores will operate separately as an entity called “SFA.” As of last fall, Saks is planning on an initial public offering that could value the e-commerce portion of the company at $6 billion. Seeing this impressive valuation, activist investor Jana Partners took a stake in Macy’s in October and urged the chain to follow suit.

Real estate transactions and e-commerce spin-offs can be lucrative for a retailer’s investors. What it means for the fashion industry is less clear. Sales were up at Saks in the months following the spinoff, and Neiman Marcus appears to be finding its footing after several years of boardroom manoeuvring, including a bankruptcy filing. But the most high profile example of this sort of financial engineering remains Sears, which was acquired by billionaire Eddie Lampert in 2005. As losses mounted, Lampert spun off the company’s properties into an independent REIT, a move that failed to save Sears from bankruptcy and eventual liquidation.

“Are the break-offs of these businesses a short-term gain? Yes,” said Robert Burke, a retail consultant. “But can it be a long-term play, too? This, we don’t know.”

‘The Department Store Is Dead’

Activist investors and hedge funds are trying to answer the same question as these retailers’ current management: whether, after two decades of declining sales, America’s department stores can be saved.

According to the US Census Bureau, department store sales peaked at around $20 billion in January 2001, but had fallen to $11 billion in February 2020, just before the pandemic reached the US. The numbers have ticked higher since the lockdowns ended, reaching $12.4 billion in October 2021, but resumed their historic decline after that. Many analysts predict the deterioration to continue, especially if inflation causes consumers to spend less on discretionary items such as clothing.

“Retail is in a situation where all the players are vulnerable right now,” said Rebecca Duval, an analyst at BlueFin Research.

Department stores have tried everything from buying rivals to launching in-house apparel and beauty lines to different store formats. Kohl’s’ best-known innovation was to partner with Amazon, in some sense its biggest competitor, to allow customers to return orders placed with the online retailer in its stores. It recently began opening Sephora shop-in-shops, and was quick to offer customers hybrid buy-online, pick-up-in-stores options during the pandemic, taking advantage of the convenient location of many of its stores in neighbourhood strip malls rather than indoor malls.

For its efforts, Kohl’s has seen its revenue drop less dramatically than Macy’s or J.C. Penney. But sales haven’t grown either. Revenue in 2019 of $18.8 billion was just south of the $19 billion in 2013.

Starboard’s offer represents a 37 percent premium to where Kohl’s shares were trading prior. That represents potential value generated from its property and equipment, valued at $6.7 billion in early 2021, as well as its e-commerce operation, which accounted for 29 percent of the company’s $4.4 billion in sales in the third quarter of 2021. In the nine months ending October 31 last year, Kohl’s generated $12.3 billion in net sales.

But if Starboard or Sycamore don’t actually change the way Kohl’s operates and seriously invests in its future, its post-sale trajectory would look very similar to now: stagnant sales and a constant struggle to stay relevant. The same goes for other retailers rumoured to be on the auction block.

“There are 100 retailers in the same boat, where they thought bringing in Amazon returns or a cafe would fix their problems,” said Lee Peterson, executive vice president at retail consultancy WD Partners. “But the writing is on the wall. The department store model is dead.”