Earlier this year, luxury retailer Saks Fifth Avenue announced plans to spin off its ecommerce business at a $2 billion valuation, backed by a $500 million minority investment from Insight Partners. Now, activist investor Jana Partners wants Macy\’s to follow a similar path. It claims that such a move could unlock billions of dollars of shareholder value.

There are just two problems. First, the Saks ecommerce spinoff looks like a dubious move at best. Second, even if Saks manages to separate its physical and digital businesses without falling behind more integrated rivals, Macy\’s business profile would make it dramatically harder to pull off such a move successfully.

What the Activists Want

Jana Partners\’ interest in Macy\’s became public earlier this month, after portfolio manager Scott Ostfeld stated at an investor conference that the company could double its stock price by spinning off its ecommerce business.

[callout]Jana Partners\’ interest in Macy\’s became public earlier this month, after portfolio manager Scott Ostfeld stated at an investor conference that the company could double its stock price by spinning off its ecommerce business.[/callout]

Ostfeld explicitly highlighted Saks Fifth Avenue\’s digital spinoff in his presentation. He noted that Insight Partners bought its minority stake at a valuation of roughly two times sales. Based on Macy\’s projected 2021 digital sales of $8.4 billion, that could make the department store giant\’s ecommerce business worth $16.8 billion. On an equity basis, that would translate to around $14 billion: nearly double Macy\’s current market cap.

A week later, The Wall Street Journal reported that Jana Partners had taken a stake in Macy\’s and sent a letter to the company\’s board outlining the spinoff idea. At least one source indicated that there are firms interested in taking a minority stake in the ecommerce business, similar to Saks\’ deal with Insight Partners.

The Danger of Separating Digital and Physical

Most retail experts panned Saks Fifth Avenue\’s ecommerce spinoff plan when it was revealed back in March. Indeed, brick-and-mortar retailers have learned over the years that creating siloed ecommerce businesses to compete with online pure-plays like Amazon was a strategy doomed to fail. Retailers that have designed true omnichannel strategies that integrate their ecommerce businesses seamlessly with their stores have had much more success.

This makes sense. After all, a long-established brick-and-mortar retailer\’s biggest competitive advantage over digitally native retailers is often its store network, which can facilitate digital sales by serving as a showroom, pickup and shipping hub, and returns center. Separating digital and in-store operations as Saks did (and as Jana wants Macy\’s to do) threatens those omnichannel synergies.

To be sure, Saks\’ leadership claims that customers will continue to have a seamless experience across the newly separated digital and physical businesses. The two companies will share a chief merchant. Service agreements between the digital and store entities will compensate the stores for facilitating order pickup, returns, alterations, etc. for ecommerce purchases. Saks CEO Mark Metrick says that the spinoff will actually remove friction in the customer journey online, helping to unlock growth.

Yet in the long run, Saks is unlikely to succeed in making the stores and the ecommerce business operate seamlessly together from a customer perspective when they have different owners. As difficult as it is to manage an omnichannel retailer from a holistic perspective, it will be nearly impossible for the two companies to coordinate functions like marketing and customer service.to present a single face to customers.

So why did Saks go ahead with the split? As Robin Lewis noted earlier this year, the move makes more sense if Saks parent Hudson\’s Bay views the stores primarily as a real estate play. The Saks Fifth Avenue flagship was appraised for nearly $3.7 billion in late 2014. Manhattan property values have fallen since then, but the store still holds massive real estate value. Many other Saks stores are also located in top-notch locations. If Hudson\’s Bay chairman Richard Baker thinks the Saks stores would sell for more than they are worth as parts of an operating business, then the ecommerce business would eventually be on its own anyway.

A Physical-Digital Split Makes Even Less Sense for Macy\’s

While Saks\’ ecommerce spinoff plan faces long odds, Macy\’s would be even less likely to succeed with such a strategy.

First, Macy\’s operates more than 400 full-line stores under its namesake banner, compared to around 40 for Saks. As a result, Macy\’s store network likely plays a bigger role in its customer relationships than for Saks. Indeed, Saks has no physical presence in many major metro areas and just one or two stores in most others.

That means most customers likely don\’t have a Saks Fifth Avenue store near their home. They may visit a store for a special occasion but would be less likely to use a store for order pickup, returns, or even alterations. In short, it\’s possible (though hardly certain) that many Saks customers don\’t care about the brand\’s physical and digital businesses being tightly integrated.

That\’s not true for Macy\’s, though. Macy\’s has stores in 49 of the top 50 U.S. markets. Many customers use those stores for trying on items, product discovery, order pickup, and returns. The stores also help boost brand awareness and even function as depots for deliveries to customers\’ homes. Macy\’s executives have stated numerous times that when the company closes a store, ecommerce sales in that market decline (particularly if there are no nearby stores).

These dynamics make the prospect of separating the stores from the digital business very tricky. How would stores be compensated for their \”showroom\” role? Who would decide whether to put a returned item out on the sales floor or ship it back to the fulfillment center? Would the ecommerce business pay subsidies to the stores just to compensate them for staying open? In theory, it might be possible to create mutually beneficial financial incentives. In practice, the need to spell out precise compensation for various functions would add a huge amount of complexity to the business.

Second, managing ecommerce shipping costs is a much bigger challenge for Macy\’s than for Saks. At a recent investor conference, CEO Jeff Gennette said that the Macy\’s brand has an AUR between $35 and $36, compared to nearly $100 for the company\’s upscale Bloomingdale\’s chain. Saks Fifth Avenue has historically had even higher AURs than Bloomingdale\’s.

For a $200 item, shipping costs would typically be modest as a percentage of sales. In many cases, the cost of shipping is less than the commission a salesperson would earn if the item were sold in a store, leading to higher profits. As a result, Saks could potentially earn solid margins operating a pure ecommerce business.

By contrast, it\’s very difficult to make money shipping a $30 or $40 item to a customer\’s home. Some retailers have tried to address this issue by imposing a high spending threshold for free shipping (such as $75). However, that comes at the price of growth, and without high growth, Macy\’s ecommerce business would not garner the kind of valuation Jana Partners hopes for.

Macy\’s has taken a different path recently, reducing its free shipping threshold to just $25. That\’s good for maximizing sales. However, it increases the importance of integrating the digital business with the store network to manage costs by encouraging customers to use stores for order pickup and returns. This heavy reliance on the stores makes the concept of an ecommerce spinoff especially dubious.

Third, in addition to the customer-facing benefits of an omnichannel strategy, managing the physical and digital businesses in a unified way represents an important lever for margin expansion at Macy\’s. For example, the company has been retooling its supply chain to reduce markdown risk.

One aspect of this strategy entails taking store inventory levels into account when choosing how to fulfill ecommerce orders. Minimizing shipping costs does not always maximize profits. Macy\’s is developing a proprietary system to account for markdown risk and out-of-stock risk when deciding whether to ship from a store or from a centralized fulfillment center. Such a system would be much harder to implement if the ecommerce business were separately owned.

Fixing the Business vs. Financial Engineering

Jana Partners isn\’t the first activist investor to propose a form of financial engineering to give Macy\’s stock price a jolt. About six years ago, Starboard Value tried to convince the company to spin off its real estate into one or more joint ventures. (Ironically, Starboard\’s model for this type of transaction was also Saks Fifth Avenue parent Hudson\’s Bay.)

Luckily for Macy\’s, Starboard eventually gave up. Real estate joint ventures didn\’t live up to their billing for Hudson\’s Bay. Sears Holdings\’ similar strategy of spinning off much of its real estate as a REIT also turned into a flop.

Attempting to separate Macy\’s ecommerce business from its stores would likely lead to similar results in the long run. Macy\’s stock might benefit initially, but shareholders\’ gains would prove ephemeral once the problems with trying to operate the two channels as separate companies started to manifest themselves.

Moreover, Macy\’s shouldn\’t need to spin off its ecommerce business to get credit for its growth. Target provides a great example. From mid-2007 to mid-2017, Target stock went nowhere as the company struggled to adapt its strategy to changing consumer habits. Since then, Target shares have roughly quintupled as the company has implemented a successful omnichannel strategy.

Similarly, if Macy\’s can return to top-line growth while improving its profitability with a better omnichannel strategy, investors will eventually take notice. On the flip side, no strategy for slicing and dicing the business will create lasting shareholder value if revenue and earnings languish.

Full disclosure: The author owns shares of Macy\’s.