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Are private equity firms the true retail chain killers?
It’s common to hear Amazon.com mentioned as a culprit when discussing why a given retail chain has filed for bankruptcy. Less commonly heard of late, but also meriting investigation, is the role that burdensome debt built up under the ownership of private equity firms has played in many of these failures.
While chains such as Gymboree, Payless ShoeSource, rue21 and True Religion have been characterized as businesses too slow to react to changes in consumer shopping behavior, that is only part of the explanation, according to a recent Wall Street Journal article. The other part is that these companies were owned by private equity firms that financed their acquisitions with debt and then borrowed more to pay dividends to themselves rather than investing in the businesses.
In the case of Payless, the Journal reports, Golden Gate Capital and Blum Capital acquired the business in a leveraged buyout in 2012 and then added to the company’s debt, which had grown to $700 million, by financing $350 million in dividends that went to the two firms. By last year, Payless’s debt load had ballooned to $840 million. In April, Payless filed for protection under Chapter 11.
Private equity firms, according to the Journal, have found that low interest rates and the availability of capital have been too good to pass up in recent years and acquired many retailers struggling under debt in the past decade. Going further back, chains including Linens ‘n Things, Mervyn’s and Sports Authority were forced to liquidate after being acquired in leveraged buyouts.
Too be sure, it’s not just privately-owned retailers that have had to play the debt juggling act. J.C. Penney has retired more than $1.4 billion in debt since 2014 and has reworked terms of its revolving credit facility, for example, to give the company more flexibility while it continues its turnaround efforts under CEO Marvin Ellison. In January, Penney announced it had sold its headquarters office building and 45 acres of surrounding land for $353 million.
- Private Equity Takes Fire as Some Retailers Struggle – The Wall Street Journal
- Information About Payless’ Reorganization – Payless ShoeSource
- JCPenney’s CFO Edward Record will leave the struggling department store – CNBC
- JCPenney Announces Successful Closing of $2.35 Billion Credit Facility Refinance – J.C. Penney Company, Inc.
- J.C. Penney Announces Sale of Home Office Campus for $353M – J.C. Penney Company, Inc.
- Would Nordstrom be better off private? – RetailWire
- What should Staples do differently now that it is going private? – RetailWire
Discussion Questions
DISCUSSION QUESTIONS: Is the debt carried by retailers today more burdensome than levels carried in the past? Has private equity firm ownership of retail chains been a positive or negative for the industry on balance?
Poll
BrainTrust
Paula Rosenblum
Co-founder, RSR Research
Robert DiPietro
SVP Energy Services and New Ventures, HomeServe
Difficult sales conditions and negative comps have put considerable financial pressure on retailers and this is reflected in their debt loads. While it seems the current narrative about private equity is generally negative — classic “black hat” raiders, pillaging vulnerable retailers — it’s important to realize that private equity plays an important role in providing retailers access to capital and liquidity.
Investors want to place capital in winning retail formats that can show sustainable growth and hold the promise of profitability. The onus continues to be on the executive team that their approaches will deliver traffic and conversion as well as new ways of monitoring ever-increasing brand equity. The due diligence process offers valuable insights as investment is contemplated, so there is a growing requirement for retailers to improve their public persona and appeal.
The risk associated with asset-based loans and other credit instruments is not new, and it’s surprisingly not well-understood. I had a talk with a Wall Street Analyst a few years ago during the Ron Johnson reign at J.C. Penney and said I thought their asset-based credit facility was their biggest risk. That person didn’t even realize that this was “a thing” in their coverage area.
I’ve worked for two different companies that got thrown into bankruptcy over their credit lines — one was a retailer, another a media company. This goes back 20 years.
So, I’m not exactly sure how we can tie loans and private equity firm ownership together, beyond the private equity firm deciding not to support its properties if they get close to the edge of their lines.
With regard to the second question, the answer is, it depends. If a company is healthy but not a real growth candidate, going private is a great idea. Shopko has done well, I believe, since going private. If a company is having cash troubles, being bought by a private equity company as a “fixer-upper” is risky. Some private equity firms like to cut and cut — and sooner or later, there’s nothing left.
There just is no one answer. But I would be very careful about mixing the apples of private equity firms and the oranges of credit lines together.
Debt is the killer of any business. However, the burden’s placed by private equity firms makes surviving nearly impossible. The problem is greed. There is a mindset today that is hurting a lot of businesses, and that is “how much money can I make today because I don’t care about tomorrow.” When a private equity firm buys a retailer, the stockholders make a killing while in most cases the company is doomed to fail within a few years because, unless they can generate an enormous amount of sales, there is no way to pay off the debt. The private equity firm sells assets such as the company-owned real estate forcing the business to pay the rent-another debt. The private equity firm borrows money when it’s needed, and that too adds to the debt. And in most cases, the private equity firm has already calculated how long the company can survive before being forced to liquidate so the firm can get back its money.
But it’s not just private equity firms; it’s businesses that choose to buy their competitors for instant growth before investing in correcting the problems that the business has, such as poor service or product quality. Then once the purchase goes through, the company now has twice the amount of challenges. If you don’t continue to invest in your business and plan proper growth while taking necessary risks, you cannot and will not survive.
As margins tighten and competition accelerates, the burden of debt has more of an impact. Private equity firms interested in building a world class brand can be a great partner for many retailers. Private equity firms strictly focused on stripping assets to maximize the returns are very damaging to retailers. You have to chose your partners wisely in this world.
Leverage works well as a financing vehicle when cash flow and margins are strong. Unfortunately, we don’t have that scenario today and I think we are seeing the tip of the iceberg.
I do agree that private equity greed could have caused a large portion of Chapter 11 protections. Certainly this is a factor, but more important is the fact that as soon as a struggling retailer goes under different ownership, immediately the incentives and priorities shift away from the business and into the pockets of the greedy private equity partners.
Look at most retailers that are founder-run. They are not (usually) the ones struggling, and this is because they care about making the business and improving on the business model and the technology they use in making this happen.
I think private equity can be a good thing, but it needs to come with the right incentives, and most often they need to keep the founder (if possible) on as the CEO or in another influential role.
Six to one, half a dozen to another. The debt issue is a huge problem for many retailers. Absent private equity funding some of those debt ridden companies would just die. Private equity companies give retailers a chance to get healthy but, as we’ve seen, sometimes the cure is worse than the disease.
The LBO (leveraged buy out) practice certainly puts pressure on profitability of a retailer and if sales and margin slips there’s a lot less wiggle room. That can lead to a death spiral of reducing costs and raising capital by reducing inventory, both to the detriment of customer satisfaction. Fundamentally though if the retailer is growing and doing well they can skate through. There are some notables where the amount of the LBO is just not sustainable. Anyone remember Mervyn’s?
Private equity firms have been affecting the CPG world in a number of ways. Private equity firms have taken over agencies, CPG brands and many retailers too. Imagine each element of the market carrying similar debt burdens. Further, private equity ownership changes the company’s priorities — usually migrating from pride-in-business to squeezing assets. Finally, private equity means that a few high-level managers will stay, waiting for a payday, while many mid-level managers leave for greater personal opportunity. That’s a brain drain on top of debt.
Retail ownership and/or executives remain perplexed in dealings with the 21st century consumer. This has created debt and asset short sales like no other era. Private equity firms are a financial firewall to keep banks from collapsing from the onslaught of debt. Retail’s problem is finding healthy profit margins that are sustainable and able to generate reinvestment dollars. Management is not looking at the means of identifying their store markets. Retailers are looking at the consumer and trying to create loyalty in the land of plenty. Not plenty of money to spend or plenty of product but plenty of buying methods and plenty of price slashing.
The stores themselves have no loyalty to vendors or product category. Determining what market and at what level of quality and price point is an abandoned effort for almost all retailers. We can get tons of retrospective and current information but accurate projections for more than six months out are almost non existent. This is why retail is in so much turmoil and it is only further aggravated by poorly-designed hiring policies and practices, the extinction of sales and marketing departments and placement of continuing education and training on the endangered species list.
If retailers continue the frantic pace of searching for revenue instead of building business they will continue to come in short having to cut more imperatives.
With private equity the game plan is usually buy on borrowed money. Borrow more money to pay investors. Sell assets to pay investors. Cut expenses to increase cash flow to pay investors. Then go bankrupt and repeat the process with another company.
I must concur with this assessment and expand on it. I know of two retailers in specific that have been driven into bankruptcy by the heavy debt burden of their private equity owners. The debt burden is compounded by the unwillingness of private equity to invest in the business, choosing to seek dividends and a quick exit at any cost over the longer-term play of investing in customer experience and assortment required to win in retail today. What a shame.
Overloading on debt is usually not a good thing for businesses and can be difficult to get out from under. What private equity firms are doing in the retail industry is a financial game not a strategic one. I didn’t see any examples of ones that succeeded but I do recall that Bain invested early in Staples … $650,000 into the venture. Within a few years, they made back eight times the money. Funny that Staples is going private — we will see how they fair.
Debt has delivered a heavy blow to many retailers of late. Is it a new problem? Not necessarily, but the conditions of today are such that retailers can’t hide their debt problems by just opening new stores as they once could. Private equity has the potential to help retailers get out of trouble, but unfortunately we’ve seen many examples lately where greed takes over and it’s just become too easy for those private equity owners to make a strong return by further driving the debt hammer down onto the retailer, who has no ability to survive.
I expect we will see more of this as more retailers are unable to hide their financial woes and, by failing to innovate and drive new sales, leave themselves no way out.
There’s a fundamental difference between debt taken on for operations, and debt taken on to enrich (a small group of) owners, so questions like “is debt good” or “is there more of it than in the past” are misleading, at best.
That having been said, businesses are supposed to exist for the purpose of fulfilling a need. If the only “need” ownership can come up with is “maximize shareholder return,” it’s time to look for the exit.
It is a combination of forces. Some external (lower comps from reduced demand) and some internal (debt from refinanced loans or sale to PE). If topline objectives are not met, then bottom line reality is harsh.
Overall, US retail is no longer growing as it had since say 1962, when Kmart/Target/Walmart all launched. And that is regardless of channel.
On this site, both demand (spend) and competitive (online) forces are well documented. Both conspire to flatten comps. Retailers that recapitalized since 2007/the home mortgage crisis when demand was crushed and then 2009/the Great Recession cratered interest rates now find themselves unable to make good on debt to whomever it is owed.
Therefore the amount of debt might be similar, but the demand is below historic levels. And, as we all know, it is not going to return to pre-2007 levels for another 20 years.
Since 2007, the US has migrated from owning homes to renting apartments. Economic consolidation has returned city center population levels beyond historic levels leaving rural areas devastated by wage stagnation and job loss. Those now entering the key life stages which drive retail sales are going about it very differently from the recent past.
At this time, what we see over and over again is the need for relevant selling models to take and grow share. Regardless of ownership (other than online disruptors), retail brands must possess a natural draw to drive traffic and convert to sales that result in an acceptable EBITDA.
Of all the shuttered retailers in past 5 years, what does the ownership look like? Didn’t all the public companies that were failing take the businesses private to throw off cash to shareholders? And then they were squeezed one last time, before they were shuttered for good?
Yep a tawdry tale and the moral is: retail ain’t for sissies!