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Is private equity ownership killing retail?
More than 1.3 million U.S. workers have lost their jobs in the past decade because of private equity (PE) ownership in retail, according to a report that came out last week from worker advocacy groups.
The figure includes 597,000 employees who worked for retailers owned by PE firms and hedge funds and 728,000 “indirect jobs” in related industries. Overall, the sector added more than one million jobs during that period.
The study found 10 out of the 14 largest retail chain bankruptcies since 2012 were at PE-acquired chains. More than one million retail workers are still “at risk” because their employers are owned by PE firms or hedge funds, including Michael’s, J. Crew and Neiman Marcus.
The large debt loads from LBOs, according to critics, make it difficult for retailers to adapt to industry changes. They also charge that the typical short-term focus tactics of PE managers — extracting cash through dividend recapitalizations and often selling off any real estate — undermines long-term success.
“Wall Street executives exploit gaps in laws and regulations, and lucrative loopholes, to amass huge profits at the expense of working people and local communities,” the report found.
The report urged increased oversight and regulation on PE firms and hedge funds, as well as stronger workers’ rights.
The study came a week after Senator and Democrat hopeful Elizabeth Warren unveiled a policy proposal to impose new rules on PE firms, which she said often act like “vampires” when they buy a business by “bleeding the company dry.”
Backers of PE firms assert they help businesses grow and support pension funds for teachers, first responders and other government workers. The PE firms also often target struggling retailers to enact a turnaround.
“This report is biased and is focused on a sector that experienced tremendous disruption over the past decade,” said Drew Maloney, president of the American Investment Council, a private equity trade group, in a statement released to media outlets. “Private equity has a clear record of supporting millions of jobs across all sectors and investing in communities across America.”
The report was researched and written by Jim Baker (Private Equity Stakeholder Project), Maggie Corser (Center for Popular Democracy), and Eli Vitulli (Center for Popular Democracy).
- Pirate Equity – Center for Popular Democracy and the Private Equity Stakeholder Project
- Private equity’s role in retail has killed 1.3 million jobs, study says – The Washington Post
- Private Equity Has Killed 600,000 Retail Jobs, Study Says – Bloomberg
- Wall Street firms blamed for killing 1.3 million retail jobs – Fox Business
- Are private equity firms the true retail chain killers? – RetailWire
Discussion Questions
DISCUSSION QUESTIONS: How much blame for the bankruptcies plaguing retail over the last decade should be placed on private equity deals? Do you see the need for greater oversight and regulation of PE firms? Might such regulation result in fewer options for failing retailers?
Poll
BrainTrust
Nikki Baird
VP of Strategy, Aptos
Gene Detroyer
Professor, International Business, Guizhou University of Finance & Economics and University of Sanya, China.
No well-run retail store jumps in bed with private equity – it’s because they are failing and haven’t figured out how to make a profit. They might have already run to Wall Street and found it too didn’t have the answers. I fault management more than PE or VC. The Hail Mary to private equity keeps the brand alive but at too high a price to remain viable.
This is exactly correct Bob. “According to Harvard Business Review, PE buying opportunity most often arises when a business hasn’t been aggressively managed and is under performing. In other words, already troubled retailers are rescued by Private Equity as a last resort.“
Correlation is not causation. It may well be that PE firms step in because they smell blood in the water already. Could some of these retailers be saved? Maybe. But that requires investment, not cost-cutting, and that’s not what PE companies do.
Should they be regulated? Perhaps a better way to look at is having requirements around how much third parties can actually make off of a company’s demise. If we could make investing in the company a more positive alternative than sucking it dry, then efforts might be better aligned to keeping companies going.
I will say this, though. A PE buys your company – that’s not a good sign.
I love “Correlation is not causation” in this context and I mostly agree with Nikki’s stance. Providing incentive for investment vs liquidation is extremely interesting — it’s complex as hell, and interesting to think about.
The one point I don’t agree with is that if a PE buys your company, it’s not a good sign. I agree that it’s not typically a good sign, but PEs with heart and CSP mindset are on the rise. I’m being an eternal optimist here, not necessarily a realist.
The crushing debt imposed by private equity firms has killed a number of retail companies already, and no end is in sight. Our economy is not well served when a privileged few can wrest the money out of a company and leave its associates unemployed. It’s unethical, it’s immoral — and it ought to be illegal.
Sadly, it has been going on for more than 30 years. There was an investor named Asher Edelman back in the ’80s and he would determine that a company was worth more if you broke it up than if it stayed as one entity. And so the only alternative to keep the company alive was to do a Leveraged Buyout (LBO), which meant you borrowed money against future earnings.
So one company I worked for had fallen into this situation with a balloon payment on the debt to boot. The last year I worked there, we made more operating profit than we had in the entire 35 year history of the company, but it wasn’t enough to cover the debt. The company went down and was sold to the highest bidder (who ironically, has since fallen into the same situation).
I agree with you … there should be some kind of controls around these activities. But taking a company private removes a lot of the control that a functioning SEC could exert over a public entity. It’s a complicated mess, and needs more thoughtful governance than we have today.
Not all private equity is “bad,” however the results speak for themselves – 10 out of the 14 largest retail chain bankruptcies since 2012 were at PE-acquired chains. Retail businesses seems to be especially vulnerable to unscrupulous PE operators because of their large asset holdings (mostly real estate) and large employee bases where pension plans and benefits can be cut or scaled back. Notwithstanding the potential for unintended consequences – including fewer options for failing retailers – I think there should be extra scrutiny in PE deals where a large number of employees are concerned. In particular, there should be additional protections for existing pension obligations.
Great point about protecting pensions!
The honest answer to this is that it depends on the intentions and actions of the private equity investors. When PE firms buy retailers to invest in them, improve governance, or turn around a business that has fallen into distress, the results can be positive.
However, when this is not the case PE can be little more than a poison. This especially applies to PE houses which debt-fund their acquisitions, using a minimal amount of their own resources and exposing the retailer to the commitment of repaying any debt. Asset stripping, cash stripping, and a general lack of transparency are also issues.
Personally, I would favor some kind of reform to make PE liable for debts they run up. If you want the rewards of capitalism, you have to accept the risks too. That’s the way it needs to work in retail and elsewhere.
It’s a numbers game. The P/E’s risk when they are borrowing against the company is minimal. And even if it costs something in fees, the one out of 10 that hits makes back all their money.
This whole conversation deserves a deeper dive. How many of the bankrupt retailers would have survived if burdened with only half the debt load? How many would have survived with zero debt? It’s easy to blame “greedy” private equity players, but what about legacy retailers and bad merchants with no vision or skill at creating and managing change? Sure, there were private equity players that were perfectly happy to participate in a purely financial play. They saw the remaining value and extracted it. But let’s also talk about the merchants who put the business in that vulnerable position to begin with.
Not all private equity acquisitions are inherently bad, but many of the retailers with PE tie-ups were in a weakened state already. So does the debt load incurred by a private equity deal spell doom for the retailer, or is the retailer already doomed? (See: RadioShack.) Some of the brands in question would have struggled in public equity markets — or they already did — but in most cases the PE deals haven’t worked to anyone’s benefit.
Dick, exactly right, up until the last few words. PE deals almost always work out for the PE firm, no matter what the results of the invested enterprise. The structure of the deals are such that PE’s equity (about 10 percent) usually comes back in various fees ASAP.
Good point, Gene — it’s not the PE firms that usually end up as the losers in these deals, even if everybody else does. Otherwise they wouldn’t be investors in these sometimes shaky enterprises.
Having worked with a number of PE firms, I can say that the accusations are not true across all firms. In the majority of cases in which I have been involved, management wanted expertise AND the funds to grow a good concept more quickly. In other cases there may be other objectives at play.
For some retailers who have gone the PE route there were already fundamental flaws in their business model and years of store closures, failed initiatives, and a lack of focus on the customer experience which led them to such a fragile state. Just as there is a false narrative that Amazon is “destroying the retail industry,” the same could be said of troubled retailers being bought by PE firms.
When executed properly. and with the right consultative support, PE acquired retailers could make a turnaround happen by focusing on a major business transformation that centers their cross channel strategies around the customer experience. However, most PE acquired retailers are deep into cost-cutting mode, which includes store closures and staff reductions.
For any PE success story to happen, it will take significant investments of time and money to truly give the retailer a fighting chance to remain relevant and profitable.
I still remember my dad telling me about an incident that happened after Merrill Lynch acquired Pathmark 30+ years ago. He was visiting stores with the new CEO, a longtime friend of his, and when they came to the first location, shopping carts were strewn around the lot and the garbage cans were all overflowing. The two of them, both in their 60s, spent half an hour collecting the carts and emptying the garbage cans. While my dad was proud of the effort, my thoughts went directly to how any retailer could let this happen in the first place.
My rough and non-objective estimate is that for every five PE acquisitions in the retail business, maybe one succeeds without going through a subsequent reorganization. The ones that do succeed have a few common characteristics, like actual retail experience (not real estate!) on the PE side and significant investment on the properties and in technology.
If retailers have the right selection of products for the local market offered at a reasonable price, offer strong local service (a well trained set of employees, a career path and resources), and have excellent technology (offering integrated online options with great delivery), private equity would not be purchasing them. Doing all four of the elements listed above well is difficult and when not executed well private equity firms are interested in taking what they can. Normally they do not come in and shore up whichever of the four elements needs help because it takes time and money so the retailers continue to fail. The failure is not caused by one thing.
A lack of vision leveraging data and analytics is thinning the herd in retail – at an accelerated rate. The demise of retail brands in recent years rests at the feet of the C-suite that made poor investment decisions and/or waited too long to take corrective actions to evolve more rapidly to meet changing consumer expectations, aka “digital transformation.” When the PE firms had to be called in, it was an inevitable outcome – extract remaining value from an already dying brand.
Private Equity firms have a role in our economy and as an investor class, they have their own risk/reward appetite. Not every deal they enter will end in bankruptcy nor be wildly successful. PE firms take on a significantly higher risk structure that by definition anticipates some failures. Lacking the role private equity firms play in the economy, we would be witnessing at least the same, if not a higher, bankruptcy rate and job losses. PE firms end up doing what previous management could not, or would not, do to have a chance at turning a profit and adding jobs. The “cause” of the pain in this scenario is not the PE firm, it’s the old management suite and the board of directors.
Should there be oversight and regulation of PE firms? Why? What they are doing is not a secret and it is not nefarious. Have my colleagues here held public stock in a retailer and cheered when a PE firm came and took it public for a 50 percent premium? We like that part.
But to assume that the PE firm is a knight in shining armor that is going to make a retailer better is just naive. The structure of these deals is one-sided. The leverage is structured so that if the deal is successful in the long run, the PE firm has an extraordinary ROI. If the deal goes bad, the PE firm just has a good ROI.
Retail is much more susceptible to destruction because it already is a leveraged business and then goes into a leveraged deal. Just a minute hiccup in cash flow means it can’t service the debt and then everything starts to go south.
Nicely stated, Gene! It’s too easy to blame all of these retail failures on PE firms. Were they solely to blame or were there other factors involved? Many of these received plenty of coverage in discussions here on RetailWire where we all commented on the various flaws in their businesses in addition to the LBO by the PE. In many ways, the real issue here is how much investment and where that investment goes.
For the rare success story of a PE buyout, there would be a meaningful investment in the retailer’s stores, supply chain, business processes, and people. Lacking those things, what expectation can anyone realistically have of a turnaround?
It’s too easy to lay blame on the PE firms, however several comments herein do articulate the fact that not all PE is to blame, and those retailers that went out of business had far more problems than just an LBO.
The net-net is that private equity is the equivalent of an undertaker. Preparing businesses for burial. Their fee for this service is mass extraction of ANY remaining value, including human assets. Face it, when a retailer fails at its own business how can a non-retailer save it?
Instances of PE/retail relationships are not all equal, but there have been some really, really egregious examples of PE companies buying a retailer for the real estate, loading it up with debt, and creating a scenario where there was little chance the retailer (and the jobs) could survive it all in a relatively healthy company. Perhaps those worst cases are the ones that need protection.
This is an exceptionally tricky area. I think there is no question that some private equity firms are pirates – setting themselves up to drain money which would otherwise be a positive part of the economy. That is immoral.
On the other hand, I think it will be extraordinarily hard to create effective laws which curtail the abuses. I have had a considerable amount of discussion with my litigator brother on the topic and there don’t seem to be many good options.
All that said, the problem usually starts because of management choices – management which turns to the private equity firms.
My comment is wishy-washy. But I think it’s reality. We can, and should, be outraged at the abuses. We also need to realize there are no easy answers.
Doug, “immoral” is a big word. Certainly, too much of this economy is financial structuring, but the reality is that what PE firms do is their business model. We can throw investment bankers in that same lot.
It is a big word. But I don’t use it only because it’s big. I use it to take care that laws are not to enforce morality, but to build society. So that no matter how angry we can be at private equity, it is clearer to note our anger is about the morality while recognizing that the only reason to regulate is about society. And it’s the second that is extraordinarily tricky. I can’t envision a way to regulate without creating as many new loopholes as we close. Which seems to mean that society must establish the pressure — not the government.
Exactly!
The purpose of private equity it to surpass proven investment means and results with as few restrictions as possible. This investment model allows for very fast entry and/or withdrawal from markets and companies that are seen as hampered by the current leadership or lack thereof. Companies with solid growth and performance with well balanced financials will rarely come under consideration and or acquisition. Employees caught in these boat rides more often than not blame previous ownership for the company woes instead of their own failure to stay with the failing product or market. Government regulations rarely stop the transgressions we wish to end. The Madoffs, ENRONs and WORLDCOMs of our recent past have clearly demonstrated how feckless government truly is as a business watchdog.
Regulation and PE = oxymoron. In any case, the idea of pure financial minds taking over and running retail businesses A) depends on the business as that’s what they might need, but mostly B) is incongruous because retail is 1/2 art and 1/2 science and with PE involved, the “art” is out the window. Would they/could they help with a new product idea that may save the business? That’s kind of funny.
I’d say take the Abercrombie road and just don’t do it. You’re better off determining your own future at the end of the day — which, BTW, applies to all of retail.
Ultimately, isn’t it a pure “cop-out” by management to go the PE route in these circumstances? In other words, they are out of ideas, and are throwing their hands up in the air saying, “someone else can fix it!”. Otherwise, if they knew how to turn their business around, they’d do it, wouldn’t they? Yes, this is a big oversimplification, but that’s what it boils down to.
PE is not to blame for a retailer’s demise, as they were likely on that trajectory before PE got involved. Unfortunately, it seems like PE isn’t interested in nurturing the business back to health via investments and instead tends to bleed it dry. I suppose they serve a purpose in the business world — they provide that last long-shot for survival.
Hmmm, what kind of “oversight and regulation” do people have in mind? One simple, logical change would be to limit “limited liability.” I suspect we’d see far fewer “heads I win, tail you lose” outcomes if there was more downside risk, but how big of an issue this really is I don’t know. If it’s important enough to prompt studies, then it should be important enough for good ones, not propaganda from vested interests … whatever their interests may be.
Are all PE firms bad for retail? No. Are many PE buyouts unfavorable to retailers, and leave them in pieces? Yes. Arguably, there are success stories, but on the surface, we have discussed far too many retail failures/closures/deaths in these RetailWire discussions in recent years to ignore what is staring us in the face — too many PE firms have scooped up retail businesses for the purpose of carving out every last ounce of tangible value, leaving the retailer with nothing in exchange.
Were they ever intended to conduct a true turnaround? It certainly does not look like it from the outside looking in.
Of course, a true turnaround would require meaningful investment, not just cost-cutting, and selling of real estate to turn a failing retailer into a profitable business. Investment in stores, business processes, supply chain, and of course people would be required for any turnaround, yet we don’t see that very often from these PE deals.
Is it predatory? Perhaps — but this is the nature of the PE business, so it isn’t clear exactly what kind of regulation could be applied to make this situation better. Clearly, something must change or we will continue to see more retail brands exiting the market through bankruptcy in the aftermath of PE deals.
Retail is about the production of cash first, grow second. Retail firms run based on growth or quarterly results are hamstrung to respond to change. The old line — birth, life, death, compost.
Retailers kill more retailers than PE firms do. Analogues to Paula recalling Asher Edelman, I started my career in the Macy’s Executive Training Program in 1986. We were the first “training squad” (that’s what we were called) to enter while Macy’s was still public (NYSE: RHM) and finish after Macy’s was taken private. This was a management-led LBO (leveraged buy out) that ultimately led to the company’s demise and eventual “sale” to Federated, formerly known as “Darth Vader.”
If Ed Finkelstein and Mark Handler would have know what eventually happened with the bankruptcy and sale to Federated, I’m sure that they might have reconsidered the LBO strategy. But CEOs and boards get worn down trying to manage The Street and they also get greedy, which is where the PE firms some times enter.
To blame this on PE firms lets hundreds if not thousands of retail “leaders” off the hook for not investing to deliver a better customer experience, leverage technology, create distinct merchandise offerings, move to digital or otherwise expand. Perhaps this is not as lame as an excuse as blaming weather for missing comps, though it could be, but it’s easy to blame others for our own shortfalls. Sure there are vultures among investors, private equity included, but there is also plenty of greed — along with beliefs in unicorns, fairies and other “silver bullets” — among retail leaders.
When the retailer is just focused on money and profits, which sometimes happens when investors (VC, PE, etc) are involved, it can put stress on delivering higher levels of service, staffing comfortably and even quality of product. That’s often a danger with these types of investors. That’s one of the reasons why retailers can fail. Sometimes the original ownership comes back in to take over and gets their company back at a fraction of what they sold it for. The problem comes as service, quality and other issues slip to a point where the retailer’s reputation takes a hit.