One by one, they fell down.
In the past three years, a slew of familiar and beloved staples — Sports Authority, Payless ShoeSource, Sports Chalet, Aerosoles and many of their peers — flocked to bankruptcy court seeking cover from a barrage of retail disruptors. The rapid rise of e-commerce, the growing importance and convenience of Amazon and an overwhelming shift in consumer preference toward experiential spending have become familiar ailments cited by the industry’s struggling herd.
Less obvious — but perhaps no less important — is the impact of private equity ownership, a glaring common denominator among dozens of recently bankrupt retailers.
The list of industry examples continues to swell: Nine West Holdings in April became the latest company to find a suitor in private equity but ultimately had to seek Chapter 11 bankruptcy protection to resolve severe debt.
In 2017, Payless ShoeSource took that route in hopes of unloading some of its nearly $840 million in liabilities — much of which stemmed from a 2012 leveraged buyout by private equity firms Blum Capital and Golden Gate Capital.
Payless’ contentious court proceedings included allegations from vendors and landlords that dividend payouts to its private equity owners made the company especially susceptible to collapse at a time when other factors were also saddling the industry.
(At issue was $350 million in dividend payments to Payless’ PE sponsors in 2013 and 2014 that creditors said contributed significantly to the family retailer’s financial struggles.)
“The depletion of their coffers put the company on a dangerous path that ultimately led to this instant bankruptcy filing,” a group of Payless’ unsecured creditors said in court documents last year. (Payless emerged from Chapter 11 in August 2017, four months after it had filed.)
Similarly, the court this month granted a request by a group of Nine West’s creditors to investigate whether Sycamore Partners’ $2.2 billion takeover of The Jones Group Inc. — then Nine West’s parent company — benefited the private equity firm at the brand’s expense. (On June 10, Nine West and Bandolino were sold to Authentic Brands Group for $340 million in a bankruptcy auction.)
Many private equity investment firms had been the lifeline thrown out to industry players amid crises or during the leveraged-buyout boom of 2005 to 2008. So, dissecting their role in the retail apocalypse can be complicated.
“The key [point] is [that this has been] the perfect storm,” explained Howard Berkower, attorney and partner at law firm McCarter & English. “The private equity formula is to be highly levered [with debt] so that they can buy out [a firm’s] existing owners or founders. They’re not looking to have the business go through a major shift.”
The PE timeline — to buy a business, create efficiencies and streamline, increase margins and sell — is typically three to five years and hinges on near-perfect market stability.
“When these firms buy companies through leveraged buyouts, they are typically looking for businesses [in industries] that are steady,” explained Josh Kosman, author of “The Buyout of America: How Private Equity Will Cause the Next Great Credit Crisis.” “They’re [seeking] companies that are [stable] and that [allow them to] cut some employees and run it on a tight budget, [in which case] they’ll be able to handle the debt and maybe even lift the earnings a bit.”
Unfortunately, Berkower noted, the sleepy nature that had defined retail in the 1980s and 1990s — think: “If you build it, they will come” — eroded quickly as the prominence of digital pure plays skyrocketed in the 2000s.
“Retail had always been thought of as one of those industries that were good for private equity because it was steady and there hadn’t been these revolutionary changes over the course of 40 years,” Berkower said. “Now it’s changed a lot — and [PE owners] don’t have the skill set, the available equity or firepower because [the companies they buy out are] already overlevered.”
Does It Ever Work?
Distressed companies looking for new ownership and owners seeking to cash out of companies they created often choose between private equity and strategic buyers.
Some experts believe PE firms are inherently flawed, and suggest their reliance on market stability is almost always a precursor to failure.
“Private equity as a general rule does not work — the numbers show it,” Kosman said, referencing the highly leveraged buyout of Federated Department Stores in 1988 that led to its bankruptcy just two years later. “I [estimate that] 52 percent of the 25 companies that borrowed a billion dollars or more in the 1980s went bankrupt.”
When it comes to retail — and footwear firms in particular — companies need their owners to have more specialized — as opposed to financial — skills to be successful, argued Sam Poser, a retail analyst with Susquehanna Financial Group LLLP.
“PE’s objective is to make money, and not to necessarily to build the business back,” Poser said. “Private equity firms underinvest after they get where they want to get, and that’s what causes the bankruptcy.”
Conversely, Poser noted, strategic buyers — which acquire companies in the same business in hopes of creating synergies and upending competition — tend to have a more vested, long-term interest as well as more relevant skills.
“Any buyer that understands the business and commits to investing and helping it grow and be more prosperous is good for a company,” Poser said. “Generally, strategic [investors] are more apt to fit that description — although not all the time — than a financial [investor].”
Michael Kors’ procurement of Jimmy Choo and Tapestry’s recent acquisition of Kate Spade are recent examples of strategic wheeling and dealing — although it will take time to assess how their businesses develop and grow.
For his part, B. Riley FBR analyst Jeff Van Sinderen said he’s seen some varied outcomes when comparing PE to strategic, but he is more inclined to place his bets on the latter.
“Results are mixed, but based on what we have seen, there seem to be more successful strategic deals than PE deals,” he said. “Leveraging the existing infrastructure — including the balance sheet and cash flow from other operations — and knowledge of a strategic buyer can go a long way.”
Notably, Jimmy Choo has thrived under several private-equity owners during its storied history, while British retail giant Kurt Geiger has also enjoyed a healthy run under this type of ownership structure. To that end, Van Sinderen is hesitant to indict private equity for all of retail’s hardships.
“Most folks have good intentions when they put together a leveraged buyout,” he said. “Few anticipated the magnitude of disruption that was going to materialize in the industry — and in some cases, the balance sheets did not afford adequate investment in new-generation initiatives that were an absolute must to compete.”