A Blog by Jonathan Low


May 15, 2020

How Private Equity Buyouts Of Retail Chains Contributed To Their Demise

Private equity firms loaded up acquired retailers with debt and then added exorbitant fees for their supposedly strategic services.

The result was a weakened retail sector with little room for trouble which is now collapsing as the pandemic stay-at-home orders and growing ranks of unemployed sink sales and profits even further. JL

William Louch and Laura Cooper report in the Wall Street Journal:

J.Crew filed for bankruptcy. Neiman Marcus sought Chapter 11 protection. The two were among dozens of retailers private-equity companies bought over the past decade, spending $89.8 billion. Private-equity firms bet their expertise and capital would help these companies navigate online competition from Amazon. Now, businesses from pet shops to luxury brands that employ1 million people, are weakened by coronavirus shutdowns, revenues falling even before the pandemic and high debt. 27 of the 38 retailers with the weakest credit profiles— 70%—were owned by private-equity firms
J.Crew Group Inc., owned by two private-equity firms, filed for bankruptcy on Monday.
Neiman Marcus, owned by a consortium including private-equity firm Ares Management Corp., sought chapter 11 protection Thursday.
It wasn’t supposed to end this way. The two popular stores were among the dozens of retailers that private-equity companies bought over the past decade, spending $89.8 billion, according to data provider Dealogic.
Private-equity firms bet that their expertise and capital would help these companies grow and navigate the rise of online competition from Amazon.com Inc. and others.
Now these businesses, from pet shops to luxury brands that collectively employ more than 1 million people, are fighting to stay afloat, weakened by coronavirus-driven shutdowns, revenues that were often falling even before the pandemic and high debt levels.
“Some of the companies coming out as in financial distress now were already struggling before Covid-19-sparked closures and the downturn, but this sure accelerated things,” said Aaron Cheris, head of the Americas retail team at consulting firm firm Bain & Co.
Private Equity in the Retail SpacePrivate-equity investment in U.S. retailers haswaned in recent years, after spiking between2013 and 2016.Source: Dealogic Inc.Note: *excluding debt
.billionU.S. Deal Value*2010’12’14’16’18’2005101520$252019x$2.80 billion
Twenty-seven out of the 38 retailers with the weakest credit profiles—more than 70%—were owned by private-equity firms on April 20, according to data from ratings firm Moody’s Investors Service.
These include sports-equipment seller Academy Sports & Outdoors, 99 Cents Only Stores LLC and Guitar Center Inc., according to Moody’s.
Critics of private equity say a broader secular decline in retail has been compounded, at least for some of these companies, by heavy debt loads they assumed in buyout deals, and the dividends and fees that they had to pay out to the private-equity companies that bought them.
“Private-equity firms’ aggressive use of debt and drawing of billions of dollars of fees and dividends from retailers has made it more difficult for those retailers to innovate in a changing industry,” Jim Baker, executive director of the activist group Private Equity Stakeholder Project, said.
Trouble at J.Crew and Neiman
TPG Capital and Leonard Green & Partners acquired J.Crew in 2011, paying nearly $3 billion and promising to expand the company in the U.S. and internationally.
The two firms initially invested $1.1 billion of equity in the deal, according to securities filings show. The rest was financed by debt that was added to J.Crew’s balance sheet. The company struggled with its debt and with consumer habits that shifted toward fast-fashion chains and online shopping. It underwent a debt restructuring in 2017.
Despite its troubles, the two firms paid themselves and their investors nearly $800 million in fees and dividends during their nine-year ownership of J.Crew, securities filings show. That amounts to roughly 70% of the money they originally invested, meaning their losses were tempered when J.Crew filed for bankruptcy.
“J.Crew’s bankruptcy is a disappointment for everyone,” said a spokesman for TPG. “We had been making strong progress with the company to maximize value through the announced strategic review.”
J.Crew had planned to launch an initial public offering this year of sister brand Madewell to raise cash and pay down some of its $1.7 billion debt. The plans were canceled when market conditions worsened in March.
Neiman Marcus declared bankruptcy with around $5.1 billion in debt, the result of two leveraged buyouts. Covid-19 pushed the company into filing, as stores had to close.
“Everything was going well in our transformation, but we had massive interest payments. Covid threw everything off track,” Neiman Marcus Chief Executive Geoffroy van Raemdonck said.
Its most recent private-equity deal saw the retailer acquired for $6 billion including debt by a consortium including Ares Management Corp. and the Canada Pension Plan Investment Board in 2013. In the following years, the company’s heavy debt load consumed most of its profits.
“Since 2014, we have invested over $1 billion of capital into our business, including opening new stores and reinvesting in the existing store network, while also investing significantly in technology and enhancing our digital platform for an omnichannel experience,” said Amber Seikaly, vice president of corporate communications at Neiman.
Debt and Dividends
Other buyouts firms have used similar tactics with retailers they own, using high-interest loans to finance deals and paying themselves dividends and fees, despite the broader headwinds facing the sector.
Taking dividends from portfolio companies helps private-equity firms return capital to their investors and can help protect their investment if a company goes bust. But the practice potentially leaves a company more vulnerable if earnings fall, as it often increases leverage and weakens a company’s cash reserves.
During the nine years that KKR & Co. has owned Academy Sports, the private-equity firm has paid itself nearly $900 million in dividends through a mix of new loans and balance-sheet cash, recouping more than 75% of its initial investment in the company, according to a report issued by Moody’s in April. The most recent dividend was paid in 2015.
Academy has had to battle tough online rivals, but appears to be in better shape than most stores to weather the shutdown. Most of its locations remain open as they are deemed an essential retailer in many areas they operate. The company also has good access to cash and strong positioning in its core markets, according to the same Moody’s report.
But high leverage, an expected fall in earnings and its “aggressive financial strategies” were contributing factors in Moody’s decision to downgrade its outlook on the company to negative last month. In April, Academy said it furloughed a substantial number of its corporate-office employees and a portion of its store personnel, some without pay. Academy employs more than 23,000 people across 16 states, according to its website.
The issues retailers face leave their private-equity owners with a difficult decision: Do they keep the companies afloat by investing more equity or walk away?

“The last thing a [private-equity firm] sponsor wants to do is throw good money after bad,” said Nazim Zilkha, a partner at law firm Dechert LP who counts private-equity firms among his clients.
As more companies fail, stores close, and employees are furloughed or laid off, the dividends and debt loads that private-equity owners took on stand to once again become a flashpoint for public criticism.
When Toys ‘R’ Us Inc. filed for bankruptcy in 2017, its private-equity backers, KKR and Bain Capital, faced backlash from employees and legislators. The two firms ultimately set up a $20 million severance fund for employees.
One of those employees, Anne Marie Smith, landed a job at another private-equity-backed retailer, Belk Inc. She was furloughed in March after the department chain closed stores following the pandemic lockdown orders.
Belk was acquired by Sycamore Partners for nearly $ 3 billion in 2015, but is now facing an uncertain future as its stores remain closed and the company is highly leveraged. “The negative outlook reflects the risk the company will not have sufficient liquidity to withstand a prolonged duration of store closures,” Moody’s said in an April report.
“It’s déjà vu all over again,” Ms. Smith said.


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