Burying Payless
Private equity moves may have hastened demise
TOPEKA, Kan. — The financiers who had taken over Payless ShoeSource didn’t have much experience selling lowpriced footwear, but they had big ideas about how things ought to be done. One was capitalizing on enthusiasm for the 2018 World Cup in the Latin American countries where the company had hundreds of stores.
When they saw an opportunity to buy 1 million pairs of World Cupbranded flipflops, the money men turned shoe sellers overruled the midlevel supply managers at corporate headquarters in Topeka, who had pointed out a couple of problems.
First, the sandals mostly wouldn’t arrive on store shelves until after the World Cup was over.
Second, they were branded with the flags of countries like Mexico and Argentina — countries where Payless didn’t have any stores.
Ultimately, the flipflops had to be unloaded at steep markdowns, one of many missteps at a company that by early 2019 would liquidate its stores in the United States and enter its second bankruptcy in rapid succession, putting 16,000 people out of work. (It emerged from
bankruptcy in January, with its third ownership group in four years.)
As in any corporate failure, there is no one cause. Over seven years, Payless went through a wringer of private equity and hedge fund stewardship that left it with inadequate technology, rundown stores and no financial cushion to survive an era of upheaval in retail.
But the collapse of Payless is more than a story of one discount shoe company that couldn’t hack it in a changing business environment. It provides disquieting clues about one of the great mysteries of the modern economy.
Why hasn’t the financedriven capitalism of the last few decades created faster growth? What if the masters of financial efficiency are making choices that don’t actually create the more dynamic, productive economy they promise?
In extreme cases, what if they don’t really know what they’re doing at all?
The difference between economies that thrive and those that falter boils down to two related factors: how effectively capital is deployed, and how well corporations are governed.
When a nation’s savings are channeled toward worthwhile projects, and effective managers are put in charge of large companies, good things tend to result. When resources are devoted to boondoggles, and companies are run by incompetent cronies, everyone ends up poorer. Think of how much richer West Germany became compared with East Germany over the four decades the country was divided.
But there is no single answer to the question of what form of capital allocation and corporate governance works best. The United States has typically relied on stock and bond markets to determine which companies get money to invest, and on independent boards of directors to govern companies. Western Europe relies more heavily on banks. Japan and South Korea have relied on conglomerates in which families of companies help finance and govern one another.
In the last generation, the United States has experienced a revolution in how this corporate control works.
In the 1980s, the first generation of leveraged buyout kings — an industry now known as private equity — identified problems with U.S. corporations. Many were poorly run, led by complacent boards of directors and executive teams reluctant to shake things up.
Buyout firms aimed to purchase those companies, fix what was holding them back and profit by making them more valuable and selling them off again. All through the 1990s and early 2000s, this shift made billionaires of their founders and attracted trillions of dollars from investors.
Their imprint on the economy is enormous: Companies owned by private equity firms accounted for 8.8 million jobs in the United States in 2018 and 5% of GDP.
But if anything, that understates the scale of the financialization of U.S. business, and the ways that management tactics of buyout kings have become the norm.
Some large hedge funds operate similarly to private equity firms, by buying and operating companies. One such fund, Alden Global Capital, controlled Payless from 2017 to 2019, the years that included the World Cup blunder. Other hedge funds use votes to get executives of publicly traded companies to act more aggressively and thus increase returns to shareholders.
The result: Financial managers exert greater control over nearly all U.S. companies than they once did.
Their willingness to cause some pain — to close factories, lay people off, renegotiate arrangements with longtime suppliers — is, many economists argue, a feature, not a bug. Society becomes richer over time by devoting resources to its most productive uses. The pain should be temporary and in theory result in a more vibrant economy for everyone.
In 2012, private equity firms and hedge funds set their sights on the troubled retailing sector, and one set of investors made the pilgrimage to Topeka, where they acquired Payless.
Payless, founded in 1956 by two cousins in Topeka, Louis and Shaol Pozez, was a business built on an innovation: that shoe salespeople weren’t entirely necessary.
Rather than keep inventory in a backroom and employ lots of salespeople, as department stores did, Payless kept boxes of shoes on open display in the store, where customers could help themselves to try on. It needed fewer workers for every pair of shoes sold, which, among other costsavings measures, allowed it to keep prices lower than many competitors could. The company became a mainstay of the indoor malls and strip shopping centers that boomed in the second half of the 20th century.
By the time a private equity group led by Golden Gate Capital and Blum Capital, both of San Francisco, took over in 2012 in a $2 billion acquisition, Payless had 4,300 stores worldwide and $2.4 billion in revenue. But it also faced profound challenges.
Many malls were entering a death spiral, with falling foot traffic, store closings and underinvestment. People were increasingly shopping online. Payless had underinvested in its information technology infrastructure.
It also had some distinctive strengths. In its 800person corporate headquarters in Topeka, a former warehouse located between a women’s prison and a potato salad manufacturing plant, it had the personnel and systems to pull off an intricate feat of merchandising and supply chain management.
The company managed to commission the manufacture of millions of pairs of shoes, often imitating the look of more fashionable brands; ship them from factories in China, Vietnam and other countries to distribution centers in the United States; and then, just in time, get those shoes into the stores where they would most appeal to the customer base.
It did all this at remarkably low cost; its average pair of shoes sold for $17.
What needed to be done was evident to Payless’ own managers and outside analysts alike: shutter underperforming stores, update others and modernize its technology.
The new owners found a new CEO in W. Paul Jones, a veteran of two retailers owned by financial engineers: Sears, under hedge fund manager Eddie Lampert, and Shopko, under private equity firm Sun Capital Partners.
Jones had seen up close both the strengths and weaknesses of this form of financialized corporate control.
“They’re incredibly valuable on the financial metrics of understanding how to get costs out of the business, how to be more streamlined, how to think about the organizational structure differently, how to find nickels and dimes throughout the organization,” and at getting maximum value out of real estate, Jones said.
“But they do not, do not, know how to operate a retail company,” he said.
That is to say, on the actual nuts and bolts of retail — creating a compelling shopping experience, with merchandise that buyers want — financial managers are out of their depth.
But he was confident that Payless under Golden Gate and Blum would be an exception. The new owners appeared to understand the business better than others in the private equity industry, Jones said, and they were committed to hiring a firstrate team of executives.
Plenty of companies that go through this process do emerge better managed, with capital deployed more wisely.
The Carlyle Group, for example, took over Dunkin’ Donuts in 2006 and spun it off to public markets in 2011 financially stronger and with 2,800 more stores worldwide. The hotel group Hilton Worldwide nearly doubled the number of rooms it managed from 2007 to 2018, while under control of the Blackstone Group.
And some of the best research on how the buyout industry affects the companies involved suggests that, on average, they become more productive.
But there is a problem. During this same period in which U.S. corporations have become more financialized than ever, the overall economy has had historically weak productivity growth.
In the 2010s, labor productivity — the amount of economic output per hour of work — has risen by less than 1% a year, the lowest of any decade on record (the data go back to 1947). It was 2.7% per year during the 1950s and 1960s, the highwater mark of the clunky, complacent, conglomeratebuilding era of American business.
That may not seem like a big difference, but sustained over time it has huge effects. At 1960s rates of productivity growth, incomes would be expected to double every 26 years. At 2010s rates, it would take 72 years.
The new CEO, Jones, and the rest of the executive team assembled by Payless’ new private equity owners in 2012 had a lot to do.
The company had modernized its logo and branding years earlier — but had been so stingy with capital spending that around 70% of stores still had 1980s vintage signs. The company’s outdated information technology systems updated inventory only once a day — making it impractical to offer buyonline, pickupinstore offerings.
Jones and his team started in on plans to upgrade technology, expand profitable international operations and invest in the highgrowth areas of athletic footwear. But even with all those outdated stores and technology, capital spending remained only at levels comparable to the previous ownership: $75 million to $80 million per year.
Meanwhile, the company made huge payments to its private equity owners.
In the twoyear period ending in January 2015, Payless generated $249 million in EBITDA, a common metric for operating profits; paid $352 million in onetime dividends to shareholders; and made $94 million in interest payments.
For every dollar that came in the door of the company in that span, it paid out $1.41 to its owners and 38 cents to its lenders. That left the company with less of a financial cushion to ride out any future challenges. And the future, as it turned out, held some major challenges.
Done right, a Chapter 11 bankruptcy is an opportunity for a company’s rebirth. It can shed the debts, lease obligations or onerous supplier contracts that might have gotten it in trouble.
The executives who led the company through its 2017 bankruptcy were confident they had done exactly that. The company shed about half of the debt on its balance sheet, closed about 700 underperforming stores, got its rent on remaining stores cut by as much as 50%, negotiated more favorable credit terms with suppliers and formed a plan to invest in new technology and expand its profitable Latin American business.
“We were going the right direction, we had stability, we had a strategy, we had a team, and we had results,” Jones said. He said the new owners should have had at least four years of breathing room to get the business on track. Golden Gate Capital said, “When we exited Payless, we left it with a rightsized store footprint and meaningful earnings opportunities for future owners.”
“It’s the antithesis of what we’ve seen in other retail bankruptcies,” a restructuring expert, Christopher Jarvinen, told Reuters at the time.
Yet 18 months later, Payless was in bankruptcy court again. Its U.S. stores were closed.
What happened? Why did Alden Global Capital, the firm that took over Payless after the restructuring, fail so badly?
One answer is that it is hard to fix decades’ worth of problems quickly, even with the help of a bankruptcy court that can wipe out debts. For example, the Alden managers enthusiastically demonstrated a new system with which store employees could call up information on a tablet to see if desired shoes were available in another store.
That sort of thing was pretty standard in the retail industry in 2018. Yet many Payless stores had inadequate WiFi for the tablets to be used. And the bankruptcy had fractured the company’s relationships with suppliers, many of them small Chinese manufacturers that had lost money when Payless experienced its cash crunch.
Former employees also described a series of mystifying errors by an Aldeninstalled leadership team with little or no experience in the retail industry. The chairman and interim CEO, Martin Wade III, was a longtime investment banker. His chief deputy, Jennifer Wild, was also new to the sector.
Beyond their lack of retail experience, former employees said, the Alden team cloistered itself in the executive suite and seemed to disdain the expertise of the staff in Topeka.
Then there were the sandals.
“Someone in Colombia isn’t going to buy Mexicothemed flipflops, and they definitely won’t buy them if they don’t get there in time for the World Cup,” said Jason Tryon, a planning and allocation manager. Those concerns, he said, were ignored. “They became convinced that, ‘You guys don’t know what you’re talking about.’ ”