Heavy debts the final straw for US retailers
Spate of bankruptcies is likely to scare off private equity firms, writes Lauren Coleman-Lochner
SPORTS Authority learned the hard way that buyout debt can be a drag. Once the biggest US sporting goods retailer, the company found it difficult to be nimble enough to stay ahead of rivals.
In retailing, consumer trends shift quickly, stores constantly need upgrades and a surprise like a winter storm can make it necessary to act fast to salvage a big shopping weekend. But Sports Authority was loaded with at least $643m in debt, a hangover from the $1.4bn leveraged buyout in 2006 by investors led by Leonard Green & Partners.
Sports Authority’s bankruptcy plan last month included closing 140 of its 463 stores, leaving workers jobless. But it has now abandoned any hope of reorganisation.
Other retailers filing recently for bankruptcy include Deb Shops, a 2007 buyout by Thomas H Lee Equity Partners; and Dots Stores, a 2011 purchase by Irving Place Capital. Also headed for the debt wall are Claire’s Stores, bought by Apollo Global Management in 2007; and Gymboree, a 2010 Bain Capital Partners acquisition.
Such struggles make it less likely that private equity firms will target retail chains in the future, says Michael Appel, founder of consulting firm Appel Associates.
“It’s just not an industry that can tolerate a lot of leverage,” Mr Appel says. Even without owing a ton of money, retailers can be slowed by fixed costs such as rent, salaries and inventory, he says.
A representative for restructuring firm Gordon Brothers declined to comment for Dots Stores, as did a Sports Authority representative. Spokesmen for Gymboree, Deb Shops and Claire’s did not respond to requests for comment.
Buyout targets are deeper underwater than most retailers by at least one measure — the ratio of net debt to Ebitda, which calculates the number of years a company would need to repay debts if its numbers remained constant. (Ebitda is earnings before interest, taxes, depreciation and amortisation.) Children’s apparel chain Gymboree has a ratio of 13; Claire’s, which caters to teenage and pre-teen girls, scores 49.5. The average ratio for the 32 companies in the S&P 500 retailing group is 1.2.
The obligations loaded on these companies are not the sole cause of their struggles. To Dina el-Mahdy, an accounting professor at Morgan State University in Baltimore, they are not a reason at all. Poor management and lender monitoring, not debt, drive companies into distress, she says. Leveraged buyouts provide a cheaper cost of capital and add value, she says.
“You can’t say high leverage ends up with high default. There are many, many things in between.”
Some in the industry see high levels of indebtedness as a new normal. Many retailers struggling now have been slowing for years, says Sandeep Mathrani, CEO of mall owner General Growth Properties.
“If you look at companies that haven’t done leverage buyouts, when they start to slide down the path from a productivity perspective, you start to see them take on their own debt,” Mr Mathrani says. “I don’t think the leveraged buyout is the culprit.”
In the fast-evolving world of retail, where the one constant is the need for investment, retailers that are labouring under heavy debt are at a disadvantage.
“Doing it right is very expensive,” says Raya Sokolyanska, an analyst with Moody’s Investor Service in New York. “Limited financial flexibility has been a reason why a lot of these retailers haven’t been able to fight back and position themselves correctly for growth.”
That is why lenders and investors may back off the retailing industry somewhat and there will be “far less activity” on the buyout side, says Durc Savini, senior restructuring banker at Guggenheim Securities in New York.
Private equity firms bet big on retail in the 2000s, taking merchants such as Claire’s, Toys “R” Us and Linens ’n Things private.
Americans were spending more and more to buy and furnish homes, and the merchants’ new owners counted on that trajectory continuing long enough to resell the businesses for a worthwhile profit.
When the recession came, that option was mostly off the table.
Tepid Christmas results last year scared private equity executives, and refinancing has become more expensive, further hurting companies’ credit, Ms Sokolyanska says.
“Some things that may have been considered a slam-dunk two years ago are now being looked at as not so easy anymore,” says Michael McGrail, chief operating officer at Tiger Capital Group in Boston.
That problem is especially acute for retailers selling other companies’ products. And while competitors were sprucing up stores and building their online businesses, Sports Authority was falling behind, says Ryan Severino, senior economist at REIS.
Charles Tatelbaum, a bankruptcy attorney at Tripp Scott, expects companies acquired through leveraged buyouts to be well-represented in the next round of retail bankruptcies because a firm with high debt is running in a three-legged race. “Based upon the anatomy of a leveraged buyout, it’s handicapped from the beginning,” he says.