What tripped up Payless shoe stores?
Some blame Alden hedge fund’s moves
Discount footwear chain’s demise will leave 16,000 unemployed
When Payless ShoeSource emerged from bankruptcy protection in August 2017, the national discount footwear company vowed to reinvent itself. But today the retailer and a hedge fund that controls it are locked in a contentious battle over its second turn through bankruptcy.
In February, just a year-and-a-half after its first Chapter 11 reorganization case, Payless landed back in bankruptcy court – this time wiping a decades-old retailer off the map in the U.S. and Canada. The turn of events has destined an estimated 16,000 workers for unemployment and disappointed consumers who relied on the chain’s 2,500 stores and website for affordable shoes.
The company intends to keep Payless’ overseas operations running.
Some of the chain’s lenders and creditors claim the collapse may stem in part from self-inflicted causes. They cite the role of Alden Global Capital, a prominent hedge fund that is Payless’ majority shareholder as well as a major lender.
Critics maintain Alden has invested in distressed companies and then in some cases installed unseasoned executives who cut costs and sold assets while failing to take steps needed for successful corporate turnarounds. Some Payless creditors and lenders also have raised questions about what they characterized as conflicts of interest between Alden and Payless.
After hearing Alden-focused court arguments last Wednesday in St. Louis, Chief Judge Kathy Surratt-States of the Eastern District of Missouri ordered anti-conflict-of-interest measures to ensure that Payless creditors and lenders receive equal treatment with the hedge fund. The provisions include the unusual appointment of a monitor to oversee the five-seat Payless board, three with Alden ties, including Heath Freeman, the hedge fund president.
Alden also is the controlling shareholder of MediaNews Group, the company that in January announced a hostile takeover effort for Gannett, which owns USA TODAY and more than 100 local media properties in the United States. MNG had nominated a six-person slate of candidates for Gannett’s board that, if elected, would have made up a majority of the company’s board of directors.
In a surprise move, MNG on Thursday halved its slate to three candidates, which means they would not control Gannett’s board, even if elected.
When Payless emerged after its first bankruptcy, the company pledged to cut prices, invest in online operations and entice shoppers with a treasure-hunt style of shopping akin to popular budget chains Marshalls or TJ Maxx.
But during the ensuing months, what some loyal shoppers noticed were changes for the worse. “From the minute you walked in the door, you knew they were struggling,” said Kathryn Carrington Bogert of Port St. Lucie, Florida. “Before I used to go in, and they would be jam-packed.”
Erin Tucker, a data analyst from Grand Rapids, Michigan, said the Payless stores she visited “were not as neat and appealing.”
“The displays were somewhat bare, and they
“(The idea that) we were the architects of the demise of the company ... is completely inappropriate.” Allan Brilliant, Alden attorney
hadn’t really updated their style in a while,” said Tucker.
Payless blamed its collapse on unexpected delays from key suppliers, a glut of shoe inventory last fall, an inability to equip all its stores with an online digital sales presence and lingering problems from the company’s previous bankruptcy.
“The challenges facing retailers today are well documented, and unfortunately Payless emerged from its prior reorganization ill-equipped to survive in today’s retail environment,” Stephen Marotta, Payless’ chief restructuring officer, said in a Feb. 18 statement that sounded a virtual death knell for a shoe chain popular with families on a budget.
‘Serious concerns’
The new bankruptcy has cast a spotlight on the Payless-Alden business relationship. The hedge fund controls more than 60% of the footwear company and is a secured creditor, placing it closer to the front of the line than others for repayment. In bankruptcy court filings and courtroom statements, some of the chain’s lenders and creditors claimed Payless:
❚ Failed to put in place a permanent chief executive officer to run the retailer after the company emerged from its first bankruptcy, and replaced departing senior management members with “inexperienced and unqualified” Alden executives.
❚ Opened a new headquarters in a Dallas office building, hundreds of miles from Payless’ base in Topeka, Kansas, in what some lenders suggested may have been a move to “bail out” an Alden affiliate that controls the Dallas building.
❚ Negotiated a $45 million loan from Alden during a 2018 cash crunch, a transaction that lenders claimed “had little beneficial effect” on the company’s financial health but enabled the hedge fund to get ahead of other lenders seeking repayment in the new bankruptcy.
❚ Agreed to a shared service contract with Aerosoles, a company that Alden bought during an unrelated bankruptcy case. Lenders want to know whether the deal terms conformed with market norms.
❚ Raised questions about a potential conflict of interest stemming from Alden-linked board members reviewing and voting on Payless matters that involved the hedge fund.
❚ Sparked separate conflict of interest concerns by seeking the appointment of a law firm to serve as the 2019 bankruptcy co-counsel for Payless after the firm represented Alden in past and current legal matters.
“Given everything that has happened, we have serious concerns with how this company is being run and controlled by Alden,” Stephen Zide, one attorney for an ad hoc group of Payless lenders, said during a bankruptcy court hearing in February.
Those lenders and some Payless creditors are pursuing an investigation of the claims while the bankruptcy case proceeds.
Attorneys for Payless and Alden say the allegations have no merit.
“We hear it again today that somehow we were the architects of the demise of the company, which we think is completely inappropriate and unsupported,” Allan Brilliant, an attorney representing Alden, said during a March 14 bankruptcy hearing.
At its newspaper company, which operates as MediaNews Group/Digital First Media, Alden has imposed deep cuts and sold real estate. Critics say the quality of the news product deteriorated, while Alden said the moves improved the company’s finances. At another investment, Memphis-based retailer Fred’s Inc., the Alden-linked board also presided over asset sales and cost-cutting while the business declined, critics claim.
Alden’s strategy of cutting costs and selling assets falls in line with a customary hedge fund strategy of serving as a de facto “liquidator” of financially distressed businesses, said James Angel, an associate professor at Georgetown University’s McDonough School of Business who specializes in global financial markets.
“If you look at their history, they’re going to be very conscious of cost and try to cut corners wherever they can,” Angel said.
“The question to ask is, are they tunneling resources out and just leaving the bankrupt shell behind? That’s the real issue.”
Alden attorney Brilliant, in an email response to questions from USA TODAY, said the hedge fund and its predecessors “have a long history of investing in stressed, distressed and bankrupt companies. Such companies are often subject to court proceedings, capital structure optimization, shifts in strategic direction, corporate headcount reductions and leadership changes.”
Best foot forward
Payless made its debut in 1956 in Topeka, Kansas, the brainchild of cousins Louis and Shaol Pozez. It pioneered the concept of allowing customers to select their footwear.
Payless eventually went public and was acquired by May Department Stores in 1979. Spun off from May, Payless became Collective Brands after a 2007 purchase of Stride Rite.
In 2012, private equity companies Blum Capital and Golden Gate Capital joined footwear company Wolverine Worldwide in buying Payless for $2 billion. In part, corporate debt amassed during that transaction led to the April 2017 bankruptcy. Just more than fourand-a-half months later, after shedding more than $435 million in debt and closing approximately 673 stores, a slimmed-down Payless emerged with Alden as a major financial investor.
At that time, interim CEO Martin R. Wade III said that with less debt, the company would invest in digital infrastructure, reduce prices and adopt the “treasure-hunt nature” of retailers TJ Maxx and Marshalls.
Wade also said Payless envisioned an opportunity in servicing other retailers by handling their shoe inventory or sales.
“We’ve got to redesign our model, so we can make all that happen,” Wade told USA TODAY in a story published in January 2018.
Tripped up
By August 2018, a month before Moody’s Investors Service warned that despite Payless’ reduced debt, “financial risk remains high owing to persistently weak trends in its core U.S. brick and mortar business and its still heavy debt service costs and modest operating margins.”
The treasure-hunt style of retail promised by Wade never happened, said Sheena Butler, senior business editor at Footwear News, who tracked Payless. She said the company may have suffered from strategic mistakes such as having too many stores after the first bankruptcy and too much debt to invest in significant retail changes.
“The everyday-low-price model was challenging because they didn’t have that other component, which was the thrill of the find,” Butler said.
The company also never pulled off a significant rehash of its online strategy, she added.
As Payless’ retail prospects worsened in 2018, supplier disruption and a computer breakdown took a toll on the company’s operations.
Payless said it sold “millions of pairs of shoes” for below-market prices in the weeks leading up to its second bankruptcy filing. The company’s $66 million loss in 2018 for its North America stores added to a loss of $11 million in 2017 for that division.
It is not shocking to see the company’s North American operations fall apart, given the retail sector’s challenges. However it is surprising for a company such as Payless to slip back into bankruptcy so quickly – especially because the footwear firm had emerged from its first bankruptcy with less debt, profit forecasts and “a certain sense of optimism,” said Josh Friedman, global head of restructuring data at Debtwire.
What went wrong?
Some Payless lenders took aim at Alden following what they characterized in a bankruptcy court filing as “mismanagement suggested by the stunningly swift collapse” of the company.
The lenders, joined by hedge fund Axar Capital Management, Payless’ second-largest creditor, filed an objection that cited Payless’ borrowing of $45 million from Alden during a cash crunch in 2018.
The loan “may not have only delayed the inevitable,” but also may have been harmful because it prevented Payless from seeking bankruptcy court protection even sooner, at a time when the company might have secured more favorable terms and higher recoveries for creditors, the companies argued.
“All the transactions that occurred between Alden and the company were at arm’s length and in fact benefited the company more than that they benefited Alden,” Brilliant, the hedge fund’s lawyer, said during a recent bankruptcy court hearing.
Payless lenders also questioned why the company “inexplicably” leased office space in Dallas as part of a plan to move the company’s headquarters there from Kansas. The filing said the plan represented “paying for twice the space” during a bankruptcy when the company could least afford it.
Payless separately disclosed that it had sold the Kansas headquarters property for $2 million in a deal that enabled the company to lease back part of the building.