Friday, April 26, 2019

"Retail’s Existential Threat? Private Equity Firms"

First up, from Pitchbook, March 25:

Sycamore set to take $1B out of Staples
In the private equity industry, dividend recapitalizations have drawn increased media scrutiny as many companies with heavy debt loads have had to file for bankruptcy. But the tactic, which involves a firm adding new debt onto a portfolio company to give itself, shareholders and/or limited partners an early payout, is still being utilized.

Retail-focused Sycamore Partners is planning to cash in on its investment in Staples through a $1 billion dividend recap, according to Bloomberg, pushing the office supplies company's total debt to more than $5.3 billion, or about 4.7x adjusted EBITDA net of cash. Sycamore took Staples private for $6.9 billion in 2017, putting a reported $1.6 billion of its own money into the deal. With the dividend recap, the firm already stands to make back nearly two-thirds of that original investment—independent of a full exit in the future.

It's unclear if the move will have any impact on Staples' operations. But Bloomberg, citing a source, reported that Sycamore could look to exit the company over the next year, with an initial public offering the most likely option.

Adding debt before an exit could come with its own set of issues, as some PE-backed companies with substantial debt have struggled on or around the public markets. Apollo Global Management-backed ADT, which had more than $10 billion in debt when it went public in January 2018, has seen its stock price drop some 50% in the ensuing 14 months. Last week, Blackstone postponed a planned IPO for healthcare benefits manager Alight—with some analysts raising concerns over the business's long-term debt of $3.4 billion.

Looking back, dividend recaps have had varied effects on PE-backed retailers, with some going mostly unnoticed and others potentially contributing to an eventual bankruptcy....MORE
And from Wolf Street, April 19:
A “bust out” is a fraud tactic used in the organized crime world wherein a business’s assets
and lines of credit are exploited and exhausted to the point of bankruptcy
— Wikipedia.
By John E. McNellis, Principal at McNellis Partners, for The Registry:
Bleeding badly, Debenhams, a 200 year old British department store chain, died last week. The coroner trotted out the usual suspects — the internet, the oversupply of retail, rising rents, tighter margins and, at the end of the dreary line-up, private equity. As it happens, Debenhams had been purchased by a private equity consortium led by Texas Pacific Group (TPG) in 2003.

That group paid £1.8 billion for the company, using £600 million in equity and £1.2 billion in debt it forced Debenhams to assume. The private equiteers promptly began selling off assets, dramatically cutting costs (store refurbishments dropped 77%) and awarding themselves large dividends for their efforts. And, no surprise, consumers lost interest in the fraying stores.

Since I first wrote about private equity’s looting and ultimate devastation of Mervyn’s (“On Private Equity and Real Estate” September 2012, behind paywall), retailer after retailer has been similarly gutted. Payless Shoes, Toys ‘R’ Us, Gymboree, Sears Holding, Mattress Firm and Radio Shack — all companies at one point owned or controlled by private equity firms — have since filed Chapter 11. In fact, Debtwire, a financial news service, calculates that about forty percent of all US retail bankruptcies in the last three years were private equity backed.

How do the private equiteers do it? Simple, the leveraged buyout. The LBO is the financial world’s pick and roll, that is, a highly effective play that is difficult to counter, especially if the PE firm takes the prudent first step of bribing its intended victim’s CEO into going along with their acquisition.

In short, the PE firm pays top dollar for a given retailer, often even overpaying, but using as little equity and as much debt as it possibly can. It then improves the company’s profitability by cost-cutting beyond prudence and, as with Debenhams, says, “What a good boy am I,” rewarding itself with a major dividend, often recovering not only its entire initial investment, but a substantial profit to boot.

A PE firm may be in good faith, it may actually use its best efforts — to be fair, equiteers sometimes succeed with their retail acquisitions — but even under the best of circumstances, retail is a difficult business, the threats from e-commerce, changing tastes and ever more nimble competitors are all too real.

Here’s the PE challenge: If you’ve already got your investment plus a fat profit out of a company, how hard are you going to continue to work on bailing it out, especially when you’ve crushed its bottom line beneath a wrecking ball of expensive debt?

Is this legal? It shouldn’t be. Is this moral? You don’t have to ask. Is this perpetrated by a single bad guy? Does private equity have its own Vladimir Putin? No. The industry is more like Ali Baba and the Forty Thieves; everyone gets in on the action. In fact, it’s hard to think of a private equity firm that hasn’t dipped its toe in this cesspool.

With apologies to those firms unintentionally left out, the players read like a who’s who of the PE industry: Bain Capital Partners, Blum Capital Partners, Cerberus Capital Management, (when a company names itself after the three-headed dog that keeps lost souls in Hell from escaping, you just might intuit a certain moral ambiguity), Golden Gate Capital, Kohlberg Kravis Roberts, Lone Star Global Acquisitions, Sun Capital Partners, Sycamore Partners, TPG and Vornado Realty Trust.
The list goes on, but you get the point. And yes, Bain was Mitt Romney’s firm, but please remember that Richard Blum, husband of Senator Dianne Feinstein, is the principal of his eponymous firm. This isn’t about politics, just money....

A spokesman for President Putin asked that he not be mentioned in the same breath as the private equity guys.