When a PE firm is through strip-mining a company.
Sports Authority, which had skipped a $20-million interest payment in January while trying to arm-twist subordinated bondholders into accepting a haircut, and which filed for Chapter 11 bankruptcy on Wednesday, isn’t the only retailer in the US that was taken over by private equity firms before the Financial Crisis.
The list is long: Neiman Marcus, Albertsons, Safeway, J. Crew Group, 99 Cents Only Stores, Bon-Ton Stores, Claire Stores, the Container Store…. And they all have problems.
They were part of a magnificent LBO boom that is still leaving skid marks on creditors, employees, and other stakeholders, via misbegotten deals where only Wall Street made money as they strip-mined equity out of these companies while loading them up with debt. Occasionally, even PE firms ended up at the cleaners when these overleveraged constructs collapsed before they could be dumped.
The largest LBO of all times, masterminded by KKR, TPG Capital, and Goldman Sachs, was the $44-billion buyout in 2007 of TXU, the biggest electric utility in Texas. In April 2014, the renamed Energy Future Holdings filed for bankruptcy with about $50 billion in debts.
Harrah’s Entertainment was acquired in January 2008 in a $27 billion deal led by Apollo and TPG Capital. Renamed Caesar’s Entertainment, it squeezed through the IPO window in 2012, but its operating unit filed for bankruptcy last year, trying to stiff its creditors out of $10 billion, which has turned into a wild courtroom battle.
Ten of the top 20 LBOs of that time eventually managed to go public. And now, like Caesar’s and Hilton Hotels, they’re struggling to keep their shares from falling below the IPO price.
By comparison, Sports Authority was a minor deal. Other LBO queens among the retailers are also popping up in the news with disappointing sales, plunging stock prices for those that are now publicly traded like the Container Store, distressed bonds and leveraged loans, layoffs, and store closings.
And PE firms have trouble exiting. The IPO market has dried up, “valuations” have plummeted, and no one has any appetite for buying the shares of troubled brick-and-mortar retailers.
Last year, 11 retailers rated by Standard & Poor’s defaulted, the most since 2009. For 2016, it looks even worse: 24 bond issues by retailers and restaurants have plunged so much that they’re now trading at “distressed levels” [Defaults and Restructuring Next for Retailers].
So the first retailer to topple in 2016 is Sports Authority.
With its 450 sporting goods stores, it’s the quintessential financialized American success story: In 2003, Colorado-based Gart Sports merged with Florida-based Sports Authority. Both were publicly traded. The combination took the name of Sports Authority and the headquarters of Gart Sports. In 2006, a group of PE firms led by Leonard Green & Partners engineered an LBO for $1.3 billion.
And now, after months of rumors, Sports Authority filed for bankruptcy. Layoffs have already been announced. And there will likely be more. According to the press release, the company plans to “to close or sell in the coming months” two distribution centers and “approximately” 140 stores. This includes, as The Dallas Morning News had reported earlier, all 25 stores in Texas.
CEO Michael Foss explained it this way:
“We are taking this action so that we can continue to adapt our business to meet the changing dynamics in the retail industry.”
“We intend to use the Chapter 11 process to streamline and strengthen our business both operationally and financially so that we have the financial flexibility to continue to make necessary investments in our operations.”
“We are taking these actions to ensure that we can do an even better job of meeting our commitment to provide our customers with a broad range of high quality sporting goods and apparel and an outstanding shopping experience, whether in our stores or online.”
If a retailer is burdened with debt, financialized to the nth degree, and focused on rewarding its PE owners, it is logical that it would miss the boat operationally, and the boat in the US is online retailing.
Online sales have been soaring year after year. According to the Census Bureau, fourth quarter online sales jumped 14.7% year-over-year to $89 billion, while brick-and-mortar retail sales inched up 1.6%, or about the rate of consumer price inflation. And that includes auto sales, which were booming. Without auto sales, just forget any illusions of growth for brick-and-mortal retailers.
Retail is a very tough industry. Competitors are everywhere. Sports Authority, which once wanted to be number one in the nation, ranks fourth behind Dick’s Sporting Goods, Academy Sports, and Bass Pro Shops. It also competed with brands that sell direct online, and with the nightmare of every retailer, Amazon. And it lost.
So it tried deep discounting to get rid of inventory, which eats into the margins, while its $1 billion in debt was sucking cash out the other end. Its online sales were dogged by growing fulfillment and shipping costs. And so it ran out of cash.
Had this happened at the peak of the credit bubble in early 2014, it is likely that the company could have issued an additional $400 million in bonds at a low interest rate, which would have kept it afloat a while longer while allowing its PE owners to strip-mine more money out of it. But at the day of reckoning, it would have been even more brutal for its creditors. Cheap and plentiful credit just delays the inevitable.
After Sports Authority skipped the interest payment, the stiffed subordinated bondholders hired restructuring and bankruptcy specialist Houlihan Lokey, whose revenues soared 25% from a year ago. It’s profiting from the growing wave of distress among US companies. Read…. What’s Booming in this Economy? Bankruptcy & Restructuring Business “Highest Since Great Recession”