“The traditional private equity model should have no place in retail.”
By Don Quijones, Spain, UK, & Mexico, editor at WOLF STREET.
Shares of UK-based multinational department store Debenhams — with 165 stores in the UK and Ireland and with 58 franchise stores in 19 other countries — were suspended today after the company and its creditors turned down two last ditch rescue offers from discount retail group Sports Direct, which owns close to 30% of Debenhams’ stock. Debenham’s shares have collapsed spectacularly since they were floated on the stock market in 2006 by its then-private equity owners, Texas Pacific Group, CVC, and Merrill Lynch Private Equity:
The latest rejection means that Debenhams, after gracing British high streets for over 200 years, now faces a “pre-pack” administration that will wipe out its shareholders, including Sports Direct which is estimated to have plowed at least £150 million into the firm.
On its corporate website Debenhams stated that while the Group’s holding company has gone into administration, its operating companies “continue to trade as normal” and its commercial stakeholders, including suppliers, are not adversely impacted by the Company’s administration. “We remain focused on protecting as many stores and jobs as possible, consistent with establishing a sustainable store portfolio in line with our previous guidance.”
Debenhams had given Sports Direct until Monday April 8 to launch a firm takeover bid that included arrangements to either refinance the group’s debt or underwrite the issuance of new shares. Sports Direct, which rescued the rival department store House of Fraser from administration last October, had offered to underwrite a £150-million rights issue for Debenhams, but on two conditions: that Mike Ashley, Sport Direct’s CEO be appointed Debenhams chief executive, and that Debenham’s lenders pledge to write off a similar amount of debt.
It was an offer Debenhams’ board of directors and lenders felt they could and should refuse. Even when Ashley upped the bid to £200 million late Monday evening, it was still rejected. Trading in Debenhams’ shares was later suspended at the company’s request. By Tuesday morning the retail group that once boasted the UK’s biggest chain of department stores had become the property of its lenders, which intend to close around 50 of Debenhams’ 165 stores via an insolvency process called company voluntary arrangement.
Many will blame the decline and fall of this high street stalwart on the growing exodus of consumers to online platforms and cheaper outlets, as well as, of course, the confidence sapping effects of the British public’s decision in 2016 to leave the EU, which both the British government and parliament now seem determined to thwart.
But in reality, the rot at Debenhams began to set in long before online retail became the menace of main street and even longer before the term “Brexit” was conjured into existence. In fact, the store’s decline can be traced all the way back to 2003 when a consortium of private equity houses led by Debenhams’ then CEO Rob Templeman and made up of Texas Pacific Group, CVC and Merrill Lynch Private Equity bought the company. The consortium funneled just £600 million of their own funds into the £1.8 billion deal, while the rest was financed by new debt that Debenhams had to take on.
Short-term thinking, chronic under investment, bucket loads of borrowing allowed the financiers to make off with bumper profits while the business was saddled with £1.2 billion of debt it was never able to pay off. As the UK Independent reports, that debt pile prevented the firm from making the sort of investments that might have given it a fighting chance of weathering the storm that is now battering the bricks-and-mortar retail sector:
“Its private equity buyers slashed costs and sold off freehold property while opening new stores to boost profits (and juice their returns) before floating the company less than three years later.
“Spending on refurbishments was cut by 77 per cent to £7 per square foot, less than a tenth of what Marks & Spencer was spending at the time.”
Following its collapse today, Debenhams joins a long line of once-ubiquitous retail chains (BHS, Banana Republic, Barratts, JJB Sports, Comet, C&A, Dixons…) that were unable to adapt to the brutal conditions that prevail on the UK high street. As a new report from the London-based estate agency Knight Frank spells out, the sector is beset with structural failings that have been “30 years in the making” and which are now “preventing the recovery of the retail market.” They include:
- Oversupply. “With national vacancy rates currently around 12.5% and allowing for 5% for ‘churn rates’ and market tension, this would imply oversupply of around 7%-8%.”
- Rental / property cost inflation. Retail rents have risen at an average annual rate of 4% since 1981. Factoring in full occupancy costs, including rents, rates, service charge and insurance, total property costs have accelerated at a much faster rate than most retailers’ sales.
- Wider cost inflation. Operating costs, including wages, salaries and utilities, are also growing faster than retail sales.
- The unstoppable rise of e-commerce. Many of retailers have lost focus as a result of “the complexity of adding online to existing business models.” Meanwhile, “the cost of developing sustainable online platforms and capital expenditure” has diverted investment away from core store-based operations, which further accentuates the decline of brick-and-mortar stores.
And last but not least…
- Over-geared balance sheets. “The traditional private equity model should have no place in retail,” blasts the report. “It is no coincidence that the vast majority of operators that have launched a CVA or gone into administration are private equity backed, while others such as Debenhams bear onerous debt from historic private equity ownership.”
The report concludes that retailers should be run as retailers, by retailers, not as cash cows by financiers. Unfortunately, for many fallen firms, their other stakeholders, and employees, it’s a little late in the day for such advice. By Don Quijones.
Sales of new passenger vehicles in Q1 2019 in the UK dropped 2.4% from Q1 2018 and 14.5% from Q1 2017, diving close to where they’d last been in Q1 2014. But “superminis” are hot. Read… UK Auto Sales Now Down 15% in Q1 from 2 Years Ago. Diesels in Death Spiral
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Leveraged buyouts need to be subject to a 20 year clawback in bankruptcy.
Leveraged buyouts should be outright illegal, or at the very least require approval of other stakeholders.
Of the 1.8 billion buyout, 1.2 billion went on the company’s balance sheet – reducing claims of current debt holders, pension funds, and other stakeholders purely for the benefit of the current equity holders and the private equity firm taking over. That should be considered an illegal transfer of wealth.
LBO is of the worst corporate capitalism which caused pensions for employees to lose especially if it was underfunded! Many became very wealthy such as T. Boone, Eddie Lambert to name a few!
We have seen the hollowing out of American middle class
Don’t forget the Mittens ! ….
Fast Eddie is the definition of Moral Hazard… He has no soul, just a degenerate
I think the next 20 years could be really interesting. Think of the companies you could ransack: Facebook, Twitter, GE, Boeing, Intel, Apple, GM, Ford. Hell, even Amazon, they are a retailer. Sell ’em short, diss ’em all over the media, take ’em private, load up ’em up with debt, and watch ’em circle the drain. What hauls could be made. The new definition of capitalism seems to be destruction rather than construction. Who knows, they may also find a way to do it with states.
GE is basically already ransacked, not by private equity but by continual management gutting for sort term profits over investing in the long-term future of the company.
I would argue Apple is in the same boat. I mean sure they have a ridiculous cash hoard that can keep them afloat for many years to come, but Tim Cook has slowly been ransacking the future of that company to juice it in the present for almost a decade now. Under his “leadership” Apple doesn’t innovate any more, it just raises price points, makes credit cards, accelerates the rate of planed obsolescence, and tries to find ways to gate-keep and lock people into preferred services. At some point all the good-will and customer satisfaction that Jobs created will wear out against this onslaught and the fortune of the company will turn almost overnight as once mindlessly loyal fans will disappear into (purchasing) diaspora or even be turned into rabid reactionaries against Apple.
“At some point all the good-will and customer satisfaction that Jobs created will wear out”
It has already.
Many only stay with apple, as they do not wish to deal with Microsoft. Hence the growth of Android.
There is a hole/Opportunity for another mainstream operating system, it is simply a matter of who fills it, and when.
Apple is following the Compaq model with is hardware, it will end in the same way as Compaq.
Old Engineer: I believe it is new engineering! Obviously we both must have fallen asleep when our engineering professors briefly mentioned the subject! I “assume” this is what happened!
The financial sector in so many areas is a scam… Designed to be a scam…to enrich and benefit a few at the expense of society…
All with the blessings of the Fed…
Those few, do they include pension funds? The need (greed) for high returns of pension funds is created due to the need to pay pensioners, keeping the ponzi scheme moving along.
What I don’t understand is why hasn’t everyone figured this private equity sell out of retailers.
“do they include pension funds?”
LBOs end up looting more pension funds then they benefit pension funds.
“Debenham’s shares have collapsed spectacularly since they were floated on the stock market in 2006 by its then-private equity owners, Texas Pacific Group, CVC, and Merrill Lynch Private Equity”
There just aren’t any hints or clues to indicate trouble brewing, all the names involved are financial Titans, top-notch straight shooters with long track records of impressive business acumen and famously known for creating value by the truck load.
Bankruptcy Manure .. by the truck load
… and the smell will never go away.
Another example of an economy increasingly built on ‘financial engineering’, i.e. creating and selling debts. No idea how to make or grow anything
Why would anyone buy shares when a PE-owned firm relists on the stock market?
Index funds have to buy.
Did anyone see the crazy stat that Wall St bonuses (yes, just bonuses) for 181K workers were 3X the combined annual earnings for 640K full time workers making federal minimum wage.
Math can be hard. I know. But let me help you out here….
Take 640K workers each making $15K a year (which is what federal min wage is). Then divide that total by 181,000. You get $53K per person.
WOW!!! A whopping $53K bonus on average for Wall St workers. My last job (before I went into consulting), I had about a $50K yearly bonus. One extremely good year it was $70K. And it was about as far away from Wall St as you can get.
But don’t let a good MSM “kill the rich” story get in the way of facts or logic.
I don’t disagree with you on a bonus being an important tool in motivating employees. And I too fondly remember those that I received. But your math doesn’t appear to be right. You figured a per-person bonus of $53K. My number is 3x that. Maybe you missed Rowen’s “were 3X” element. The number I get is $154K on average per person, using Rowen’s numbers.
Yes of course you’re right. I missed the 3X part.
Even so $150K bonus for Wall St isn’t that outrageous. Compare the value add between a quant analyst and a burger flipper and I think if anything evil Wall St guys are underpaid relatively speaking.
“Compare the value add between a quant analyst and a burger flipper”
The burger flipper preforms some small task with very minimal marginal benefit to society while the quant helps find ways to legally rob people en-mass thereby offering a large negative value-add to society?
I suspect the quant’s salary represents a debt on the books of society from the perspective it’s only goal is to assist the wealth divide.
Nothing special about a $150K bonus on Wall Street. You’d figure more than a million people were getting at least that.
I think Rowen was pointing out that 181,000 Wall Street workers EACH got a bonus of 3x the combined annual Minimum Wage of 640,000 workers.
To be precise that is 181,000 Wall Street workers got a bonus – just a bonus – of about $2.9 billion each ($15K x 3 x 64K). I have to admit – that is impressive – I see what Rowen is saying.
The good times are definitely back folks!
Somebody on Wall Street has 10 Billion dollars and I don’t.
And I don’t care.
So what would happen if we waved the wand & outlawed LBOs?
It’s highly probable these failed retail companies would still go bankrupt, stores would still shut, employees would still get laid off, pensions probably wouldn’t be any better funded.
Failed retail companies (Debenhams , Toys-R-Us, etc, etc, etc) use LBO firms because they literally can’t qualify for any other type of financing. It’s a desperation move, like dealing with a loan shark.
I don’t have a problem with LBO firms acting as undertakers for failed companies, however, I have a huge problem for what I consider financial fraud which drives the LBO:
o The failed & now LBO’ed companies are forced to take out huge loans that are highly unlikely to be completely repaid;
o Loan proceeds are immediately paid to the LBO firm as “management fees” or some other contrivance;
o The underwriting bank quickly securitizes & sells these momentarily “high-interest notes” to pension funds and others;
o Sooner or later (usually sooner) the LBO’ed company defaults on payments & the whole fraud gets washed away in bankruptcy.
I absolutely agree there should be reasonable regulation regarding how much cash (x times free cash flow, if any) can be taken out of LBO’ed firms. This simple regulation would vastly reduce the LBO activity.
“Failed retail companies (Debenhams , Toys-R-Us, etc, etc, etc) use LBO firms because they literally can’t qualify for any other type of financing. It’s a desperation move, like dealing with a loan shark.”
This is what I have suspected. The CEO&Board didn’t just roll out of bed one day and say, “Let’s sell out to the LBO guys”. They did it because they could see no path to sustain the business past a certain period of time; usually a few years.
I don’t think there should be much regulation of this. I am not sure why many average portfolio managers (e.g. of pensions), would want to buy any of this stuff (stocks, bonds of the LBO paper). Sophisticated speculators might have a profitable edge.
I wonder if the ratings agencies “properly” rate this paper. If so, any investor should know what they are buying.
So….as far as bad outcomes like job, pension loss, paper value going to zero; those would have come anyway.
This doesn’t quite add up. The first move of the LBO scammers is to force the victim to borrow enormous sums and pay the money to them rather than invest it in the business. The LBO firms are not lending to the business. If the business lacked the borrowing power before the LBO, how could it borrow that money post LBO?
An LBO is not a financing move done by the company out of desperation.
An LBO is a buyout of the current equity ownership, giving them a large sum of money for control of the company. The equity owners see a great opportunity to cash out their shares at high valuations, that’s why they do it.
The CEO may be against it (“hostile takeover”) or for it … typically the CEO is heavily incentivised with shares and options, so they benefit by cashing these out as well.
Nope; LBO is absolutely, definitely for certain a desperation move. Period.
If they could get better terms elsewhere, they go “elsewhere”.
Debenham’s downfall predates the ve mob. When D was bought by the Burton group, nowadays commonly known as Arcadia (Philip Green) the aim was to counteract the ups and downs of the fashion industry with the stability of department store trade. Subsequent selling off D left Arcadia over exposed. Whilst D did not have enough easy cash flow to withstand.
The ve/pe mob took advantage but they didn’t cause the underlying problem.
So….ML….taking an advantage..does Not create another problem….lolol
The easiest way to become a billionaire is to rob and murder companies, especially is they have cash reserves or a pension fund that can be stolen.
All perfectly legal because it’s easy enough to weasel dimwitted voters into electing your employees to make sure of it.
I am amazed at how docile the populous is… guy loses his job, his pension, etc., and the LBO artist walk away having stripped the company bare. My sister worked for a big healthcare company for over 20 years. She got cancer and they declined her claim for chemo, for some reason relating to the specificity of the drugs. I felt like the POS that made that decision would have essentially essentially signing my sister’s death warrant if we had not been able to pay. They eventually did cover her, but you get the idea… and trust me, the last thing someone needs is a cancer diagnosis and to get hosed by the insurance company.
That guy may try to complain to his elected representative or senator, but since all politicians accept out-of-area contributions…so the little guy who lost his job and has no money to contribute gets zero.zero time from his “own” representative or senator.
Sucks to be a voter, but it’s great to be a contributor.
L B Os
L B Os
MONEY for nothing with LBOS!
Leveraged buyouts definitely need to become illegal.
raxadian…Not leveraged buy-outs….Leveraged Bye Byes….lolol
Department stores. What are those again? Oh right those big stores at either end of an empty mall that nobody under 70 evert steps into.
And you say they went under?
Will Tesla collapse the same way?
Is Tesla also in a dying industry like retail?
You think retail is a dying industry? Wow. You need to look up a company called Amazon.
I’ll tell you a little about Amazon.
Amazon are a big retailer with revenues of over $118 Billion in 2017 and guess what? Again few their revenue by over 25% in 2017!
That’s no lie.
Amazon is a retailer that is going places.
You should really look them up and learn a few things about retail in the 2010s. It is most certainly not a dying industry buddy.
Retail is short for Brick & Mortar Retail. Amazon isn’t really strong in that. They only have some supermarkets.The not Gas, Cars & Groceries Brick & Mortar Retail is dying in the 2010s and gas wil be in the 2020s.
Aloha…gosh,lets simply think about this…if you take MORE Money Out..than you PUT In…what could possibly go wrong….lololol
PE to blame? Barking up the wrong tree. It’s the deranged monetary policy of the central banks that creates the debt flood in the first place. Rising property rents and underpriced take-over financing are just symptoms.
As a smart consumer simply avoid products from newly PE-owned businesses: prices typically go up while the quality goes down.
It’s not that people don’t want to shop on the high street anymore. The shops simply can’t afford anymore to hold enough stock and sell at a good price.
High taxation is another factor that’s killing small UK shop owners – there is a reason that in many places outside of central London there are only chains and charity shops (tax free) left.
Debenhams was filled with debt in 2003, What you call deranged monetary policy happened after 2008.
British tax policy isn’t helpful but chains rule the world outside cities like London. Finding a none chain store inside a mall is very rare
ps. in reality a “better” tax policy would only have lead to higher rents.
hmmmm, Amazon holds stock, tons of it. Maybe someone should just put a door on an Amazon warehouse and call it a department store…
I can only assume it’s dumb institutional investors, for instance investing on behalf of the employees pensions of these kinds of businesses, that enable the wolves to do this.
The financial apathy of the plebs, who demand high returns, ignorant of the cost (neutral or more likely negative on society overall), cause this problem.
While you have people willing, even through ignorance, to be bag holders, you’ll get scammers taking advantage.
How can LBOs be legal?
It is interesting that the U.K.has problems in retail not unlike those in the U.S. Leveraged buyouts and stock buybacks are definitely a major problem, but the nature of what they sell is probably the problem no one likes to talk about. Retailers refused to buy products from factories in their respective countries, and without fail everything seen today in the stores is cheap, commoditized junk that is marked “Made in China”. Of course, the native factories shut down, firing millions of people. Now those formerly well paid employees no longer have the money to spend on the expensive Chinese made junk sold everywhere, and the retailers who bit that bullet are now dying in great piles. Who ever said there is no justice anymore? You haven’t seen seen nothing yet! Wait until Lowes and Home Depot implode up over their own stock buyback excesses. No more s**t from China and no more green, warped, and knotty pallet-grade lumber!
Normally when an LBO occurs in retail; they obtain more credit from the suppliers; the Venture Capitalists milk out the cash with consultancy fees; milk the company pension fund then let it go bust or to keep the reputation of the Venture Capitalist in tact sell it for a dollar to someone that will front the demise of the company 15 months later.
“Pre-packs” are there to wipe out ordinary supplier debts and do it all gaian.
I think that the multiple retailers are suffering from growing trend within the shopping public who shop online and then return the goods to the store if it is not appropriate or size/quality fail.
The store of course suffers negative sales without the usual contra offset. A friend of mine commented that it was standard procedure amongst Millenials these days.