Are Private Equity Firms Killing American Retailers?
Traditional U.S. retailers are experiencing a tough year, with more than a dozen already having declared bankruptcy in 2017. The growth of e-commerce, as well as competition from European rivals such as H&M and Zara, are often blamed for the troubles at brick-and-mortar chains. Yet there is another, less recognized, factor weighing on a number of retailers—the role of private equity investors, which operate by loading up companies with debt.
Take Rue21, a teen-focused retailer that some analysts think is in imminent danger of bankruptcy. The chain was bought by private equity firm Apax Partners in 2013 for $1.1 billion. Loaded up with debt of almost $1 billion, Rue21 has struggled to make its debt payments amid waning demand for its clothing.
Private equity (PE) funds operate by raising money from investors and using the funds to acquire companies that, while distressed, still have value. PE executives then direct management to make strategic and operational changes in order to boost business performance. The goal, buyout firms say, is to turn companies around and eventually sell them for a profit. PE firms make money by collecting fees for managing funds and in taking about 20% of the earnings when a business is sold. But PE firms also tend to fund their acquisitions partly with debt raised by the target company. That can leave already struggling businesses swimming in red ink, hindering their recovery—or pushing them into insolvency.
“When you are in public relations for private equity, you say leveraging up the company imposes discipline, because they have to generate a certain amount of cash to pay the debt,” said Jude Gorman, General Counsel at Reorg Research. “It sounds great until you say, ‘But what happens when some sort of secular trend hits and the company doesn’t have the cash to make the loan payment?’” The result, he noted, are companies like Rue21, which are struggling to juggle their loan repayments while figuring out how to get consumers back in their stores. With so much cash servicing debt, that means less money available to invest in improvements that could help keep the retailer in business. Some retailers end up shuttering stores to save money, but companies are often in a bind because they need to keep their shelves stocked with inventory to attract consumers, as well as retain enough staff to deal with customers and ensure a pleasant shopping experience. “When you combine the costs with the debt—then a thing comes along called Amazon and you don’t have the customers anymore, all your 13-year-old girl customers are shopping at H&M—what are you going to do?” he said. “There’s no real solution.”
Many of the worst-performing retail bonds are backed by private equity companies, according to Bloomberg News. Neiman Marcus, owned by Ares Management and the Canada Pension Plan Investment Board, has almost $5 billion in debt. Other troubled retailers backed by private equity firms include discount shoe store Payless, which filed for bankruptcy in April; Eastern Outfitters; and Gordmans Stores. “What a private equity companies does is they put in a small equity check, then have the company borrow a bunch of money, secured by the assets of the company,” Gorman said. “Rue21 is emblematic of everything that is going on with retail, especially the private equity overlay.”
Private equity investment in the retail sector picked up before the financial crisis, reaching a peak of $32 billion in retail investments in 2006, according to data from Dealogic. After a slump during the financial crisis and the recession, private equity investors ramped up their investments, reaching a post-recession peak of $11.7 billion in 2013. Given the struggles of retailers since 2016, it is no surprise that private equity firms are backing away from the sector. This year, only $452 million of private equity has been invested in retailing businesses, Dealogic noted.
The problems are not limited to retail. Marsh Supermarkets, an Indiana-based grocery chain that dates to the 1930s, filed for Chapter 11 bankruptcy protection on Thursday. Marsh was owned by PE firm Sun Capital, which bought the chain in 2006 for $325 million. More broadly, the role of private equity in corporate America has come under greater scrutiny, with critics questioning whether their investments lead to negative outcomes for workers, such as lower wages and benefits. The recent book Glass House by Brian Alexander, for example, examined the history of Lancaster, Ohio, the home base of glass company Anchor-Hocking. Two PE firms owned the glass factory at different times. Buyout firms have a goal of delivering returns to their investors, which means issues such as job security and living wages may factor as strongly into their operating plans. In Lancaster, a system that rewarded financial engineering was substituted for a more old-fashioned capitalism, where corporate leaders had deeper ties to the community.
Citations
- http://cbsn.ws/2pHbKt3 CBS News
- http://bit.ly/2qeMN9s – Motley Fool
Vice Media Prepares to Fund its Journey to the Future of TV
Some media entities may be struggling to keep their financial heads above water, but not Vice Media. The one-time alternative culture magazine that became a new-media colossus just keeps on getting bigger. The company is said to be working on a new round of funding that would give it a theoretical market value of more than $5 billion, or about $1 billion more than it was worth the last time it raised money in 2015, according to multiple news reports based on anonymous sources.
Sky News says one of the funders that is considering a $500 million investment in Vice is TPG Capital, an investment fund based in the U.S. with $70 billion under management that owns stakes in Airbnb and J. Crew, among other things. Others that are said to be interested include CVC Capital Partners, a private-equity fund that was spun off from financial giant Citicorp in the 1990s. Vice’s previous funding round came from Disney, which invested $200 million in December 2015, doubling its previous investment of the same amount, which was announced at the same time that Vice said it would take over a TV channel run by A&E Networks (a joint venture between Disney and Hearst). Those investments gave Disney about 20% of the company’s shares. Other investors include 21st Century Fox, which in 2013 bought what was then a 5% stake in Vice for $70 million.
According to Sky News, the investment round is designed to fund Vice’s global expansion, and a move into “scripted” or TV-style programming to go with its news and entertainment coverage. The financing push is seen by some as a prelude to an eventual initial public offering (IPO) that could take place later this year. In February, Bloomberg reported that Vice had hired Morgan Stanley and the Raine Group to help it raise money for a fund that would be used to develop and produce “scripted programming for TV, mobile devices, and movie theaters.”
Vice has said it wants to expand into offering more traditional types of programming in more than 80 countries this year, and has signed a number of deals with media companies and telecom providers in the Middle East and Asia for distribution. Whether Vice will eventually do an IPO has been the subject of much debate, fueled in part by comments from Vice CEO Shane Smith on the topic. In December, he said that the company had met with a number of big banks about the possibility of an IPO, and the company started filing audited monthly financial statements, often a precursor to going public.
Some analysts say there is also the chance that Smith could decide to sell the company rather than go public, however. Disney would make a logical candidate, since it already owns a significant portion of the shares, and is also looking for growth candidates that can compensate for the inevitable decline of more mainstream assets like ESPN. In a speech at the Edinburgh Film Festival last year, Smith said he faced a dilemma when thinking about whether to sell or IPO. “Do I do something that’s good with me, stay independent, or do I do something that’s good for the shareholders?”
Developing scripted-style TV shows, even short ones, can be an expensive proposition, which helps explain the need for funding. And the more Vice moves into TV content, the more it will run into other players such as Amazon, YouTube and Facebook, all of whom have their eyes set on being the future of TV. Vice is seen by many as a hedge for the traditional media companies that have invested in it, as they try to bridge the gap between the decline of their existing cable and other assets and the rise of the mobile, millennial, cord-cutting consumer.
However, whether Vice would make a good IPO remains to be seen. Smith has said in the past that Vice has a $1 billion annual revenue run rate, but little is known about the current state of its actual finances. Media companies can be problematic investments because most are based at least in part on an advertising-driven model. Much like the media business itself, the advertising industry is also going through unprecedented upheaval as a result of the Internet, with Google and Facebook controlling an estimated 75% of all digital advertising. Despite those challenges, BuzzFeed is also said to be considering an IPO either this year or in 2018. It has raised a total of $400 million in two rounds from Comcast-owned NBCUniversal, the last of which gave the company a theoretical market value of about $1.7 billion.
Citations
- http://for.tn/2qcazob – Fortune
- http://cnb.cx/2bg7DAW – CNBC
The Good News Is . . .
- The Commerce Department said retail sales increased 0.4% in April from March. Sales ticked up just 0.1% in March and fell in February. The increase suggests that consumers may spur faster growth in the April-June quarter after the economy barely expanded in the first three months of the year. The rise also indicates that the struggles of large retail chains, such as Macy’s and JC Penney, reflect changes in consumer buying patterns rather than broader economic weakness. Sales at department stores fell 0.2%, while online retailers reported sales growth of 1.4%, the strongest of any group.
- Nordstrom, Inc., a leading department store chain, reported earnings of $0.43 per share, an increase of 65.4% over year-earlier earnings of $0.26 per share. The firm’s earnings topped the consensus estimate of analysts by $0.16. The company reported revenues of $3.4 billion, an increase of 3.2%. Management attributed the results to growth in its online sales, contributions from its TD Bank partnership, and an increase in its customer base.
- Coach announced its acquisition of Kate Spade for $2.4 billion or $18.50 per share. It is the latest in a series of purchases by the company, which aims to build a luxury group in the vein of European groups like LVMH Moët Hennessy Louis Vuitton and Kering, with two major differences: an identifiably American aesthetic and price. “The acquisition of Kate Spade is an important step in Coach’s evolution as a customer-focused, multibrand organization,” Victor Luis, Chief Executive of Coach, said in a statement on Monday. Coach has recently struggled against heightened competition, its own discounting of products and a bloated store network. It is betting that its extensive experience in opening and operating specialty retail stores globally, and brand building in international markets, can unlock Kate Spade’s largely untapped global growth potential.
Citations
- http://bit.ly/Y4FaTF – US Dept. of Commerce
- http://cnb.cx/2lwnm3s – CNBC
- http://bit.ly/2qb3zbz – Nordstrom, Inc.
- http://nyti.ms/2pH3HeT – NY Times Dealbook
Planning Tips
Guide to Finding Foreclosed Investment Properties
Foreclosed homes can represent one way to invest in real estate that affords a unique opportunity to pay below-market value for homes which would not be available to you under normal circumstances. Below is a brief guide to finding foreclosed homes for sale. Remember that there are risks and difficulties associated with purchasing homes in foreclosure, so be sure to consult with your financial advisor to determine if this type of investment is appropriate for your financial goals and situation.
Pre-Foreclosures – A property is in pre-foreclosure after the mortgage lender has notified the borrowers that they are in default, but before the property is offered for sale at auction. If a homeowner can sell the property during this time, he or she may be able to avoid foreclosure proceedings, and its negative effect on their credit history and future prospects. As such, some homeowners are willing to negotiate. Pre-foreclosures are typically listed in county and city courthouse buildings. In addition, many online resources, including www.foreclosure.com, list properties that are in the pre-foreclosure phase.
Short Sales – Short sales occur when the lender is willing to accept less than what is owed on a mortgage. Borrowers do not necessarily need to be in default of the mortgage payments for a lender to agree to a short sale; however, they typically need to prove some type of financial hardship, such as the loss of a job, which is likely to result in default. Often the residence in question is underwater, meaning it is worth less than the outstanding mortgage balance. In order to qualify as a short sale, the lender must agree to “sell the property short” by accepting less than is owed, and the home must be listed for sale. These properties are usually advertised as short sales “pending bank approval.” Purchasing a short sale property is in most regards the same as a traditional purchase, but the language in the contracts will differ, specifying that the terms are subject to the lender’s approval. A bank may take several months to respond to a short sale offer, so the process can take considerably longer than a traditional purchase. Many real estate websites, including individual firms or listing services, offer the option to search by short sale.
Sheriff Sale Auctions – A sheriff sale auction occurs after the lender has notified the borrower of default and allowed a grace period for the borrower to catch up on mortgage payments. An auction is designed for the lender to quickly get repaid for the loan that is in default. These auctions often occur on a city’s courthouse steps, managed by the local law-enforcement authorities. The property is auctioned to the highest bidder at a publicly announced place, date and time. These notices can be found in local newspapers and in many online locations by performing a search for “sheriff sale auctions.”
Bank-Owned Properties – Properties that do not sell at auction revert back to the bank; that is, they become Real Estate Owned (REO) properties. They are often managed by a bank’s REO department, which maintains a listing of the bank-owned properties. Online sources such as www.realtytrac.com have extensive listings that can be searched by city, state or zip code.
Government Owned Properties – Some homes are purchased with loans guaranteed by the Federal Housing Administration (FHA) or the Department of Veterans Affairs (VA). When these properties go into foreclosure, they are repossessed by the government and sold by brokers working for the government. A government-registered broker must be contacted to purchase a government-owned property. Buyers can research such properties on www.hud.gov.
Citations
- http://bit.ly/2qbWEhW – Zillow
- http://bit.ly/2pHxh4D – TheBalance.com
- http://bit.ly/2qBmE7E – Investopedia
- http://abcn.ws/2raQqxd – ABC News
- http://bit.ly/2qb1wEh – creonline.com
