Buyouts Saddle Stressed Retailers with Debts They Can't Pay
Sports Authority was loaded with debt, a hangover from the 2006 LBO led by Leonard Green & Partners
Sports Authority Inc. learned the hard way that buyout debt can be a drag.
Once the biggest U.S. sporting-goods retailer, the company found it difficult to be nimble enough to stay ahead of rivals. In retailing, consumer trends shift quickly, stores constantly need upgrades and a surprise like a winter storm can make it necessary to act fast to salvage a big shopping weekend. But Sports Authority was loaded with at least $643 million in debt, a hangover from the $1.4 billion leveraged buyout in 2006 by investors led by Leonard Green & Partners.
Sports Authority’s bankruptcy plan includes closing 140 of its 463 stores, leaving workers jobless and shopping centers across America anchorless.
Other retailers filing recently for bankruptcy include Deb Shops Inc., a 2007 buyout by Lee Equity Partners, and Dots Stores Inc., a 2011 purchase by Irving Place Capital. Also headed for the debt wall are Claire’s Stores Inc., bought by Apollo Global Management in 2007, and Gymboree Corp., a 2010 Bain Capital Partners acquisition. For more on distressed retailers, see Retail Outlook: More Deals, More Bankruptcies Ahead and American Apparel's Bankruptcy Underscores Challenges for Retailers.
Such struggles make it less likely for private equity firms to target retail chains in the future, said Michael Appel, founder of Appel Associates, a consulting firm that works with retailers.
“It’s just not an industry that can tolerate a lot of leverage,” Appel said. Even without owing a ton of money, retailers can be slowed by fixed costs such as rent, salaries and inventory, he said.
A representative for the restructuring firm Gordon Brothers Group declined to comment for Dots Stores. So did a Sports Authority representative. Spokesmen for Gymboree, Deb Shops and Claire’s didn’t respond to requests for comment.
Buyout targets are deeper underwater than most retailers by at least one measure -- net-debt-to-Ebitda ratio, which calculates the number of years a company would need to repay debts if its numbers remained constant. (Ebitda is earnings before interest, taxes, depreciation and amortization.) Children’s apparel chain Gymboree has a ratio of 13, according to data compiled by Bloomberg; Claire’s, which caters to teenage and pre-teen girls, scores 49.5, the data show. The average ratio for the 32 companies in the S&P 500’s retailing group is 1.2.
The obligations loaded on these companies aren’t the sole cause of their struggles. To Dina El Mahdy, an accounting professor at Morgan State University in Baltimore, they’re not a reason at all. Poor management and lender monitoring, not debt, drive companies into distress, she said. Leveraged buyouts provide a cheaper cost of capital and add value, she said.
“You can’t say high leverage ends up with high default,” she said. “There are many, many things in between.”
Some in the industry see high levels of indebtedness as a new normal. Many retailers struggling now have been slowing for years, said Sandeep Mathrani, chief executive officer of mall-owner General Growth Properties Inc.
“If you look at companies that haven’t done LBOs, when they start to slide down the path from a productivity perspective, you start to see them take on their own debt,” Mathrani said. “I don’t think the leveraged buyout is the culprit.”
Bankruptcies can be favorable to malls because it can allow them to replace struggling retailers with better stores that may be able to shoulder higher rents, Mathrani said.
In the fast-evolving world of retail, where the one constant is the need for investment, retailers laboring under heavy debt are at a disadvantage.
“Doing it right is very expensive,” said Raya Sokolyanska, an analyst with Moody’s Investor Service in New York. “Limited financial flexibility has been a reason why a lot of these retailers haven’t been able to fight back and position themselves correctly for growth.”
That’s why lenders and investors may back off the retailing industry somewhat and we’ll see “far less activity” on the buyout side, said Durc Savini, senior restructuring banker at Guggenheim Securities in New York.
Private equity firms bet big on retail in the 2000s, taking merchants such as Claire’s, Toys “R” Us and Linens ’n Things private. Americans were spending growing amounts to buy and furnish homes, and the merchants’ new owners counted on that trajectory continuing long enough to resell the businesses for a worthwhile profit. When the recession came, that option was mostly off the table.
Tepid Christmas results last year scared private equity executives, and refinancing has gotten more expensive, further deteriorating companies’ credit, Sokolyanska said.
“Some things that may have been considered a slam-dunk two years ago are now being looked at as not so easy anymore,” said Michael McGrail, chief operating officer at Tiger Capital Group in Boston.
That problem is especially acute for retailers selling other companies’ products. With the rise of smartphones, shoppers can compare prices in an instant. While competitors such as Dick’s Sporting Goods Inc. were sprucing up stores and building their online businesses, Sports Authority was falling behind, said Ryan Severino, senior economist at REIS Inc.
Charles Tatelbaum, a bankruptcy attorney with Tripp Scott in Fort Lauderdale, Florida, said he expects companies acquired through leveraged buyouts to be well represented in the next round of retail bankruptcies because a firm with high debt is running in a three-legged race.
“Based upon the anatomy of an LBO, it’s handicapped from the beginning,” he said.
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