Bloomberg

UPDATED -- The belabored turnaround attempt of American Apparel Inc. includes store closures, apparel updates, a modified loan, and the ouster of founder Dov Charney, who is suing the business. But those moves proved too little too late, and the business filed for Chapter 11 bankruptcy protection on Oct. 5, following a notice from the New York Stock Exchange warning of a potential delisting. Experts expected the chain to be one of several likely to fold under pressure. Overexpansion has been a problem for American Apparel and other retailers, as pre-Internet era brick-and-mortar plans prove tough to pare down because of the long-term commitment required by commercial real estate leases. 

Potential bankruptcy cases and subsequent lease dumping will give dealmakers the opportunity to buy the businesses themselves, but also to scoop up groups of leases at a time, renegotiate them with better terms and grow healthy companies.

In addition to American Apparel (NYSE: APP), retailers Abercrombie & Fitch Co. (NYSE: ANF), American Eagle Outfitters (NYSE: AEO), Sears Holdings Corp. (NYSE: SRH) and Wet Seal have all found themselves restructuring real estate holdings as part of larger turnaround plans, to varying degrees of success. See below for in-depth profiles of all five struggling retailers.

“Generally retail is dramatically overstored,” says Greg Segall, CEO of Versa Capital Management LLC (left), the Philadelphia-based private equity firm that bought teen clothing chain Wet Seal out of bankruptcy in April. “Overstoring” occurs when a retailer has too many brick-and-mortar locations, or sometimes if the locations are too large. “Real estate can be a leader in creating distress, or it can become a second anchor as your real estate struggles under a failed strategy,” he says.

A handful of developments in September underscore the tough times retailers are facing. Department store Macy's (NYSE: M) announced that it will close between 35 and 40 underperforming locations this fall, and surfwear brand Quiksilver filed for Chapter 11, immediately announcing store closures. And Joe's Jeans, the denim retailer that landed on Mergers & Acquisitions' Distressed Comapny Watch List after it paid $98 million to acquire jeans-brand Hudson and then defaulted on loans, is selling itself for a paltry $67 million. (Separately, Hudson will be sold for $13 million.) Meanwhile, reports circulated that fast-fashion retailer Forever 21 is reconsidering large store footprints. The brand has a 90,000 square-foot store in New York’s Times Square and a 125,000 square-foot location in Las Vegas, but reports suggest those sizes have hurt the brand’s profitability and are causing it to turn to outside investors for a new loan.

Retailer unraveling opens opportunities for dealmakers, both for acquiring and turning around distressed companies, and for scooping up the groups of leases often jettisoned during bankruptcies. Overstoring will continue to contribute to bankruptcy filings, especially when coupled with other forms of distress. The evidence is already apparent in the Chapter 11 

A slew of retailers filed for bankruptcy right after the 2014 holiday season, and another group is expected to do the same in early 2016. Retailers tend to file for Chapter 11 after the holiday sales season – either using cash earned during the season to pay restructuring costs, or using the period to decide if they need bankruptcy protection.filings of retailers RadioShack, Wet Seal, Delia’s, Dots, Deb Shops, Body Central and others.

“The American household is still in the process of tightening its belt, the cross-currents of Internet competition are formidable, and we haven’t yet begun to see all of the consequences,” says James Tancredi, a partner at Day Pitney LLP who focuses on restructuring.

Overstoring is something modern retailers struggle with all the time, because of the ever-changing habits of today’s consumers, as they calibrate and recalibrate how many retail venues they should have.

Real estate isn’t the only source of money problems for these businesses. Changing consumer-shopping habits, fast fashion and e-commerce are also behind the recent shakeout of mall-based retailers. (See related graphic.) For more on dealmaker interest in e-commerce businesses, read Retail Reboot: Investors Snatch Up E-Commerce Services).

“We’re in a period of great transition,” says Tancredi. “It’s not distress, it’s transition.” But he notes that ending the journey on the gloomy side, in a place where not all retailers keep their doors open, is more likely than not.

“A direct result of Internet competition is the need to reduce fixed costs,” says Tancredi. “The cost of physical facilities is one of the most significant costs in retailing – Amazon can sell you something cheaper because it doesn’t have a frilly store on Madison Avenue.”

Pre-bankruptcy, retail owners should attempt negotiations with landlords regarding lease costs, though that won’t always succeed. Lease commitments often make it difficult to manage property holdings outside of a restructuring process, which is why they are frequently addressed in the first steps of a bankruptcy proceeding.

But after going through the most recent recession, landlords may be more willing to haggle so they can avoid having to find new tenants.

“The astute landlords are a bit more flexible in terms of reaching reasonable accommodations during a period of distress or great transition because of concerns about retention,” says Tancredi (left). “They understand what the outcomes are that are likely to be achieved in a bankruptcy, so that avoiding a bankruptcy is oftentimes a motivation to enter into an adjustment.”

Versa, a firm that specializes in acquiring and reconfiguring distressed retailers, restructures the portfolio company’s real estate holdings “almost every time,” Segall says.

“Retailers tend to love all their stores, it’s like they’re their children – they’re all beautiful kids,” Segall says. But the underperformers need to be closed, with business savvy trumping sentimental attachment. “If you imagine that what we do is similar to an emergency room, the patient comes in … with all these problems … we didn’t make them that way – we are just trying to prescribe the way to get back to health,” Segall says.

That approach, Segall notes, has the benefit of hindsight. “If I had been the CEO of that retailer, I might have picked the same bad stores. At the end of the day, it’s all business judgment.”

Versa’s experience with retail real estate restructuring includes working on plus-size women’s retailer Avenue. The brand blamed a 2012 bankruptcy on lease costs, which it says were high because they were signed before the recession. Versa bought the company out of Chapter 11 in April 2012.

“We were able to quickly close over 100 locations,” Segall says. And since then, Avenue has turned around to growth. “They’ve been able to go into those locations we closed and operate profitably,” Segall says.

 

Here’s a look at five retailers and the role that real estate plays in unique restructuring processes:

 


 

1. Abercrombie & Fitch


As Abercrombie & Fitch Co. (NYSE: ANF) tries to distance itself from the high-school bully reputation instilled under former CEO Michael Jeffries, the company has undertaken a massive turnaround, complete with store closures, apparel design updates --losing most of those well-known logo T-shirts-- and staffer moves.

The revamp attempt comes after years of questionable ethical practices under Jeffries, which coupled with a tough retail climate and an even tougher teen retail market has led Abercrombie to post significant sales declines.

Sales at the brand have been sliding for years. Ever the optimist, Abercrombie had some good news to announce in the Aug. 26 second-quarter earnings call: that sales declines weren’t as bad as was expected. The retailer posted sales declines of 7 percent at Abercrombie, and 1 percent at Abercrombie-owned Hollister.

“Our results exceeded what we signaled in our first quarter earnings call and give us confidence that we are on the right track, although we recognize that we still have much to achieve,” said Abercrombie chairman Arthur Martinez, formerly of Sears, on the retailer’s earnings call. The announced sales decline amounts to $817.8 million.

Over the past several years Abercrombie has closed a few hundred stores. But as part of the company’s turnaround plan, it is working to update others. Both Abercrombie and Hollister stores are well known for low lighting, loud music and cologne-tinged air.

Following the departure of Jeffries, store employees are referred to as “brand representatives” instead of “models,” the shirtless models hired for events are no more and the very sexual advertising has been toned down.

The brand has hired some fashion heavyweights to improve its styles: Kristina Szasz, formerly of Tommy Hilfiger, and Karl Lagerfeld as head designers for women’s styles; Kurt Hoffman, formerly of Club Monaco, as general manager for men’s; Aaron Levine, also formerly of Club Monaco, as head of men’s design; Monica Margerum, formerly of Kohl’s, as head of planning operations; and Amy Sveda, formerly of Carter’s, as general manager for Abercrombie kids.

The hope is that the flock of well-regarded designers can breathe new life into Abercrombie’s offerings, which even with the most recent updates remain far from impressive. The company has been removing logos from most of its clothes to move its attire into 2015, but not everyone thinks Abercrombie’s design is moving in the right direction.

“This does not really go far enough and, indeed, the net impact has been to leave the fall collection looking ill-defined, bland and basic,” says Neil Saunders, CEO at retail research agency and consulting firm Conlumino.

Aside from apparel problems, the brand still has a perception problem, and it has been dragged very publicly into several lawsuits, including one that it lost in the U.S. Supreme Court after it didn’t hire a Muslim woman because she wore headscarf for religious reasons.

 


 

2. American Apparel


American Apparel, which is closing locations as part of a long-term turnaround plan, has spent the past year and a half on a downward spiral so slippery it ended in bankruptcy. In September, the brand received a delisting notification from the New York Stock Exchange calling future operations "questionable," and in October, it filed for bankruptcy protection. The company faced Chapter 11 rumors back in 2011, but the basics purveyor was able to skirt a filing. American Apparel declined to comment for this story.

As vendors report late payments (while employees report armed guards), American Apparel might not have the cash to operate for the next 12 months, the company admitted in its quarterly filing with the U.S. Securities and Exchange Commission on Aug. 17.

In that same SEC filing, the brand also said sales suffered, with a 17.4 percent year-over-year decline, because it didn’t have enough new products to sell. For a retail company with the primary goal of apparel sales, that is problematic.

“It’s like saying, ‘I died because I forgot to breathe,’” says Saunders, of American Apparel’s statement. “If you don’t have new product, of course you’re not going to make sales.”

The company's pre-arranged Chapter 11 plan, which has not yet been approved by the U.S. Bankruptcy Court for the District of Delaware in Wilmington, contemplates a debt-equity swap that would put lenders, including hedge fund Standard General LP, in control. For more on the bankruptcy filing, see American Apparel Files for Bankruptcy, Plans Debt-Equity Swap. Reports that American Apparel was calling on bankruptcy advisers to talk about a potential deal circulated in late August.

Before the filing, American Apparel announced increased financial flexibility, supplied in the form an updated $90 million loan. That capital includes about $40 million from the company’s previous lender, Capital One Business Credit Corp., which had provided American Apparel with a $50 million asset-based revolving credit facility. Wilmington Trust NA is the administrative agent for the amended loan, with existing creditors Standard General, Monarch Alternative Capital LP, Coliseum Capital LLC and Goldman Sachs Asset Management LP included in the loan syndicate.

The Los Angeles-based business has to pay multi-million dollar interest payments twice a year – one in October and one in April. Just before the April payment was due, New York hedge fund Standard General stepped in and loaned the company $15 million. 

“It’s just generating too great a loss, and it may have done some renegotiations, but its loans don’t allow it to sustain that kind of loss-making,” Saunders (right) says.

The retailer announced it was implementing $30 million in cost-cutting initiatives in July, including store closures. Updating its apparel lineup is part of the struggling brand’s turnaround plan, as it tries to shed an overtly sexual image.

American Apparel has been working to distance itself from ousted founder Dov Charney (below), who formed the Los Angeles-based chain in 1989. Charney has been slapping his brainchild with lawsuit after lawsuit since he was removed from his post in June 2014 and then again in December, amid allegations of behavioral misconduct. A judge recently ruled in American Apparel's favor in one of the suits -- saying the company isn't responsible for fees Charney incurred while defending himself from alleged breaches of an agreement. 

In 2014, Standard General picked up an American Apparel stake and Charney handed the hedge fund his voting power in exchange for an internal conduct review (Standard General today owns less than 1 percent of the business). The process ended in his termination, and overlapped with American Apparel’s fielding of a buyout offer from New York private equity firm Irving Place Capital that valued the business at more than $200 million, according to a source with knowledge of the transaction. (Standard General declined to comment for this story, and Irving Place did not respond to requests for comment.)

That buyout window has all but closed for American Apparel, since most acquirers want to avoid an asset so prone to collapse under a heap of financial, apparel and legal problems.

The bankruptcy filing could very easily work in American Apparel’s favor. It gives the brand a few months to keep the lawsuits at bay, plus give it the breathing room to restructure. Coming out of bankruptcy a reorganized company, especially under new ownership, could also help the brand figuratively sign its divorce papers from Charney, whose lawsuits would remain tethered to the old business.

 


 

3. American Eagle


Supplying a glimmer of hope in the teen, mall-based, retail space, American Eagle Outfitters (NYSE: AEO) posted a 20 percent profit increase, year-over-year, in the second quarter. That profit was driven by an 11 percent increase in sales.

Those numbers look so strong because of how weak profits were before. American Eagle’s second quarter of 2014 saw a 7 percent sales decline, SEC filings show.

American Eagle’s good news comes in the midst of a massive turnaround--one that, judging from the numbers, seems to be working.

Store closures have been part of American Eagle’s restructuring too – back in 2014, the brand announced it was closing 150 locations. In addition to store closures, American Eagle has downsized office space and corporate overhead.

Though things are looking up for the brand, its stock price took a hit after chief marketing officer Michael Leedy stepped down. Leedy was responsible for some of the retailer’s e-commerce efforts. 

He also orchestrated the end of airbrushing on American Eagle's lingerie models for the Aerie line, in an extremely well-received advertising campaign called Aerie Real. That segment of American Eagle's business is also doing well, with an 18 percent sales increase year-over-year in the second quarter, SEC filings show. 


 

4. Sears 

In August, Sears reported a profit for the first time in three years, and real estate was the reason. The troubled department store posted $2.7 billion from forming Seritage Growth Partners, a real estate investment trust (REIT) that conducted a sale-leaseback deal with Sears’ store locations.

Sears is constantly honing real estate holdings. “When we make a decision to close a store we believe that is a vlue creating decision based on the store’s underperformance,” Riefs says.

“When we make a decision to close a store, we believe that is a value-creating decision, based on the store’s underperformance,” Sears spokesperson Howard Riefs tells Mergers & Acquisitions. Unlike most retailers, which lease their locations, Sears has owned property historically – giving it the flexibility to conduct the Seritage transaction. The company is constantly honing real estate holdings. As the company adjusts store footprints, Seritage may place new tenants in the excess space.

“The passage of time has often turned legacy properties into properties that are on valuable streets and avenues, where they can be assets,” says Tancredi, speaking generally. “Owning property is a mixed bag. They longer you’ve owned it, unless it has been run into the ground in a bad neighborhood, there is some reasonable likelihood that there’s some value.”

The Seritage deal was financed in part by CEO Edward Lampert’s hedge fund – which paid $745 million for common shares and limited partnership units, and in part by mortgage and mezzanine loan held by Sears and Kmart subsidiaries. Though Sears has stated the REIT formation is in its best interests, multiple shareholder lawsuits have been filed as a result, SEC filings show.

There are concerns about the value of Sears’ locations, some of which are in less-than-desirable rundown areas, and malls lacking foot traffic.

Lampert (right) has been involved with Sears since the company’s 2005 merger with Kmart. He’s been in place as CEO since 2013, and under his watch, undergoing what he refers to publicly as a “transformation,” the company has divested a handful of assets, including Land’s End Inc. (Nasdaq: LE), Sears Hometown & Outlet Stores Inc. (Nasdaq: SHOS) and Sears Canada Inc. (Nasdaq: SRSC).

In July, Sears also restructured part of its debt so that $1.3 billion matures in April, with the $2 billion previously scheduled to mature in April, pushed to mature in 2020.

Sears, originally Sears Roebuck & Co., has been around since 1916 – decades before the dawn of the Internet. The business is known for selling a wide range of products, including tools, lawnmowers, appliances and apparel, all of which can be purchased online, either through Sears or competing retailers.

The chain has decided to distance itself from some low-margin categories, including consumer electronics – a segment where Sears has incurred losses since 2010. Sears is also moving toward a membership model, working to move into smaller store locations, and leasing parts of stores to other retailers that could potentially attract more foot traffic. Digital modernization has also been key for Sears. It has developed a rewards program, mobile platforms, and the ability for customers to buy online and pick up in store, plus digital kiosks and checkout points.

Sears prides itself on its financial maneuvering: “The company continues to demonstrate that it has the financial flexibility to fund its transformation and meet its obligations,” Sears says, reporting its second quarter results on Aug. 20. But experts agree that financial maneuvering is not generally how a retailer regains profitability.

“One thing Sears has not done in years is grow same-store sales,” says Saunders. “The only way that company is going to survive and move back into profitability is to grow in-store sales.”

Sears says it isn’t going the way of Circuit City, Borders and RadioShack, and pointed out on numerous occasions that it has been declared all-but dead before, and pulled through.

But the department store still hasn’t figured out how to reverse consistent sales declines, which endured even into the profitable second quarter with Kmart and Sears Domestic store sales down 7.3 percent and 14 percent, respectively. It’s worth noting that the second quarter supplied Sears with the fourth consecutive quarter of improved Ebitda performance, Riefs says.

“You can be fancy with your financial mechanisms, but ultimately, you need to grow your way to profitability, not save your way to profitability,” says Saunders.

 


 

5. Wet Seal


For post-bankruptcy, mall-based retailer Wet Seal, real estate restructuring has played a crucial role.
The teen retailer shut 338 stores in January. Within the month it was in bankruptcy. Now, under Versa’s ownership since April, Wet Seal operates about 170 of the best-performing locations. 

“Their concept was to take advantage of the restructuring process to retain exposure to their best mall properties,” Segall says. “Reducing the number of store locations and the cost of those that we kept is certainly a positive contributor to the company, even though we have a lot of other things we have to see if they work out.”

Wet Seal, headquartered in Foothill Ranch, California, filed for Chapter 11 after incurring $150 million in losses in two years, and defaulting on $27 million in notes. “The continuing fundamental shift in consumer behavior away from traditional mall shopping toward online-only stores and increased competition throughout the specialty retail fashion industry have created a difficult operating environment,” Wet Seal CFO Thomas Hillendrandt said in bankruptcy documents.

The brand’s store count is in the hands of management, according to Segall, who says he suspects they will be both opening and closing stores.

Going forward, e-commerce will play a role of increased importance for Wet Seal. Online sales lately make up about 15 percent of Wet Seal’s business, compared to about 5 percent before the bankruptcy filing, according to Segall.

“E-commerce’s relative importance is larger,” Segall says.

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