In most stories about retail these days, private equity is depicted as the bad guy—dooming operators by piling on debt. And not without reason. Buyout firms have been behind many of the industry’s biggest bankruptcies. In fact, 10 of the 14 biggest retail bankruptcies since 2012—as measured by liabilities at the time of Chapter 11 filing—were buyout-backed chains. Topping that list is the $7.9 billion filing, in September, of Toys “R” Us (which Bain owned as part of a consortium that included KKR and Vornado Realty Trust). But the roster of buyout busts includes a host of familiar brands such as another Bain investment, Gymboree ($1.4 billion filing), as well as Sports Authority ($1.5 billion), Payless ShoeSource ($1 billion), and Nine West Holdings ($1.4 billion).
More carnage is on the way. In March, Moody’s said it expected a wave of new retail defaults this year, with a surge in debt maturities coming due in 2019 and 2020 and rates on the rise. The credit rating agency’s current watch list of 18 retailers deemed “distressed”—with a debt rating of Caa1 or worse—includes PE-owned names such as J. Crew, Guitar Center, and Neiman Marcus. The retail reckoning continues.
But as the example of Canada Goose shows, private equity investors can offer retailers a huge boost when things go right. PE firms have helped speed up the evolution of dozens of companies in ways that now seem to be helping them stay competitive in the much-changed, Amazon-disrupted landscape.
The bottom line: When you go to your local shopping center, there’s a good chance that the finance whizzes of private equity have had a hand in the empty spaces left by defunct retailers, as well as in the ones that are surviving and thriving. Here’s how they’re reshaping the mall.
The classic playbook for private equity is to buy a company using an ample dose of borrowed money, then unlock value either by getting more efficient operationally or selling off units, or both. Typically, the PE investors will look to unload the company after three to five years via a public offering (with the proceeds often used to pay down debt) or a sale. The debt involved acts as a lever that boosts returns when things go well, but it can be an albatross when things are going south. The borrowing can also help finance the large management fees and dividends that often represent a big chunk of a buyout firm’s returns.
An unsentimental view of this debt-powered approach is that it merely hastens the demise of chains that are doomed to fail. Such was probably the case for some of the recent retail bankruptcies. “Many of them would have gone out of business anyway,” says Erik Gordon, a professor at the University of Michigan’s business school and faculty adviser to the university’s venture capital fund.
Indeed, the retail fails in recent years have been disproportionately concentrated among mall-based apparel chains, such as Wet Seal, American Apparel, and Aéropostale, in a sector in which few companies are thriving, or retailers that were slow to build an online presence, like Sports Authority or outdoor-gear purveyor Gander Mountain.
The sheer number of struggling retailers linked to private equity today, however, reflects a burst of optimism about retail in the PE industry more than a decade ago. Between 2006 and 2008—before the global financial crisis tanked the markets and e-commerce hit critical mass—private equity firms sat on record amounts of money pumped in by gigantic investors like pension funds and wealthy individuals. So they went shopping. The rationale was that buyout firms could make a mint by getting retailers leaner—and that soaring real estate prices limited the risk. Chains could always sell well-located stores to raise cash if needed. The result was a historic retail buyout boom: In 2006 and 2007, PE firms made $108 billion worth of acquisitions involving 300 U.S. retailers of various sizes, according to Dealogic. That’s 10 times the dollar value of PE retail acquisitions made in any other two-year period since the 2001 recession. A decade later, the 2016–17 combined deal volume was a mere $13 billion.