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Analysis: Private equity ownership common in retail bankruptcies

The Payless ShoeSource chain, which has stores on

The Payless ShoeSource chain, which has stores on Long Island, filed for bankruptcy in April 2017 with liabilities of $1 billion to $10 billion. Photo Credit: Newsday / Aisha Al-Muslim

Long Islanders have seen major retailers file for bankruptcy in the last few years, bringing an end to well-known chains such as sporting goods retailer Sports Authority, apparel retailer The Limited, teen retailer Wet Seal and Pathmark and Waldbaum’s supermarkets.

Clothing retailer Aéropostale has clung to life after filing for bankruptcy, closing more than 150 stores, laying off workers and being sold. American Apparel is winding down its business.

The loss of stores where people bought clothing, sporting equipment or food is highly visible evidence of the problems at brick-and-mortar chains, including falling sales, growing debt loads, oversaturation of stores — and the continued growth of online rivals like Amazon.

What is less visible is that each of these chains was owned by a specific type of investor that relies heavily on borrowed money: private equity firms.

These are risky times for retailers to be owned by private equity firms because of the high debt loads the retailers must shoulder at a time when their ability to pay it off is weakening, bankruptcy and retail experts say.

“If you add the struggles of the retail industry, increased debt has created an environment that accentuates the likelihood of failure,” said bankruptcy expert Chuck Tatelbaum, a senior attorney at Fort Lauderdale-based law firm Tripp Scott.

Private equity firms, also known as buyout firms or financial sponsors, generally acquire companies through “leveraged buyouts.” These are deals in which the buyer contributes a small amount of cash toward the purchase price and borrows the rest, often using the target company’s real estate as collateral.

The burden of paying back the debt is on the target company, not the buyout firm.

Private equity firms typically own companies for five years and then sell them either to other buyers or to public investors in an initial public stock offering, experts said. The goal in either case is to return investment capital and generate profits for their investors, which are typically public pension funds, large corporations, charitable funds, university endowments and other institutional investors.

Private equity deals expanded rapidly in recent years to take advantage of low interest rates. But that expansion occurred just as brick-and-mortar retailers found their business model under severe stress.

“When there is a leveraged buyout, there is no margin of error in the retail operation,” Tatelbaum said.

A Newsday review of court documents, news reports and bankruptcy data from several research, financial and consulting firms found that 43 large retail or supermarket companies, which owned chains with 10 or more locations, have filed for bankruptcy in the United States since January 2015. The 43 companies controlled 52 brick-and-mortar chains. Twenty-one of the companies had stores on Long Island. Retailers selling only online and restaurants were excluded from the count.

Of those 43 companies, 18 — more than 40 percent — were owned by private equity firms. The remainder were public or private companies or owned by a hedge fund.

Newsday relied on data from S&P Global Market Intelligence, BankruptcyData, AlixPartners and Moody’s Investors Service.

Defenders of private equity firms say they turn acquired companies into healthier businesses and provide them with long-term capital.

“More often than not PE firms . . . will strengthen the operation and find ways to reduce waste,” said James Maloney, vice president of public affairs for the American Investment Council, a Washington, D.C., private equity industry trade group.

‘Vampire investing’

But the firms’ typical methods of loading their acquisitions with heavy debts, and extracting large cash dividends from them, have generated criticism.

Private equity firms “are going to try to extract as much value as possible from the company prior to its filing bankruptcy,” said Barry Ritholtz, chairman and chief investment officer of Manhattan investment advisory firm Ritholtz Wealth Management. “It is vampire investing. You are investing in a company that is living, suck out as much as you can and then be done with it.”

But Maloney says buyout firms want to avoid bankruptcy for their investments because “if a company enters bankruptcy, that is a loss to the” private equity firm, Maloney said. Private equity firms “are only successful if their portfolio companies are successful.”

Retailers controlled by private equity that have not filed for bankruptcy, but are struggling to turn around their businesses because of their debt load, include luxury retailer Neiman Marcus, apparel retailer J. Crew, accessories and jewelry retailer Claire’s Boutique , and children’s apparel chain Gymboree, according to retail consulting and investment firm Davidowitz & Associates Inc. of Manhattan, Moody’s and news reports.

And there are prosperous retailers, such as Hudson’s Bay Co., which owns Lord & Taylor and Saks Fifth Avenue, that have been owned by private equity companies.

Scores of bankruptcies

But bankruptcies have surged this year, with 12 major retailers filing, including high-end clothing retailer BCBG Max Azria and consumer electronics chain RadioShack. Last year, 15 filed for bankruptcy and 16 in 2015, according to the Newsday analysis.

“When retailing is in a downturn and bankruptcies and store closings are all over the place, if you go into one of these private equity deals, you are more likely to collapse,” said retailing consultant Howard Davidowitz, chairman of Davidowitz & Associates.

Bankruptcy protection allows companies to reorganize their operations, reject or restructure leases, renegotiate their debt and sell assets or the company, said bankruptcy expert Marc Hamroff, managing partner of the Garden City-based law firm Moritt Hock & Hamroff.

The private equity firm with the most retailers that declared bankruptcy since 2015 was Philadelphia’s Versa Capital Management, according to the Newsday analysis. Versa, which specializes in distressed investments, has controlled clothing and footwear retailer Bob’s Stores, outdoor clothing and equipment retailer Eastern Mountain Sports and Wet Seal, all of which had stores on Long Island. Versa declined to comment.

In February, Irvine, California-based Wet Seal filed for Chapter 11 bankruptcy protection. It closed all of its 171 stores and laid off nearly 3,700 employees. In March, the chain’s intellectual property was acquired for $3 million at a bankruptcy auction by Boston investment firm and liquidator Gordon Brothers Group, which plans to rebuild the brand.

Wet Seal had previously filed for bankruptcy in January 2015, and Versa soon acquired the company out of Chapter 11 for $7.5 million.

Another Versa investment, Meriden, Connecticut-based Eastern Outfitters LLC, the corporate parent of Bob’s Stores and Eastern Mountain Sports, filed for bankruptcy protection in February. A $101 million cash offer from British sporting goods retailer Sports Direct to buy about 50 of the stores was approved by a bankruptcy judge on Wednesday. The chains have already started closing other stores.

Eastern Outfitters had acquired Bob’s Stores and Eastern Mountain Sports following the April 2016 bankruptcy of Vestis Retail Group LLC, the Versa-backed previous owner of the two chains. Versa bought them back for $1.5 million in cash and the forgiveness of $35 million in loans that had been made to the chains.

The July 2015 bankruptcy of Montvale, New Jersey-based supermarket operator Great Atlantic & Pacific Tea Co., also known as A&P, parent of the Waldbaum’s and Pathmark stores, hit Long Island hard. A&P was owned by private equity firms Mount Kellett Capital Management, of Manhattan, and Yucaipa Companies, a Los Angeles firm led by billionaire Ronald Burkle.

A&P listed liabilities — debt and other obligations — of more than $1 billion in its 2015 bankruptcy filing. It had first filed for bankruptcy in 2010 before emerging in 2012 as a privately held company.

Mount Kellett did not respond to requests for comment.

Yucaipa “owned such a small sliver of” A&P, said spokesman Frank Quintero. Bankruptcy court records show Yucaipa owned nearly 23 percent of A&P. “We weren’t in control of that company for many years.”

Yucaipa is described as a private equity firm by financial reporting organizations. Quintero said it is an investment firm, not a private equity firm, because it mostly uses the founder’s capital, rather than investors’ money.

“We hold businesses for a long time,” Quintero said. “We buy businesses to grow them and help them.”

The closure of nearly 300 A&P-owned stores affected about 28,500 employees in the Northeast.

John Candia, 29, of East Meadow, worked at the Waldbaum’s in Jericho. A a part-time customer service supervisor, he was with the chain for 11 years. He was unemployed for a year until he found a part-time job in November as a cashier at a Kohl’s store.

“People don’t really realize how much closing of stores hurts us, not just financially, but emotionally and mentally,” said Candia, who still can’t bring himself to visit the Hmart supermarket that replaced his Waldbaum’s. “To try to forget what happened is the hardest thing.”

Topeka, Kansas-based shoe chain Payless ShoeSource, owned by Golden Gate Capital and Blum Capital Partners, two San Francisco private equity firms, filed for Chapter 11 bankruptcy this month with $1.5 billion in liabilities. Payless said it plans to reduce its debt by almost 50 percent. It has started to close nearly 400 of its more than 4,400 stores as part of the reorganization, including three on Long Island.

Payless paid nearly $350 million in debt-funded dividends to its private equity owners and their investors since the company’s 2012 leveraged buyout, Moody’s reported in March.

Golden Gate Capital declined to comment. Blum Capital Partners did not respond to requests for comment.

Sports Authority, of Englewood, Colorado, was bought by Los Angeles-based private equity firm Leonard Green & Partners in 2006 for $1.3 billion. Sports Authority filed for Chapter 11 in March 2016 with liabilities of $1.1 billionand has closed all of its more than 450 stores and laid off about 14,500 people.

Leonard Green did not respond to requests for comment.

The number of retailers that Moody’s considers “distressed” is at its highest level since the Great Recession, it reported in March. Moody’s identified 19 distressed retailers that it has rated, including Payless, department store chain Sears and supermarket chain Fairway, that had more than $3.7 billion in public debt maturing in the next five years.

“When things are good, you can handle the debt,” Davidowitz said. “When it gets bad, debt kills you.”

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