BARBARIANS AT THE MALL
Sep 1, 2006 12:00 PM, By Elaine Misonzhnik
At least for now, leveraging real estate to complete a deal looks like a better bet than issuing junk bonds, which is what the raiders of the 1980s did. When Campeau bought Federated, he used 97 percent leverage, giving the balance sheet a 32:1 debt-to-equity ratio. And this was at a time of high interest rates — Federated's junk issues carried coupons of 16 percent and 17.75 percent, saddling the chain with interest payments well exceeding its cash flow.
When Apollo and NRDC bought the struggling home furnishings chain Linens ‘n Things for $1.3 billion last year, they committed to providing at least $633.4 million in equity or roughly 48 percent of the purchase price. Texas Pacific Group and Warburg Pincus paid $1.55 billion, or approximately 30 percent in equity, when they bought Neiman Marcus for $5.1 billion in May 2005. “They have more to lose if they screw up, so they will be much more conscious and conscientious in managing their money effectively,” Hooper says.
Will these investors prove to be the catalyst that beleagured retailers need?
“In retail, to effect dramatic change takes longer than a single quarter and having to report quarterly earnings under the public eye sometimes is dysfunctional,” says Bruce Cohen of Kurt Salmon. “Under private ownership, over the course of a number of years, changes can occur more smoothly, so the companies that already decided that they need to accelerate change should benefit from this environment.”
Anthony Chukumba, who follows retailers for Morningstar, agrees that the near-term focus of public markets can keep management from doing what's needed to reposition some retail chains. “When you are a public company, what Wall Street is looking for is growth, so you open more stores,” he says. “But if you go private, the investors will focus on generating cash flow and in a lot of these cases, the retailers will have to close stores. It will no longer be growth for growth's sake.”
And things get trickier when it comes to retailers who are putting themselves up for sale because they are in distress. In those cases, management often changes as private equity turns to a well-known crop of retail wizards.
Most observers believed Kohlberg Kravis Roberts, Bain Capital and Vornado Realty Trust bought Toys ‘R’ Us, for $6.6 billion in March 2005 as a real estate play. But in practice the new ownership has put a huge emphasis on reversing the retailer's flagging fortunes. They started by getting rid of excess space. In the past year, 75 of Toys ‘R’ Us’ 674 stores were closed and 12 were transformed to Babies ‘R’ Us locations.
But the company also tapped Target Corp. Vice Chairman Gerald Storch as its chairman and CEO. At Target, Storch managed supply chain operation, technology services, financial services, and Internet divisions. The company has also formed a series of new strategic partnerships to improve its logistics, and re-think its online strategy. It also hired Ron Boire, Best Buy's former global merchandising manager, to bring the chain's offerings more in line with the digital age.
“Today's seven- and eight-year-olds don't want a Barbie, they want their own cell phone,” Johnson says. “And Ron Boire brings the Best Buy experience, he was also at Sony Corp. [for 17 years], so you can be sure that's why he was brought in.”
On a less prominent scale, there's also Millard “Mickey” Drexler. Drexler, who had been CEO of Gap, Inc. for almost 20 years, and was hired by J. Crew owner Texas Pacific Group to lead the clothing retailer in a new direction in October 2002.
With a greater emphasis on product quality and the addition of beachwear, wedding attire and children's apparel lines, Drexler has been able to take the company from $768.3 million in revenue at the end of January 2004 to $804.2 million in 2005. Sales increased by 17 percent this year, from $139 million last July to $163 million a month ago.
Those are surely results his former company would love to emulate these days as it has suffered through another weak sales patch toying with old and new concepts.
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