Private Equity Racks Up Checkered Record in Retail Buyouts (6/29)
Jun 29, 2009 1:21 PM, By Elaine Misonzhnik
Real estate pipe dream
Back in the heyday of the buyout era, many private equity players felt they could justify paying billions of dollars for retail chains because there was always the possibility of a real estate play if the retail operation went under, says Johnson. At the time, retail landlords clamored to get back spaces from struggling tenants so they could finally turn a profit on their below-market rents. What private equity raiders hadn't foreseen was that a pullback in consumer spending would coincide with a severe downturn in the commercial real estate sector. With retail property values falling 25 percent since they reached their peak in 2007, according to research from New York City–based Real Capital Analytics, empty stores are no longer worth a fortune. Expectations are that values may drop another 15 percent before bottoming out.
When the consortium of Sun Capital Partners, Cerberus Capital Management and Lubert-Adler and Klaff Partners bought mid-market department store chain Mervyns from Target Corp. for $1.2 billion in July of 2004, Mervyns' real estate was among its main attractions. At the time of the buyout, Mervyns was struggling—it was just another mid-market chain in a moribund department store sector, according to Johnson. But it had a fleet of more than 250 stores, including 155 that were company-owned. The stores averaged approximately 80,000 square feet in size and represented quite an attractive chunk of space as real estate values continued to climb up.
But in spite of some modest efforts to turn around the struggling chain—for example, broadening product selection and bringing in more private label products,—Mervyns' retail operation never prospered. The fact that Lubert-Adler, whose focus is on real estate rather than retail, spun off Mervyns' real estate division and sold many of the chain's leases to third parties, bringing up Mervyns' rents, made the situation much worse. Meanwhile, by the end of 2008, as the chain was liquidating, its property holdings had lost most of their value. When department store operator Kohl's and apparel seller Forever 21 teamed up to buy 43 leases belonging to Mervyns in December of last year, they paid from 20 cents to 25 cents on the dollar for the assets, according to sources involved in the transaction.
"The problem was that there were too many big boxes coming online," says Hooper. "I think it was just a strange safety net if people expected real estate to provide any kind of a fallback—even [during the boom years] people realized there were too many big boxes. That was never destined to be a really strong out."
Too much risky business
The big question right now is whether the aftermath of the recent LBO run will leave the retail landscape as battered as the private equity attack of the 1980s. When the acquisitions were taking place, industry experts pointed to the fact that private equity players were being more careful about taking on debt than during the gung-ho days of the 1980s LBO era. They generally employed leverage levels of 40 percent or 50 percent rather than 90 percent. That was supposed to safeguard against credit-related bankruptcies and liquidations. In many cases, they also made good-faith efforts to improve the retailers' operations, instead of focusing only on the bottom line.
But then the global credit crisis hit and the current recession turned out to be the worst one since the 1930s, in addition to the fact that there were now a lot more retail concepts chasing limited demand for discretionary goods than there were 20 years ago, says Johnson.
"Wal-Mart and other value retailer are sucking up any available excess demand," he notes. "And it's leaving marginal players beached—when the tide goes out, you see which swimmers don't have trunks on."
Still, that's the nature of the private equity business, adds Hooper—the whole leveraged buyout model carries with it a high level of risk, especially for those firms that target high-profile acquisitions.
"It's just a cycle that the markets go through," he notes. "If you are comfortable making a ton of money in good years and losing a lot of money in bad years, that's fine."
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