This story is featured in the 1Q 2019 edition of the PitchBook Private Market PlayBook.
Walking through any mall in the US, it's tough not to notice how the retail landscape has changed over the past decade. For one, it feels like there are fewer people around. Many stores have gone out of business. And for others, it's unclear how they remain in business at all.
Indeed, it's a different retail world now. And private equity's relationship with the industry is perhaps as volatile as ever.
It's been so bad, in fact, it's worth wondering what the pair's future together will hold. At the very least, the data seems to indicate interest is way down.
Since peaking in 2015, the number of PE deals in the US retail industry has declined annually, according to PitchBook data. That isn't altogether surprising, given elevated multiples have made finding bargains in every industry more difficult.
But the roughly 25% YoY decrease in PE retail deals from 2017 to 2018 was no doubt significant. And so is the fact that 2019 is off to a very, very slow start, with just six deals completed through the first six weeks of the year.
It's fair to wonder if investors might be gun-shy after a slate of recent PE-backed bankruptcies have dominated headlines. None was more jarring or drew more attention than the disaster at Toys R Us, which filed for bankruptcy in September 2017 more than a dozen years after Bain Capital, KKR and Vornado Realty Trust took the company private for some $6.6 billion.
The fact that Bain Capital and KKR set up a reparations fund for a failed investment was unprecedented for an industry that typically values the bottom line over just about everything.
Creditors ultimately decided to liquidate operations, leaving 33,000 employees without jobs or severance. The backlash was so strong that Congress stepped in, with Bain Capital and KKR ultimately setting up a $20 million fund to pay those employees part of the severance they were owed.
Now, not every example is so extreme. And there have been a handful of PE and retail success stories, no doubt. But the fact that Bain Capital and KKR set up a reparations fund for a failed investment was unprecedented for an industry that typically values the bottom line over just about everything.
Time will tell whether that sort of mea culpa becomes the norm, but it seems KKR will be more open to helping when things go south. In early February, the buyout firm pushed for raises and severance for employees that stick around at mall retailer Things Remembered, a KKR portfolio company that plans to wind down operations by March 30, per Bloomberg. The total cost wasn't going to be crippling, since the business reportedly only spent around $9 million monthly on wages. But it's fair to wonder: Will other firms be willing to do the same now that the spotlight has magnified?
In February, Enesco, a fellow PE-backed gift retailer, agreed to buy some remaining Things Remembered stores out of bankruptcy for $17.5 million. Buyout shop Balmoral Funds has owned Enesco since 2015.
While investors ponder their moral duty, the future of many PE-backed retailers remains unclear.
Neiman Marcus, a high-end clothing retailer, has been performing well financially since it relaunched its ecommerce strategy and cut jobs. But the business has roughly $4.5 billion in debt still weighing down its balance sheet. That's largely due to its long history of PE ownership. Ares Group and Canada Pension Plan Investment Board acquired the business from TPG Capital and Warburg Pincus for some $6 billion in 2013. The company has failed in its attempts to go public or find a buyer in the years since, all the while dealing with extensive turnover of key executive positions.
Gymboree is already on the fast track to oblivion, after it filed for bankruptcy for the second time in January. The news came nearly a decade after Bain Capital originally bought the children's clothing retailer for $1.8 billion in 2010. The company now plans to close its 800 stores under the Gymboree and Crazy 8 brands, while trying to find a buyer for its high-end brand, Janie and Jack.
At J.Crew, the state of affairs isn't much better. The company is paying $30 million every quarter in interest payments as part of its roughly $1.7 billion debt load, per a mid-2018 report from The Washington Post. In the piece, GlobalData Retail managing director Neil Saunders compared the company's turnaround plan at the time to "rearranging deck chairs on the Titanic."
This after TPG Capital and Leonard Green & Partners took the business private in 2011 for $3 billion, with TPG acquiring a 75% stake and Leonard Green the remaining 25%.
Indeed, PE's involvement hasn't done much to help brick-and-mortar retailers of late. However, much of that has been out of their control. Few could have predicted the rise of Amazon or the overall change in consumer habits when many of these buyouts took place. And now that these companies need to fundamentally change their business model, many don't have the financial flexibility to adapt. Not the best look for investors that tout themselves as turnaround specialists.
Last year, there were zero retail buyouts of $5 billion or more in the US after three were completed in 2017. Don't be shocked if mega-deals continue to dwindle, since many retailers have had to rethink how to do business.
It's not that PE firms are incapable of succeeding in retail. Look no further than Canada Goose, the high-end parka maker that Bain Capital acquired in 2013. Selling coats at around $900 apiece, the company received great publicity when Kate Upton wore one on the cover of Sports Illustrated's swimsuit issue. Under Bain Capital's ownership, the company later opened a flagship store in New York, while celebrities such as Bradley Cooper and Emma Stone have been spotted wearing the puffy fashion statements.
In 2017, Canada Goose went public in an offering that valued the business at around $1.8 billion. With Bain Capital still owning some of the company, Canada Goose stock has since skyrocketed from $17 to more than $50 per share, pushing its market cap to $5.5 billion.
But it's safe to assume that not every middle-of-the-road retailer is going to have Sports Illustrated swimsuit models hocking its products. So that leaves other PE firms still interested in retail to get creative, perhaps looking at niche companies rather than the typical brick-and-mortar behemoth that would require a massive buyout.
Last year, there were zero retail buyouts of $5 billion or more in the US, according to PitchBook data, after three were completed in 2017. Don't be shocked if mega-deals continue to dwindle, since many retailers have had to rethink how to do business.
And until many of those middle-market retailers either restructure or close shop entirely, the spotlight will continue to shine on the PE investors that have seen businesses deteriorate on their watch. The question is whether others will try to jump in to find the few remaining opportunities before even more retailers fade off into the distance entirely.