March 31, 2017
Authored by: Bryan Cave and Andrew Schoulder
Despite the downturn in many retail sectors, retailers should not automatically adopt a “glass half empty approach” but instead view the impending cycle as creating opportunities for companies in both the U.S. and globally.
In recent months, a steady stream of analyst coverage has painted a bleak outlook for the retail industry. Between February and March 2017, BCBG Max Azria, Eastern Outfitters, hhgregg, Gander Mountain, and Gordmans were among the companies added to the long list of retailers to seek bankruptcy protection. In February 2017, Moody’s Investors Service reported that the number of distressed U.S. retailers has tripled since the 2008-2009 recession. With 19 companies currently in Moody’s Caa/Ca retail portfolio, industry analysts are forecasting this current distressed cycle will surpass the conditions that existed for the industry in 2008-2009. The continued growth of online retailers is expected to hasten that result.
For companies with healthier balance sheets, the current level of distress in the industry could present prospects for strategic acquisitions, to diversify, or expand domestically or globally. Likewise, retailers feeling the financial strains of the downturn may still have viable options to outlive competitors and capture market share of those less successful. In either case, to unlock these opportunities retailers would benefit from divorcing themselves of any apprehension associated with the notion of restructurings, distressed assets, or the U.S. Chapter 11 bankruptcy process.
Flexible retailers with an understanding of the Chapter 11 sales process can compete for the same lucrative opportunities private equity funds have historically enjoyed without significant competition from industry participants. In most downturns, there is rarely a shortage of private equity funds purchasing new portfolio companies at distressed prices. Adequately capitalized and motivated retailers can compete for these same assets. Indeed, in many cases retailers may have advantages over private investment funds, such as:
- Retailers have an enhanced ability to assume fewer liabilities and bid more competitively by leveraging existing synergies associated with supply chains, manufacturing, vendors, and labor costs;
- An institutional understanding of the industry allows retailers to absorb assets more efficiently through reduced reliance on existing management and retention of third party operating consultants; and
- The investment horizon to achieve an internal rate of return for industry participants is customarily longer than the typical three to five years for private investment funds, thereby providing retailers with a higher ceiling for bids.
To be competitive, retailers will need to adapt to the accelerated timetables that are customary for distressed acquisitions. Prospective purchasers may have as little as a few weeks to submit a bid. Justifiably, many companies will have reservations in pursuing transactions on such an accelerated basis. The Chapter 11 sales process offsets some of those concerns through court-approved certainty to cherry pick assets free and clear of debt, uneconomical contracts, litigation, and other liabilities. Since distressed sellers place a premium on a bid that can be executed on an expedited timeframe, retailers interested in these opportunistic acquisitions would benefit by briefing boards and executives in advance.
Don’t Deny Distress
For many financially distressed companies there is a tendency to adopt a wait and see approach. When the reality sets in that their downward earnings curve is not an anomaly, businesses will often embark on a frenzied cost cutting initiative. For retailers this usually involves an en masse closure of stores, layoffs, and price discounts. In many cases it is already too late for these reactive initiatives to have an immediate impact as lenders and vendors will begin expecting concessions from retailers to avoid the dreaded “b” word – bankruptcy.
A proactive approach to restructuring could be the difference between emerging as a leaner but profitable company instead of a retired brand with liquidated inventory. Retailers that are not currently feeling the same level of financial strains as others in the industry will benefit from implementing measures to maintain the health of the business. The preemptive nature of these changes will provide management and the board with greater discretion that may not otherwise be available if lenders are driving strategy. However, the steady decline in the retail industry may not leave companies with the luxury of time to phase in financial initiatives. Companies in this position are often given the choice between Chapter 11 and temporary solutions that could jeopardize the long-term viability of the business. As a general rule, Chapter 11 should be viewed as a tool of last resort. With that in mind, key decision makers would be well armed by having the wherewithal to make their own informed decisions when considering options for addressing debt, unprofitable contracts and leases.
Whether the retail downturn lasts for one year or three, the survivors should not take their success for granted. Just as dieters need to remain disciplined to preserve their achievements, it is no different for retailers. It would behoove retailers to adopt some aspects of the discipline necessitated by a restructuring as part of the fabric of future business strategies to avoid over-extending with respect to new territories, inventory levels, head count, etc. To do otherwise, would expose those companies to the same fate shared by a long list of businesses that emerged from a restructuring only to liquidate one to five years later.
For questions or additional information, contact the author or any member of the Retail team.