In April, Staples’ private equity owner, Sycamore Partners, paid itself a $1 billion dividend ahead of a possible IPO for the office supplies giant. It was paid for through a loan that will, as these things go, stay with Staples and add $130 million in annual interest costs. Bloomberg noted the size of the debt-financed dividend to Sycamore “left even seasoned leveraged-buyout experts agog.”

BDCR Notes: By the way, there are two BDCs with senior debt exposure to Staples, Inc. which predated the $1bn dividend, totaling $19.4mn.  The debt is provided by Barings BDC (BBDC) and Garrison Capital (GARS), and both were valued at par at March 31, 2019. They are participants in a liquid term loan facility which, according to Advantage Data’s real time information, continues to trade at the same level today. Whatever one may think of these private company dividends – each of which results in much finger wagging when they occur – the debt market appears to believe no material damage has occurred to the lenders towards the top of the company’s credit pile.

The eye-popping figure grabbed headlines, but it is a relative footnote in the history of private equity’s checkered relationship with the retail industry. Wall Street financial firms have poured tens of billions of dollars into the industry over the past decade and a half to acquire more than 120 retailers. Those deals were often made through debt-fueled buyouts that left retailers vulnerable to changes in the market. And there have been some serious changes in the retail market of late.

While there are some notable success stories — such as Burlington, BJ’s Wholesale and Dollar General — there have also been more than two dozen bankruptcies of private equity retail acquisitions over the past 15 years, according to Retail Dive’s analysis.

BDCR Notes: For the record, there was modest BDC financing of the first two retailers named – again according to Advantage Data’s extensive records, and both were repaid without incident. 

Current or formerly private equity-owned retailers filled out the ranks of bankruptcies in the early months of 2019. Of the major retailers that have gone into bankruptcy this year tracked by Retail Dive, 80% were owned by private equity companies or had been in the recent past.

They were: Shopko, Charlotte Russe, FullBeauty Brands, Things Remembered, Beauty Brands, Z Gallerie, Payless ShoeSource and Gymboree. (Payless and Gymboree were both private equity-owned going into their 2017 Chapter 11s, after which lenders took control.)

The CEO of one of those retailers, Z Gallerie, even noted when filing for bankruptcy that its “overall performance has declined significantly” since its 2014 acquisition by private equity firm Brentwood Associates, with those declines “self-imposed,” including a failure to invest enough capital in e-commerce.

BDCR Notes: Of the 8 names mentioned, the BDC sector has exposure to 6. The exceptions – as far as we can tell – are Shopko and Beauty Brands. [That last name just filed for Chapter 7 liquidation and will not survive the bankruptcy prtocess).

Here- very briefly – is what happened to the other six:

Charlotte Russe: We covered the set-back at this women’s clothing retailer in a March 19, 2019 article.  We won’t repeat the findings here, but will point out that this has proved to be a complete disaster for the BDCs involved, exacerbated by the failed attempt – by way of a debt for equity swap – to own and manage the company following its first failure in 2017. Total losses, which will be finally realized probably in the IIQ or IIIQ 2019, are likely to exceed $50mn. The BDCs position in the senior secured debt did little to mitigate the losses because Charlotte Russes ended up having little value in liquidation – as you’d expect – once the professionals, the liquidation firm and any asset based lenders were paid off. At the end of 2017 BDC exposure at cost was $53mn. At March 31, 2019, the remaining FMV was $1.2mn. The BDCs involved: FSK, Main and HMS Income. (FSK inherited the Charlotte Russe loan from CCT).

FullBeauty Brands: This is a fascinating case but one we’ve not covered as closely as others given that all the several BDCs involved are in the non-traded category. Nonetheless, the exposure (99% in first lien) was substantial at cost just before the filing: $84mn. The fascinating part is that the company agreed a restructuring with its lenders and went in and came out of bankruptcy in a record 24 hours. This allowed the company to shed $900mn of its $1.0bn in debt in a classic debt for equity swap, according to news reports. We assume the 3 main BDCs involved – FSIC II, FSIC III and FSIC IV – booked major realized losses. Given these are non-traded funds, it’s hard to say for certain but FSIC II – for example – seems to have incurred Realized Losses of ($60mn) in the transaction. The aggregate loss once the dust settles will be close to the amount invested. That could go higher if more monies are advanced as FullBeauty – a plus size retailer now 70% on the internet – seeks to keep the business going. That was what happened at Charlotte Russe with unfortunate results. 

Things Remembered: The company is a mostly mall based business (cue ominous music) dedicated to personalizing gifts. The only BDC exposure was from Ares Capital (ARCC), a lender since 2006 (!). Starting in 2014, the company began to under-perform and defaulted in the IVQ 2015, when ARCC’s exposure – all in first lien debt – was $15.7mn.  We actually wrote an article about its then credit problems all the way back in April 2016. Roll forward to February of this year and an unprofitable Things Remembered (EBITDA negative $4mn, according to one report) filed for bankruptcy as part of a sale of parts of the business to a third party buyer. Many locations to be sold and many jobs lost. From what we can tell ARCC wrote off the bulk of its $18.7mn investment ($15.9mn in realized losses the 2018 financials and perhaps more in prior periods). A three year long attempt to right the ship failed to succeed. The business sold for $17.5mn. 

Z Gallerie: This furniture and furnishings chain, which filed Chapter 11 earlier this year, was also the subject of an article by the BDC Reporter. There are two BDCs involved – one private (Sierra Income) and one public (FSK). Again FSK has inherited this credit from Corporate Capital Trust or CCT that was. The total invested capital at risk – all in senior secured debt – is $34.6mn and has been mostly written down on an unrealized basis by the two lenders as Z Gallerie continues negotiations with its creditors and the court. Whether the BDC lenders will seek to become owners ( like so many of the deals mentioned above), or just take their licks and move on is unclear. If the latter occurs, chances are most – if not all – the debt will be written off. 

Payless ShoeSource: Like Charlotte Russe (and Z Gallerie which went Chapter 11 in 2009 as well), Payless is a Chapter 22, i.e. has filed twice for bankruptcy protection. This was a troubled company – judging by BDC valuation levels – since 2015, when there were 3 BDCs involved and $24mn of first and second lien debt was at risk. By the time Payless filed for bankruptcy the first time exposure in IQ 2017 had jumped to $67mn. However, nearly $50mn of that was an ABL facility by TSLX, which has done well financing troubled companies. The rest of the exposure was more long standing, belonging to a GBDC JV, as well as FSIC II and FSIC III, as well as Sierra Income. Except for TSLX, most of the exposure appears to have been either repaid or written off as part of the first Chapter 11. (Sierra received warrants which were presumably written off later). In March 2018, TSLX and FSK advanced $22mn to the post bankruptcy Payless, but in an ABL only. As a result, both BDCs are valuing their exposure at par at the end of IQ 2019 even though Payless filed for Chapter 11 a second time in February 2019. The debt was repaid post quarter end, according to FSK, and at par. 

Gymboree: Another Chapter 22 company ! Before the first Chapter 11 in 2017, there were 3 BDCs with exposure, with BlackRock TCP Capital (TCPC)with the greatest exposure. TCPC seems to have been invested in an ABL facility and to have been repaid in full in late 2017. There has been no BDC exposure since 2017 and thus no exposure to Gymboree’s second Chapter 11 in January 2019. 

‘You can’t outrun debt’

Those are the retailers that have already folded or been forced to reorganize this year. Moody’s currently rates 12 retailers as distressed, defined as carrying Caa and lower ratings, which indicate a higher risk of default. (We have excluded food retailers.) Of those distressed retailers, nine — or 75% — are private equity-owned, according to Retail Dive analysis. Their ranks include household names, such as PetSmart — the largest private equity buyout in retail history — and Neiman Marcus, which has been negotiating with lenders to extend its debt maturities.

BDCR Notes: No current BDC exposure to either name.

“When you look at the definition of leveraged buyout, what’s the first word that you see? These companies start below the eight ball,” says Moody’s retail analyst Charlie O’Shea. “When you load retailers with leverage, you’re taking a risk.”

Private equity-owned retailers in distress
Retailer Private Equity Owner Acquisition Year Moody’s Rating
Academy Sports + Outdoors KKR 2011 Caa1
Guitar Center Ares Management 2014 Caa1
PetSmart BC Partners 2015 Caa1
J. Crew Leonard Green & Partners 2011 Caa2
David’s Bridal Clayton, Dubilier & Rice 2012 Caa2
99 Cents Only Stores Ares Management 2011 Caa2
Indra Holdings Freeman Spogli 2014 Caa3
Neiman Marcus Ares Capital 2013 Caa3
TOMS Shoes Bain Capital 2014 Caa3

BDCR Notes:

Academy: Cion with $12.2mn of senior debt, discounted (15%).

Guitar Center: No exposure.

J. Crew: No exposure

David’s Bridal: Another candidate for Chapter 22, based on recent credit ratings. Cion has $2.6mn in debt and equity at different values. Not material. 

99 Cents Only: There are 3 BDCs with exposure: OCSI and OCSL in the 2022 debt and TSLX in the 2021 debt. The Oaktree BDCs had discounted their loan values by (11%-14%) at March 31 2019, but TSLX had not. That seems to be because the TSLX exposure is in an ABL, while the others are not. At least the 2022 debt seems to be publicly traded according to Advantage Data and is valued at a (15%) discount to par. That suggests a loss of income and/or capital is possible at the Oaktree BDCs.

Indra Holdings: Or Totes Isotoner. There are two BDCs with exposure and it’s substantial: $92mn. ARCC is in the worst shape with both first and second lien exposure. The $67mn at cost is on non accrual and has been since 2017 and is discounted by four-fiths of its value. ARCC and CGBD also have $18mn of exposure in the first lien debt, which they’ve written down on an unrealized basis by (18%) and (45%) respectively. No, we can’t account for the wide difference in valuation. 

Neiman Marcus: No exposure.

TOMS Shoes: There are two BDCs with nearly $10mn of exposure to this footwear company. Moody’s had an update on their speculative debt rating for Toms just the other day, as we covered on the BDC Credit Reporter. As we say in the Company Profile for Toms, the chances of a bankruptcy or restructuring in the next year seems high. That probably explains why MAIN and HMS Income have discounted the debt by (18%). Judging by prior valuations by the BDCs that could go much higher if Toms does not find a way out of its debt hole. 

Source: Moody’s, PitchBook, Debtwire, Retail Dive Research. Editor’s note: Ares Management is a subsidiary of Ares Capital. [BDCR Notes: We don’t believes Ares Management is a subsidiary of Ares Capital]. 

With data from PitchBook, Debtwire, and our own research, Retail Dive has compiled information on 125 private equity acquisitions going back to 2002 of retailers that are relevant to the publication’s coverage. The list is not complete, and is continually being added to.

Of those acquisitions, 26 — almost 21% — have filed for Chapter 11 at some point. That rate is higher than it was in November, when Retail Dive first crunched the numbers.

“The common theme is the balance sheet,” O’Shea said. “You can’t outrun debt. Debt always wins.”

But the leveraged buyout in 2006 by a private equity group, which included Bain Capital and KKR, left the toy seller with billions of dollars in debt that hurt its ability to compete and its margin for error. O’Shea noted that Toys R Us had a relatively strong core business even ahead of the bankruptcy. (It reported positive earnings from operations through its final years before filing.)

Even so, the company’s creditors were ultimately unable to agree on a plan of reorganization and saw more value in the retailer’s remaining assets than it did in the business. And like that, Toys R Us was no more.

Extracting value

Private equity acquisitions took a dip after 2016, according to previous Retail Dive analysis. That was a year when bankruptcies in the industry began to accelerate, and it preceded a record-breaking year that outpaced the recession-era pace of retail bankruptcies.

Late 2018 saw a global financial selloff that was “disastrous” for the financial markets that typically finance private equity buyouts and led to a decline in merger activity, said Will Caiger-Smith, associate editor for leveraged finance at Debtwire. Since then, the “bankers whose job it is to make sure there’s a steady supply of new loans to investors have been scrambling to make up the shortfall,” he said

The Staples deal — which came not even two years after Sycamore took the company over in retail’s third-largest buyout — is at least one sign Wall Street is still not shy about adding debt onto retailers even after the waves of bankruptcies.

Sycamore has already seen one of its retail acquisitions — women’s shoe and accessories seller Nine West — go into bankruptcy. The financial machinations that left Nine West laden with debt after Sycamore’s leveraged buyout of the Jones Group was a source of conflict in that Chapter 11 case. (Sycamore declined through a spokesperson to comment for this article.)

BDCR Notes: Yet another FSK investment: $6.5mn , valued at zero. 

Sycamore is not alone. The private equity owners of PaylessToys R Us and others have come under scrutiny in bankruptcy cases over allegations they moved money out of those retailers and into their own pockets. Payless owners Golden Gate Capital and Blum Capital were sued by the retailer’s creditors over $400 million in dividend transactions that added debt onto the shoe seller, similar to what Sycamore did with Staples. The private equity firms settled the suit.

But if Staples is any indication, private equity hasn’t been subdued by the court tussles. One reason may be that, as Craig Solomon Ganz, a partner with law firm Ballard Spahr, noted, it is difficult to prove in court that a private equity firm knowingly ran a company into the ground while stripping out value for itself.

Moreover, the current loan and bond terms tend to favor private equity companies over lenders. “What that means in practice is, even if you buy a company and it doesn’t perform as you had hoped, or you failed to turnaround its sales or revitalize its business, you still have a lot of tricks up your sleeve to extract value from the investment” because financing terms are beneficial for private equity firms’ interests, Debtwire’s Caiger-Smith said.

Still in the game

As for defaults and bankruptcies, investor money on both the lending side and in private equity funds still needs somewhere to go. And retail may still be attractive, despite the recent Chapter 11s.

“If there’s an accretive process that they can underwrite for their credit folks, then yes, they’re still in the game for these things,” Ganz said. “But I think the days of where they were buying them with a little less due diligence and a little less credit analysis, because they saw some cash flows and they saw that they could — legitimately, not fraudulently — pull out some of their equity out of it and get a good return for investors on the short term, I think those days might be gone. Because it’s not as much of a short-term play.”

And those Chapter 11s don’t necessarily mean that a private equity owner lost its investment. “It’s absolutely possible that a private equity firm could still generate a return even in a deteriorating situation,” said Debtwire senior retail analyst Philip Emma.

He noted private equity firms, in addition to their equity stake in a company, will often also buy some of its debt, adding another way to profit, along with real estate and business unit spin-offs, all of which can provide sources of profit beyond selling the acquired company”.

BDCR Notes: This article has focused on the headline retail problem names. We have our own list – also not comprehensive but representing a useful start. We’ve identified at least 10 additional retail-related credits, with hundreds of million of dollars of BDC exposure in different forms that we are keeping an eye on because they could go the way of Payless, Charlotte Russe, Things Remembered etc.