Private equity is often legalized theft. Here’s how it’s done, from Wolf Richter at wolfstreet.com.
An astounding list of the meltdown: PE firms doomed the retailers.
One of the big forces in the brick-and-mortar retail meltdown are private equity firms that acquired retail chains via leveraged buyouts during the LBO boom before the Financial Crisis or more recently. Numerous of those retail chains have now filed for bankruptcy.
A PE firm typically borrows to undertake the leveraged buyout. But instead of carrying the debt at the firm, the debt is loaded on the acquired company, on top of the debt it had before the buyout, and it has to service that large pile of debt.
In addition, PE firms typically extract fees and “special dividends” from their portfolio companies which will fund them with additional debt. These fees and special dividends are tools with which PE firms extract profits up front. Lenders and other creditors carry the risks.
The final goal is to unload the portfolio company by selling it either to a large corporation or to the public via an IPO within a few years (seven years is a rule of thumb).
This works ok-ish in a booming industry. But brick-and-mortar retail – particularly apparel stores, shoe stores, sporting goods stores, department stores, and the like – came under withering attack from online sales in recent years, while suffocating under their debts.
Toys ‘R’ Us shows how this was done: PE firms KKR, Vornado Realty Trust, and Bain Capital Partners acquired the publicly traded shares of Toys ‘R’ Us in an LBO in 2005. In 2004, Toys R Us had $2.2 billion in cash and short-term investments. By Q1 2017, this had collapsed to just $301 million. Over the same period, long-term debt surged from $2.3 billion to $5.2 billion.
In other words, “cash minus debt” was -$112 million in 2004. By 2017, it had ballooned to -$4.9 billion.
While the PE firms were busy extracting cash, the company, cash-strapped and focused on cost-cutting, failed to create an online presence that could compete with Amazon and others, didn’t successfully make the transition to electronic devices, video games, and apps, and let its physical stores deteriorate. It should have spent the last decade investing heavily in its future. Instead, it was forced to borrow large amounts of money just to enrich its PE-firm owners. In September last year, it filed for Chapter 11 bankruptcy.
To continue reading: The Private Equity Firms at the Core of Brick & Mortar Retail Bankruptcies