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Private Equity in the Thick of Bricks and Mortar Retail Implosion


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2017 Apr 25, 4:38pm   456 views  1 comment

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As Wolf alludes in this post, one of the reason so many real world retailers are hitting the wall so hard is that private equity leverage and asset stripping made them particularly vulnerable. While the losses to online retailers would have forced some downsizing regardless, the fact that so many are making desperate moves in parallel is in large measure due to the fact that the tender ministrations of their private equity overlords have made them fragile.

Eileen Appelbaum and Rosemary Batt, in their landmark book Private Equity at Work, described a real estate looting strategy that as of 2014 had already ruined some formerly viable retail and restaurant chains. As we summarized their observations:

For instance, one way that private equity overlords enrich themselves at the expense of the businesses they acquire is by taking real estate owned by the company, spinning it out into another entity (owned by the PE fund and to be monetized subsequently) and having the former owner make lease payments to its new landlord.

The problem with this approach is usually twofold. First the businesses that chose to own their own real estate did so for good reason. They were typically seasonal businesses, like retailers, or low margin businesses particularly vulnerable to the business cycle, like low-end restaurants. Owning their own property reduced their fixed costs, making them better able to ride out bad times.

To make this picture worse, the PE firms typically “sell” the real estate at an inflated price, which justifies saddling the operating business with high lease payments, making the financial risk to the company even higher. Of course, those potentially unsustainable rents make the real estate company look more valuable to prospective investors than it probably is.

Eileen Applebaum provided examples of how this worked (and regularly left bankruptcies in its wake) in an interview with Andrew Dittmer.

Now here is the cute part. First, remember that the private equity fund manager makes out regardless of whether their investors do well, since nearly 2/3 of their total fees are not related to performance. We’ve posted on how private equity fund managers get rich on management fees alone.

However, private equity fund managers do have an incentive not to burn private equity limited partners, since they want to raise more funds. The real estate asset stripping op co/prop co model is analogous to the discredited dividend recap strategy, which was widely criticized after Clayton & Dubilier quickly bankrupted Hertz that way. But leveraging up a company in a very big way and extracting a lot of cash, which the op co/prop co model does, allows the private equity fund manager to make a big distribution to investors early on, producing a handsome IRR on that deal.

And if the deal goes bad, what happens? The end result to the private equity investors depends on how much cash was returned, between the real estate sale and any positive cash flows afterward, before the company goes bust. It could turn out to be pretty profitable to a bit of a turkey.

The real losers are the lenders to the retailer. And who might they be?

Increasingly they are the very same investors as in the private equity funds. Private equity fund managers offer credit funds, which lend in large measure to private equity deals.

More: http://www.nakedcapitalism.com/2017/04/wolf-richter-private-equity-in-the-thick-of-bricks-and-mortar-retail-implosion.html

#Econmics #PrivateEquity #BrickandMortar

What will be the excuse when blaming everything on Amazon and Wal-Mart plays out ? Poor management ?

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1   MisdemeanorRebel   2017 Apr 25, 7:54pm  

That Wolf Richter, he's pretty Hotep.

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