Is US Retail Doomed?
By Richard H. Golubow
Posted: 11th October 2017 09:12United States based brick and mortar retailers are filing for bankruptcy protection at the highest rate since the Great Recession, with at least nine filings in the first quarter of 2017. That equals the number of bankruptcy filings for all of 2016. It also puts the industry on pace for the highest number of bankruptcy filings since 2009, when 18 brick and mortar retailers sought bankruptcy protection. According to Moody’s rating agency, another 19 brick and mortar retail chains with in excess of $3.7 billion in debt that matures over the next five years face possible bankruptcy by year-end.
While a deep recession might explain an epic collapse for large retailers, gross domestic product has been growing for eight straight years, gas prices are low, unemployment is under 5%, and the last 18 months have been excellent for wage growth, particularly for middle and lower-income Americans. If retail stores cannot do well let alone thrive in this environment, what happens when the economy slows down as it is destined to do in the future?
The rising number of bankruptcies reflects a continuing decline in brick and mortar retail, and is generally and widely attributed in large part to consumers making more purchases online, and shifting their spending toward food, travel and other experiences over trendy clothing. While these factors are constantly cited in the media, there appear to be other core rudimentary business principles at work that are not industry specific.
For example, many brick and mortar retail filings are the result of highly leveraged buyouts by private equity firms, saddling a company with a crippling debt load. A typical private equity firm will purchase what is perceived as an undervalued retailer and seek to implement substantial cost reductions in anticipation that such actions will increase profitability and enterprise value. While pursuing cost-reduction is an objectively sound strategy, such firms often underestimate the need to modify a company’s operational strategies by, for example, investing sufficient capital in critical areas like the brand's store fleet or digital operations.
Reversing revenue declines is a big challenge for distressed retailers, who lack the cash to invest in their businesses. Often, these companies' knee-jerk reaction is to slash prices on their merchandise, which further erodes profitability.
Problems at distressed retail chains are about to get more acute with the slow but steady rise in interest rates. Already struggling with decreased sales, rising interest rates will make it tougher for retailers to refinance their debt as it comes due.
Further, the United States supply of physical stores continues to outweigh shopper demand, putting pressure on the industry's profits. As more shopping shifts to online, the costs of maintaining brick and mortar stores will prove too much for many retail chains. As chains liquidate or restructure, their store footprints are eliminated or reduced. Aeropostale, for example, closed nearly 600 stores in its bankruptcy reorganisation last year. Meanwhile, Sports Authority's 460 stores went dark after it liquidated in its bankruptcy.
It isn't just bankrupt retailers leading to the shutdown of retail locations. Macy's, J.C. Penney, Sears and Kmart are in the process of closing nearly 400 stores, as smaller chains take similar actions. In retail, when anchor tenants like Macy’s closes its doors, that means there are no longer Macy’s shoppers that will stroll over to another store in the mall. Some stores have co-tenancy clauses in malls that give them the right to terminate the lease and leave if an anchor tenant closes its doors. Those vacancies are likely to have ripple effects through the retail and commercial real estate industries, since people do not like to shop where there's a lot of vacant space. Thus, the failure of one or more anchor tenants can ultimately shutter an entire mall. When a big chain goes out of business or significantly scales back its brick-and-mortar locations, tremors are felt by other stores or even in other sectors. Increased real estate vacancies and reduced rental income can result in shopping center owners defaulting on loans with its lenders. Thus, commercial real estate development becomes riskier precipitating increased borrowing costs, while lenders demand lower loan-to-value ratios.
Troubled retail chains, perhaps more so than any other business sector, face an uphill battle to successfully reorganise absent a near consensual plan of reorganisation. Indeed, failed retail reorganisations that disappear via liquidation are more typically the rule rather than the exception. Some insolvency and real estate industry leaders have opined that is because of a change in the bankruptcy code in 2005, which trimmed the timeline retailers have to gain approval for sale or reorganisation. While a debtor used to be able to spend more than a year in bankruptcy, they now have approximately seven months days to decide whether to assume or reject a store's lease. Because going-out-of-business sales can take 90 days to run, senior lenders often try to make that decision in as little as 120 days. There are, however, other plausible reasons why many retailers cannot reorganise their financial affairs in a bankruptcy.
For example, debtor-in-possession lenders to retailers in chapter 11 are providing less new money, and more aggressive event milestones in their financing agreements than they did pre-Great Recession. These lenders understand that many times the liquidation value of a retailer’s assets against which they will lend is greater than the going-concern value of a select number of stores. So, any hiccup during the reorganisation process sets the stage for an expeditious liquidation that will bring large sums of money into a bankrupt estate with lenders paid fairly quickly.
Brick and mortar retail is not doomed, but rather, has changed and continues to evolve. Many are reducing their store footprint, cutting costs, reducing inventory and shifting their focus to e-commerce. Bankruptcy can be a very effective tool and provide a gateway to a new or improved business model, as the Bankruptcy Code allows for debtors to reject leases and caps the damages relating to such rejections. Bankruptcy alone as a tool to reduce store count is often not sufficient to reorganise a struggling retailer. Ultimately, companies must adapt to a changing retail environment, and in particular, they must figure out how they can be relevant to customers, whether through personalisation, exclusive product offerings or to otherwise stand out as a difference maker.
Then, as always, companies must develop, implement and aggressively follow four elementary business principles necessary to survive and thrive.
1. Prepare, Maintain and Update a Business Plan.
A business plan is critical to the governance and success of a well-managed company. A proper plan includes plans for sales, marketing, operations, capital-expense budget, and a cash-flow projection. It is the roadmap that should guide every aspect of the business. It is the primary tool that aids in executive decisions to increase revenues and profitability while minimising expenses. As markets change for better or worse, it is critical to adjust the business plan accordingly.
2. Achieve Cash-Flow Stability.
Planning and executing balanced inflow and outflow of cash is critical to the success of a well-run company. When financial conditions deteriorate or fluctuate, as they are prone to do in very poor and unpredictable economic times, owners and operators must anticipate significant monthly income swings and actively manage and adjust cash flow accordingly.
3. Constantly Evaluate Your Business Revenues and Expenses.
Maximising corporate efficiencies such as managing expenses, inventory levels, and capital expenditures, while making the hard day-to-day decisions, often determine the difference between success and failure. You must resolve to constantly assess, challenge, and reconsider historical, business-as-usual allegiances to people, products and processes.
4. Prepare Timely, Accurate, and Meaningful Financial Reports.
All financial reports should be as close to error free as possible and meaningful to reflect the information necessary to profitably operate the business.
Richard H. Golubow, Esq.
Winthrop Couchot Golubow Hollander, LLP
660 Newport Center Drive, Suite 400
Newport Beach, California 92660-5946
Richard H. Golubow is a founder and the managing partner of Winthrop Couchot Golubow Hollander, LLP, a financial restructuring, insolvency and bankruptcy law firm located in Newport Beach, California. Mr. Golubow has extensive experience in the areas ofbankruptcy, out-of-court workouts, distressed asset sales, UCC foreclosure sales, and general assignments. His diverse client base includes representation of debtors, creditors, creditor committees, trustees, assignees for the benefit of creditors, and asset purchasers in a wide range of industries. Mr. Golubowhas also been retained and designated as a bankruptcy law expert on several occasions.
Mr. Golubowhas been honored as the recipient of financial restructuring awards by several leading financial publications, including M&A Advisor for a 2017 “Deal of the Year” Award. He holds an “AV Preeminent” Peer Rating, and has been selected as a “Super Lawyer”, including a 2017 “Top 50 Orange County Super Lawyer.” Mr. Golubow is a member of the International Network of Boutique and Independent Law Firms, an invitation only network of lawyers from boutique law firms with the highest level of knowledge, experience, reputation and credentials comparable or superior to lawyers at the highest-ranking full-service law firms.