Bankruptcy boom: distress in the US retail space
September 2017 | FEATURE | BANKRUPTCY & RESTRUCTURING
Financier Worldwide Magazine
September 2017 Issue
Despite overall spending in the US retail space continuing to grow steadily, today’s reality is that traditional brick and mortar retailers are being squeezed out of the picture by online shopping competitors, with many filing for bankruptcy then pulling down the shutters for good.
Certainly, the bankruptcy filings for 2017 make for distressing reading for the US retail industry. In short, so far this year, more than 300 retailers have filed for bankruptcy (mostly Chapter 11 filings) – up 31 percent year-on-year, according to BankruptcyData.com. While most of the filings have been made by small and medium-sized businesses, a number of retail household names are also in the mix, including Aeropostale, Payless ShoeSource, RadioShack, rue21, Gymboree, The Limited, and many more.
“Over the past three years, a significant number of well-known retailers have filed for bankruptcy protection,” confirms John H. Bae, a partner at Baker Botts LLP. “The size of these retailers varies from smaller operations like Jo-Jo Holdings, Inc. with 10 stores, to larger operations like RadioShack with more than 4000 stores in the US and abroad. The type of business of these retailers varies, but the vast majority of them operate in shopping malls with expensive commercial leases.”
In the view of Joshua Sussberg, a partner at Kirkland & Ellis LLP, it is the retail operators with a large brick and mortar presence and underdeveloped omnichannel platforms that are under the most intense pressure, as they attempt to adapt to the ever changing environment and internet -hungry purchasers.
That the US retail space is distressed clearly comes as little surprise to those with their finger on the pulse. Indeed, 67 percent of respondents to AlixPartners’ ‘2017 North American Restructuring Experts Survey’ stated that retail was the US industry they believed most likely to face distress in the coming years.
Cause and effect
One question vexing the US retail space is the extent to which the bankruptcy filings seen over the past year can be seen as a temporary aberration or part of an inevitable evolution of consumer shopping and spending tastes. According to Mr Sussberg, the prime reason for the uptick in filings is the shift in consumer preference away from pure in-store purchases. “Being able to provide an overall experience through the internet, combined with a retail presence, seems to be the trend for consumers,” he suggests.
As a result of this trend, the high cost of an expanded retail footprint has been difficult for many retail companies to satisfy, especially when combined with the need to infuse capital into omnichannel development. In addition, Mr Sussberg notes that the demand for ‘fast fashion’ – products that are produced quickly for consumption and at a less expensive cost (by companies such as H&M and Zara) – has impacted those branded apparel companies that require a long lead time from development to production and which goods necessarily carry a higher cost because of a more involved production process.
Of particular significance are the similar profiles of many of the retailers filing for bankruptcy protection, many of which have large commercial lease obligations for their brick and mortar stores and substantial debt burdens, not to mention fewer customers entering their stores. “Virtually all the well-known retailers that have filed for bankruptcy in the past couple of years identified declining foot traffic in malls as the principal cause of the distress in their business,” says Mr Bae. “Many of these retailers were also the subjects of leveraged buyouts which imposed substantial debt burdens on top of weak operating performance.”
While many companies filing for bankruptcy firmly point the finger at online shopping as the reason for their woes, Andrew Schoulder, a partner at Bryan Cave, deigns to mention that the act of purchasing products or services over the internet is hardly a new phenomenon. “The band aid has been on for so long and part of what we are seeing now is the adhesive coming off, he suggests. “But investors and lenders are unwilling to allow the bleeding to continue in the current environment. For some businesses, the market is willing to double down after restructuring the footprint and capital structure through Chapter 11, and many believe that investors have reached the point where they feel it is necessary to cull the herd.”
What then do the recent bankruptcy filings in the US retail space tell us about consumer trends and their likely impact on the future of the industry? Moreover, how far can the issues currently bedevilling segments of the industry be extrapolated across US retail as a whole?
“BCBG is a great example of what is happening across the US retail world,” says Mr Sussberg. “It is also a huge success story in that the company will reorganise and capitalise on its brand for many years to come, although on a much smaller scale.” At its peak, the fashion house BGBG operated at more than 500 retail locations, but an underdeveloped omnichannel platform and the fast fashion movement – designs moved quickly from the catwalk to capture current fashion trends – necessitated a restructuring in the face of significant leverage (which the company had used to expand) and high occupancy costs.
Despite this, the BCBG brand has proven to be valuable and the firm’s recent restructuring (completed in early August) is capitalising on that value. Going forward, the plan is for BCBG to operate a reduced retail footprint of approximately 45 retail locations and licence its apparel and brand for continued distribution around the world. “BCBG will also dedicate resources to further developing its internet and omnichannel platform,” believes Mr Sussberg. “The restructuring transaction will raise significant value and ensures that BCBG remains in operation for years to come. The reduced footprint and brand recognition model is something that I think we may also see in other retail restructurings.”
Further examples that exemplify the transition taking place in the US retail space include that of Payless Holdings LLC and Aeropostale. Payless, which filed for Chapter 11 on 5 May 2017, and Aerostaple, which made its own filing approximately one year earlier, both cited virtually identical reasons for the decline of their businesses, though the primary reason was a shift toward online retail channels. Both companies also blamed large debt burdens, commercial lease obligations and declining profits as the drivers of their Chapter 11 filings.
“The US retail industry will have to adjust to the changing tendencies of their target customers,” says Mr Bae. “If burdensome leases and a decline in foot traffic are the principal causes of distress in retail, then the obvious path forward for the retail industry is to reduce the footprint of the brick and mortar stores and increase the retailer’s online presence. That will also have an effect on mall owners and operators which will suffer declines in tenants and occupants.”
Filing for bankruptcy does not, of course, mean an end to a retailer’s operations; a number of options can be explored in the bid to survive, with restructuring chief among them.
“Although many retail companies such as Radio Shack, Wet Seal, Coldwater Creek, Eastern Mountain Sports and HHGregg have gone out of business through their Chapter 11 filings, others, including Pacific Sunwear, BCBG, Payless, Gymboree and rue 21, have executed or stand ready to execute restructuring transactions that preserve going concern operations,” affirms Mr Sussberg. “The reason these companies have been successful is because of careful strategic planning, both internally and with key stakeholders. This includes a detailed review of the company’s existing footprint and significant consideration of cash needs in an effort to ensure development of appropriate omnichannel technology that will enable market penetration and hopeful growth.”
Another important factor, and one that is especially pertinent in retail, is whether the business in distress waited too long to react. “A few recent situations demonstrate that survival is possible by proactively tightening your belt, early,” attests Mr Schoulder. “Investors may be more amenable to recapitalising a business model that has been carefully right sized, or at minimum, providing additional time to facilitate a sale process. Too often, retailers are scrambling to conduct store closures, layoffs and heavy discounting of current inventory. By that time, you have damaged relations with vendors, landlords and lenders. The discounting has tarnished your brand and left little to reorganise around.”
Reengagement and reinvigoration
Given consumer spending trends, it seems likely that bankruptcies will continue to rise in the years to come. Should this come to pass, then fresh strategies will need to be explored if US retailers are to have any chance of stopping the rot and reinvigorating the industry.
“Retailers will continue to face financial distress and we do not anticipate a decline in retailer bankruptcy filings,” says Mr Bae. “Some well-known retailers have been struggling for a long time and their situations do not seem to be improving. Therefore, they will need to continue to explore different strategies to increase consumer foot traffic, such as Walmart introducing groceries. But it is doubtful that the current shift from in-store shopping to online commerce can be reversed.”
Further strategic moves being adopted by a number of retailers include changing the in-store experience by creating niche areas within their stores for certain products or lines. Others have dedicated substantial floor space in their primary locations to their discount businesses. “Ultimately, bankruptcy will still be important because one of the most logical options for retailers is to use the Bankruptcy Code to ‘right size’ their business to match the tendencies of their target customers to the extent that is still possible,” suggests Mr Bae. That said, even those retailers that are successful in restructuring their operations once may find themselves in a Chapter 11 scenario again – a fate that most retailers will be unable to survive for a second time, as demonstrated by RadioShack and American Apparel, for example.
“It seems likely that restructuring activity will continue in the retail industry in the months and years to come because of the ever changing landscape and technological advances,” says Mr Sussberg. “Many retail companies are actively engaged in cost reduction efforts and the types of planning activities that are necessary to potentially avoid the need for an in-court restructuring. The success of these efforts will depend on the willingness of lease counterparties to engage in meaningful negotiations, trade vendors to continue affording terms and companies having enough capital to ensure appropriate development of their omnichannel presence.”
Going forward, retailers able to maintain the flow of goods and the possibility of an ongoing, viable enterprise will be the ones that recognise the need to plan and adapt to the changes sweeping the industry – necessary measures which serve to assure the US retail space that when the shutters come down today, they do not stay down tomorrow.
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