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One of the problems in UK retail (before CV) is PE buyers, acquiring retailers and then loading them with debt Debenhams (about to go bust this week) is a clas

One of the problems in UK retail (before CV) is PE buyers, acquiring retailers and then loading them with debt Debenhams (about to go bust this week) is a classic example - until 20yrs ago it owned it's premises, PE bought it, loaded it with debt and then split off the property into a separate company and signed the stores to ever increasing rents Debenhams can't service the debt and the ever increasing rents (and they've lost their way as a business) PE debt killed Toys r Us, and many other retailers in the UK too PE leveraged buyouts are generally bad for everyone except the PE firm, and in some cases lenders

JamesBarney 7y ago
Amazon killed Toys R Us.
valuearb 7y ago
Toys R Us was killed by the internet. When you own a dying business, spinning off its properties makes perfect sense. Real estate has long term value the business no longer has. And of course rents rise over time, why would your real estate business subsidize the dying business with below market rates?
- youngtaff 7y ago
  In the US maybe, in the UK there are toy shops (Entertainer, Smyths Toys) that successfully operate retail premises as well as internet sites Smyths very much looks like a better Toys R Us
valuearb 7y ago
BTW, you are dead wrong about PE leveraged buyouts, they are generally good for everyone including the firm. I don't know much specifically about Debenhams, but what often happens in situations like that goes like this super simplified example. An entrepreneur builds a successful business and eventually tires of getting up at 5 am or just wants to secure the massive wealth they've built. So they endeavor to sell what they built and shop it to interested parties, and the best price comes from a PE firm. That's good #1, because of the PE firm the entrepreneur was able to get the best price for their life's labor. Lets say the business had annual sales of $100M, and profits of $4M, and the winning bid was $40M (10x earnings). But the PE firm knows that the firm owned all of it's buildings and paid no rent. Market rents would have been $2M a year, so the actual economic profit of the business was only $2M. The PE firm doesn't want to tie up $40M, so it goes to a bank or a consortium of lenders to see how much they can borrow against the purchase value. Lenders not being stupid, won't let the PE firm spin out the properties into another company if they give a large loan, so the PE firm breaks up the company into two parts, real estate and stores, and gets loans for each. The real estate arm now gets $2M in income every year from the stores at current market rents, so lenders loan it $15M at 8% interest, costing $1.2M a year in interest. The stores now have a $2M annual profit after paying rent, they also borrow $15M at 8%, and both subsidiaries net $800,000 a year after paying interest. The new owner, the PE firm, takes the $30M in loan proceeds, reducing their total investment to $10M, and they earn around $1.6M in annual dividends from the company, or a 16% return. If they hadn't leveraged up, they would have made $4M a year on $40M, only a 10% return. Ten years pass. Rents in the areas of the store locations have doubled (a 7.2% annual increase) because those locations were so well selected by the founder to be in areas that saw a higher increase in population and traffic. Now the stores subsidiary has to pay $4M a year in rent. But the problem is store earnings haven't kept pace, sales have grown to $150M a year, but profits before rent and interest have only grown to $5M a year, because there is now also more competition from Walmart, Sprouts and Whole Foods. Now they can't afford to keep up their interest payments, and the CEO of the stores subsidiary asks the PE firm to make the real estate subsidiary give them substantial discount on their rent, after all, the PE firm owns both of them, why favor the real estate subsidiary when the stores are at risk? But the CEO of the real estate subsidiary argues the opposite. Their real estate is valuable, if the stores go out of business he can quickly rent their spaces to new tenants that will gladly pay full rents, and will diversify her portfolio of tenants to make her business more secure. The partners at the PE firm by this point know full well what the real problem is. Despite the boom in population, the stores aren't reaping proportionate increase rewards because they simply can't. The founder was brilliant at buying real estate but that covered for flaws in the stores business model. Maybe they never had the necessary size to compete with bigger chains, maybe they were always poorly run, or maybe the PE firm dropped the ball in who they put in charge. It doesn't matter what the cause is, in the end the PE firm lets the stores file for bankruptcy and surrenders it's ownership to the lenders. The lenders will fire sale the inventory to get as much of their loans back as possible, but still take a large loss. But the real estate firm is now making $4M a year renting to new, stronger tenants in great locations, likely paying higher wages (good #2). The PE firm made around $15M in dividends from both subsidiaries before the stores went bankrupt, and at same time they sell their real estate firm for $40M (minus $15M in loans). So in the end their $10M earns a gain of $30M over ten years, despite the bankruptcy. That seems like a huge gain, but it's only an annualized return of somewhere between 15% and 20% a year depending on how dividends were paid. That's a very good return, but not a world beater. The PE firm lost because the stores failed. If they had just maintained their original value so they could be sold for the $20M that they cost in the original purchase. Now their gains are $50M, and their annualized returns are above 20%. Very few PE firms go into deals like this planning for the main business to fail, and to make up for it with asset sales. It greatly reduces your long term returns or can even leave you with huge losses. If the founder had never sold, the same problems likely occurred. Maybe he runs the stores better, but he would still have to deal with higher levels of competition, and finding good new locations would have gotten harder. Eventually he would have had to wonder whether splitting the business made sense, that he had a dynamite set of real estate properties being held back by struggling stores rapidly being overtaken by larger and better funded competition. The day the stores start losing money would be the day he would be forced to take drastic action similar to what a PE firm would do.
- youngtaff 7y ago
  Apart from the PE firm doesn't loose as they'll extract the value of the stores they sold as a dividend long before the business fails

JamesBarney 7y ago

Amazon killed Toys R Us.

valuearb 7y ago

Toys R Us was killed by the internet. When you own a dying business, spinning off its properties makes perfect sense. Real estate has long term value the business no longer has. And of course rents rise over time, why would your real estate business subsidize the dying business with below market rates?

youngtaff 7y ago
In the US maybe, in the UK there are toy shops (Entertainer, Smyths Toys) that successfully operate retail premises as well as internet sites Smyths very much looks like a better Toys R Us

valuearb 7y ago

BTW, you are dead wrong about PE leveraged buyouts, they are generally good for everyone including the firm. I don't know much specifically about Debenhams, but what often happens in situations like that goes like this super simplified example. An entrepreneur builds a successful business and eventually tires of getting up at 5 am or just wants to secure the massive wealth they've built. So they endeavor to sell what they built and shop it to interested parties, and the best price comes from a PE firm. That's good #1, because of the PE firm the entrepreneur was able to get the best price for their life's labor. Lets say the business had annual sales of $100M, and profits of $4M, and the winning bid was $40M (10x earnings). But the PE firm knows that the firm owned all of it's buildings and paid no rent. Market rents would have been $2M a year, so the actual economic profit of the business was only $2M. The PE firm doesn't want to tie up $40M, so it goes to a bank or a consortium of lenders to see how much they can borrow against the purchase value. Lenders not being stupid, won't let the PE firm spin out the properties into another company if they give a large loan, so the PE firm breaks up the company into two parts, real estate and stores, and gets loans for each. The real estate arm now gets $2M in income every year from the stores at current market rents, so lenders loan it $15M at 8% interest, costing $1.2M a year in interest. The stores now have a $2M annual profit after paying rent, they also borrow $15M at 8%, and both subsidiaries net $800,000 a year after paying interest. The new owner, the PE firm, takes the $30M in loan proceeds, reducing their total investment to $10M, and they earn around $1.6M in annual dividends from the company, or a 16% return. If they hadn't leveraged up, they would have made $4M a year on $40M, only a 10% return. Ten years pass. Rents in the areas of the store locations have doubled (a 7.2% annual increase) because those locations were so well selected by the founder to be in areas that saw a higher increase in population and traffic. Now the stores subsidiary has to pay $4M a year in rent. But the problem is store earnings haven't kept pace, sales have grown to $150M a year, but profits before rent and interest have only grown to $5M a year, because there is now also more competition from Walmart, Sprouts and Whole Foods. Now they can't afford to keep up their interest payments, and the CEO of the stores subsidiary asks the PE firm to make the real estate subsidiary give them substantial discount on their rent, after all, the PE firm owns both of them, why favor the real estate subsidiary when the stores are at risk? But the CEO of the real estate subsidiary argues the opposite. Their real estate is valuable, if the stores go out of business he can quickly rent their spaces to new tenants that will gladly pay full rents, and will diversify her portfolio of tenants to make her business more secure. The partners at the PE firm by this point know full well what the real problem is. Despite the boom in population, the stores aren't reaping proportionate increase rewards because they simply can't. The founder was brilliant at buying real estate but that covered for flaws in the stores business model. Maybe they never had the necessary size to compete with bigger chains, maybe they were always poorly run, or maybe the PE firm dropped the ball in who they put in charge. It doesn't matter what the cause is, in the end the PE firm lets the stores file for bankruptcy and surrenders it's ownership to the lenders. The lenders will fire sale the inventory to get as much of their loans back as possible, but still take a large loss. But the real estate firm is now making $4M a year renting to new, stronger tenants in great locations, likely paying higher wages (good #2). The PE firm made around $15M in dividends from both subsidiaries before the stores went bankrupt, and at same time they sell their real estate firm for $40M (minus $15M in loans). So in the end their $10M earns a gain of $30M over ten years, despite the bankruptcy. That seems like a huge gain, but it's only an annualized return of somewhere between 15% and 20% a year depending on how dividends were paid. That's a very good return, but not a world beater. The PE firm lost because the stores failed. If they had just maintained their original value so they could be sold for the $20M that they cost in the original purchase. Now their gains are $50M, and their annualized returns are above 20%. Very few PE firms go into deals like this planning for the main business to fail, and to make up for it with asset sales. It greatly reduces your long term returns or can even leave you with huge losses. If the founder had never sold, the same problems likely occurred. Maybe he runs the stores better, but he would still have to deal with higher levels of competition, and finding good new locations would have gotten harder. Eventually he would have had to wonder whether splitting the business made sense, that he had a dynamite set of real estate properties being held back by struggling stores rapidly being overtaken by larger and better funded competition. The day the stores start losing money would be the day he would be forced to take drastic action similar to what a PE firm would do.

youngtaff 7y ago
Apart from the PE firm doesn't loose as they'll extract the value of the stores they sold as a dividend long before the business fails