"There was a huge availability of capital and concessions made to retailers during the recession, which kept them hanging on," said Michael Appel, president of retail restructuring practice Appel Associates. "The problem though was it allowed retailers to keep doors open, but without making management or operational changes. Now for many, there's nothing left."
Appel was chairman of Loehmann's while it attempted, though ultimately failed, to restructure. The retailer liquidated in 2014.
"You can do a financial restructuring, but if you don't have a defensible business proposition, you get liquidated anyway," he said.
Now, those debts are reaching the end of their runways, meaning it's time for retailers to pay their creditors. The problem is, the debt loads are bigger than many can handle, and there's no time left to make up the cash needed.
Massive debt ... thanks to private equity
Half of the retailers filing for Chapter 11 this year are owned at least in part by private equity, and the pattern is expected to continue. Moody's has a number of other retailers owned at least in part by private equity on watch lists based on upcoming debt maturities, including J. Crew, Neiman Marcus, David's Bridal, rue21, Claire's and Charming Charlie.
Even David Simon, CEO of mall operator Simon Property Group, who unsurprisingly often plays a cheerleader role for positive retail trends, can't deny the impact private equity is having on retailers.
"The [retailers] that aren't surviving in a tough REIT apparel environment are the ones that were highly levered and had the imprint of private equity on it," Simon said on his most recent earnings conference call. "If you look at, kind of, where that pressure point has been, it's more than just our apparel business is bad, it's because, well, they couldn't survive with leverage on it."
How is it that so many private equity investors — known for having some of the smartest minds in finance — missed the impending degradation of the sector?
Decades ago, it was among the most popular of leveraged-buyout plays. The popular notion was that these firms could buy a retailer, make the business more efficient while expanding its footprint in new markets, and then sell the company or take it public at a higher price.
It didn't always turn out that easy.
David Bonderman, the chairman and founding partner of TPG Capital, summed it up at the Milken Institute Global Conference in Los Angeles this week: "The internet has proven much more resilient and much more important than most of us thought a decade ago when this started to happen."
Bonderman was speaking about retail, an industry he said he now plans to avoid.
Turns out, the challenge for many retailers was that they racked up such high-interest payments that they were unable to invest as heavily in e-commerce or other areas of the business.
"Because of the pressure to generate returns, they constructively do something that effectively burdens a company with so much debt, it can't sustain that debt," said Ron Sussman, a former bankruptcy litigator who focused on retail. "When it tanks, it's only the PE guys and gals who make it out."
While the bankruptcies of some retailers have cost private equity firms millions, in aggregate, the industry's retail investments have been positive. Between 1997 and 2014, pooled gross returns for private equity investments in the retail sector have never been negative, according to data compiled by Cambridge Associates, an investment firm. In 2013 and 2014, the sector returned 28 percent and 25 percent respectively.
One way private equity has been able to salvage these investments is through dividend recapitalizations. These are effectively payments made to the private equity owners from additional debt placed on the retailer. Given the openness of the financing markets over the last few years, these dividends have become fairly common.
This year, such loans issued by retail companies to finance dividends to private equity amounted to $2.7 billion, according to LCD, an offering of S&P Market Intelligence. That compares with $1.65 billion in all of 2016 and $3.17 billion in 2015.
It's impossible to know what retailers like Payless, which filed for bankruptcy earlier this year, would have looked like without private equity backers. But the mountains of debt and several turns of leverage did not help.
Either way, the confluence of these factors leaves Gottlieb asking: "If you are a retailer in distress, how in God's name can you come out of it?"