Not Liquidation, But Evaporation

Businesses have long relied on Wall Street's so-called experts for guidance and help with finances. Unfortunately, what many failed to take account of was the financial community's singular focus on fee-generation, its inability to look and think beyond the current quarter, and a pathological aversion to prudence and common sense.

Why else would the retailing sector, for instance, have expanded so dramatically and relied so heavily on borrowed money at a time when consumers were becoming increasingly overburdened, personal savings were at record low levels, wages were stagnating and the economy was increasingly awash in overcapacity?

In "Retailing Chains Caught in a Wave of Bankruptcies," the New York Times' Michael Barbaro details the inevitable result of so much bad decision-making.

The consumer spending slump and tightening credit markets are unleashing a widening wave of bankruptcies in American retailing, prompting thousands of store closings that are expected to remake suburban malls and downtown shopping districts across the country.

Since last fall, eight mostly midsize chains — as diverse as the furniture store Levitz and the electronics seller Sharper Image — have filed for bankruptcy protection as they staggered under mounting debt and declining sales.

But the troubles are quickly spreading to bigger national companies, like Linens ‘n Things, the bedding and furniture retailer with 500 stores in 47 states. It may file for bankruptcy as early as this week, according to people briefed on the matter.

Even retailers that can avoid bankruptcy are shutting down stores to preserve cash through what could be a long economic downturn. Over the next year, Foot Locker said it would close 140 stores, Ann Taylor will start to shutter 117, and the jeweler Zales will close 100.

The surging cost of necessities has led to a national belt-tightening among consumers. Figures released on Monday showed that spending on food and gasoline is crowding out other purchases, leaving people with less to spend on furniture, clothing and electronics. Consequently, chains specializing in those goods are proving vulnerable.

Retailing is a business with big ups and downs during the year, and retailers rely heavily on borrowed money to finance their purchases of merchandise and even to meet payrolls during slow periods. Yet the nation’s banks, struggling with the growing mortgage crisis, have started to balk at extending new loans, effectively cutting up the retail industry’s collective credit cards.

“You have the makings of a wave of significant bankruptcies,” said Al Koch, who helped bring Kmart out of bankruptcy in 2003 as the company’s interim chief financial officer and works at a corporate turnaround firm called AlixPartners.

“For years, no deal was too ugly to finance,” he said. “But now, nobody will throw money at these companies.”

Because retailers rely on a broad network of suppliers, their bankruptcies are rippling across the economy. The cash-short chains are leaving behind tens of millions of dollars in unpaid bills to shipping companies, furniture manufacturers, mall owners and advertising agencies. Many are unlikely to be paid in full, spreading the economic pain.

When it filed for bankruptcy, Sharper Image owed $6.6 million to United Parcel Service. The furniture chain Levitz owed Sealy $1.4 million.

And it is not just large companies that are absorbing the losses. When Domain, the furniture retailer, filed for bankruptcy, it owed On Time Express, a 90-employee transportation and logistics company in Tempe, Ariz., about $30,000.

“We’ll be lucky to see pennies on the dollar, if we see anything,” said Ross Musil, the chief financial officer of On Time Express. “It’s a big loss.”

Most of the ailing companies have filed for reorganization, not liquidation, under the bankruptcy laws, including the furniture chain Wickes, the housewares seller Fortunoff, Harvey Electronics and the catalog retailer Lillian Vernon. But, in a contrast with previous recessions, many are unlikely to emerge from bankruptcy, lawyers and industry experts said.

Changes in the federal bankruptcy code in 2005 significantly tightened deadlines for ailing companies to restructure their businesses, offering them less leeway.

And the changes may force companies to pay suppliers before paying wages or honoring obligations to customers, like redeeming gift cards, said Sally Henry, a partner in the bankruptcy law practice at Skadden, Arps, Slate, Meagher & Flom and the author of several books on bankruptcy.

As a result, she said, “it’s no longer reorganization or even liquidation for these companies. In many cases, it’s evaporation.”

Several of the retailers that filed for Chapter 11 bankruptcy protection over the last eight months, like the furniture sellers Bombay, Levitz and Domain, have begun to wind down — closing stores, laying off workers and liquidating merchandise.

In most cases, the collapses stemmed from a combination of factors: flawed business strategies, a souring economy and banks’ unwillingness to issue cheap loans.

Bombay, a chain with 360 stores, was considered a success in the furniture world, after its sales surged from $393 million in 1999 to $596 million in 2003.

Then the chain decided to move most of its stores out of enclosed malls into open-air shopping centers. It started a children’s furniture business, called BombayKids. And it started carrying bigger items, like beds and upholstered couches, with higher prices than its regular furniture.

Consumers balked at the changes, hurting Bombay’s sales and profits at the same time that its expenses for the ambitious new strategies began to grow. The timing was unenviable: By early 2007, the housing market began to falter, so purchases of furniture slowed to a trickle.

The company was running out of money, but banks refused to lend more. “They did not want to take the chance that we might not repay the loans,” Elaine D. Crowley, the chief financial officer, said in an interview.

In September 2007, Bombay filed for bankruptcy protection. The highest bid for the company came from liquidation firms, who quickly dismembered the 33-year-old chain. Bombay, which once employed 3,608, now has 20 employees left. “It is very difficult and sad,” Ms. Crowley said.

The bankruptcies are putting a spotlight on a little-discussed facet of retailing: heavy debt.

Stores may appear to mint money by paying $2 for a T-shirt and charging $10 for it. But because shopping is based on weather patterns and fashion trends, retailers must pay for merchandise that may sit, unsold, on shelves for long periods.

So chains regularly borrow large sums to cover routine expenses, like wages and electricity bills. When sales are strong, as they typically are during the holiday season, the debts are repaid.

Fortunoff, a jewelry and home furnishing chain in the Northeast, relied on $90 million in loans to help operate its 23 stores, using merchandise as collateral.

But by early 2008, as the housing market struggled, the chain’s profits dropped, meaning its collateral was losing value and the amount it could borrow fell.

In better economic times, the banks might have granted Fortunoff a reprieve. But with a recession looming, they refused, forcing it to file for bankruptcy in February. In filings, the chain said it was “facing a liquidity crisis.” (Fortunoff was later sold to the owner of Lord & Taylor.)

Plenty of retailers remain on strong footing. Arnold H. Aronson, the former chief executive of Saks Fifth Avenue and a managing director at Kurt Salmon Associates, a retail consulting firm, said the credit tightness and consumer spending slowdown have only wiped out the “bottom tier” companies in retailing.

“This recession dealt the final blow to these chains,” he said. But several big-name chains are looking vulnerable. Linens ’n Things, which is owned by Apollo Management, a private equity firm, is considering a bankruptcy filing after years of poor performance and mounting debts, though it has additional options, people involved in the discussions said Monday.

Whether more chains file for bankruptcy or not, it will be hard to miss the impact of the industry’s troubles in the nation’s malls.

J. C. Penney, Lowe’s and Office Depot are scaling back or delaying expansion. Office Depot had planned to open 150 stores this year; now it will open 75.

The International Council of Shopping Centers, a trade group, estimates there will be 5,770 store closings in 2008, up 25 percent from 2007, when there were 4,603.

Charming Shoppes, which owns the women’s clothing retailers Lane Bryant and Fashion Bug, is closing at least 150 stores. Wilsons the Leather Experts will close 158. And Pacific Sunwear is shutting a 153-store chain called Demo.

Those decisions were made months ago, when it was unclear how long the downturn in consumer spending might last. If March was any indication, it is nowhere near over. Sales at stores open at least a year fell 0.5 percent, the worst performance in 13 years, according to the shopping council.

(Hat tip to Bruce)

Comments

[roger pasa]

Why such a stupid move? in chess it is called "TUNNEL VISION"the player will focus only on one objective and is completely oblivious to all the other threatening pieces,in business the focus is exclusively on the gratification of the immediate profit the rest of the world does not exist: LOL.

[roger pasa]

Why such a stupid move? in chess it is called TUNNEL VISION the player will focus only on one objective and is completely oblivious to all the other threatening pieces. In business the focus is exclusively on the immediate gratification of the profit motive,the rest of the world does not exist. lol

[Debtus Maximus]

They forgot to mention CompUSA.

[Commenter]

Wall Street is indeed guilty as charged.

However, the retailers themselves are largely to blame. Largely the CEOs. If 100 stores gets me in a Gulfstream I, then maybe 1,000 will get in in the cherished V?

The chains going under are selling crap and/or are NOT cheap in price. The Sharper Image - please - nothing worth spending my money on found its way into their "collection" for the past 5 years or so.

Target, for example, is NOT cheap in price. Its image is spun to be trendy AND cheap in price, but in reality it is not cheap. Consumers are figuring this out. And now that basic staples are de rigour and trendiness is secondary, watch their stock price sink along with their CEO's tenure on the Gulfstream.

As much as we have overhang capacity and inventory in home building, we have more in retailing - especially big box retailing. I've been saying for years that this segment of the US economy has the most overhang and is the biggest bubble (in the US) - besides the asset inflation bubble - which includes the western world & japan....

Lastly, the retail pricing model needs adjusting. Retailing involves minimal risk and the traditional % markup will go the way of the dodo bird. Just as the realtor comission will do the same...

All leading to a spiral of 10% "offically reported by the lying gov't" (20% "real") unemployment this time next year and state sales collections off by 25%.....

A death spiral, and as any pilot will attest to these are very "hote california" like in nature. Once in, never out.....

[Leonard Raucci]

Michael,

I have been following your blog for quite some time now, and it is one of my must reads every day. Thank you so much for all you do.

I want to make a suggestion to you, and your readers, which will help them get beyond the obvious sources of our financial destruction (that of course being Wall Street Alchemy, a paid for congress, the Fed, Treasury, etc..), and allow them see the ultimate source.

Read "The Bilderberg Group" by Daniel Estulin, if you have not already. I can not stress enough the importance of this information - as it applies to the destruction of our dollar and our nation. There are also some very good youtube clips. Do not dismiss this as conspiracy....all of the information presented is backed up by documented facts!

[Rocky]

When the income tax rebate checks go out starting next month, that may signal the last burst in impulse retail spending for a while. Using one's house as an ATM has been over for months. In the upscale regional shopping area near me, the large store formerly occupied by Bombay Furniture is empty. So is the store formerly occupied by Thomasville. So are a host of smaller businesses, including one nicknack store that lasted last less than six months, and a bookstore that had been in business for years. One fancy diner looks like it has been nuked. The restaurant and its designer booths are in tact but there are no people. A 3 day quit notice is taped to the front door for unpaid rent etc. of $60,000. An upscale condo complex nearby is struggling to sell the last of its units. All of its retail space on the ground floor is empty. One new restaurant opened but appeared to last only a few weeks!

[wawawa]

Just tell me which retails are good candidates to SHORT ?