How Private Equity Firms Will Profit From COVID-19

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Burdened by debt and interest payments, J. Crew was unable to take on lower-priced competitors.

It’s no surprise that the first big retailer to file for bankruptcy during the coronavirus pandemic is owned by private equity. J. Crew, acquired by PE firms Leonard Green & Partners and TPG Capital in 2011 in a leveraged buyout that loaded the company with debt, sought bankruptcy protection on May 4.

J. Crew joins a long list of private equity–owned retail chains that have made millions for their Wall Street owners, pillaging the companies they buy while costing hundreds of thousands of retail workers their jobs. Private equity owners shuttered stores at an alarming rate over the last decade, disrupting the lives of more than 590,000 retail workers. Some household names are out of business entirely: Toys “R” Us, Sports Authority, Charlotte Russe, Gymboree, and Payless ShoeSource, to name a few.

Without passage of the Stop Wall Street Looting Act (SWLA) to rein in unsustainable debt and put an end to private equity owners enriching themselves, otherwise successful retailers brought low by the COVID-19 pandemic will be fair game for these vultures.

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There’s no honor among financial titans either. While their portfolio companies struggle now, PE firms are more than willing to stiff the creditors they depend on to finance their debt-ridden takeovers in order to increase their take.

J. Crew is an exemplar. It was a successful retailer whose casual styles were a favorite of former First Lady Michelle Obama. Leonard Green and TPG paid $3 billion for the chain, but in the first two years after the buyout, they helped themselves to more than $700 million in dividend payments and fees, according to filings with the Securities and Exchange Commission. PE firms operating in Europe are not permitted to siphon off money this way in the first two years—a prohibition the SWLA would extend to U.S. companies.

Burdened by debt and interest payments, J. Crew was unable to take on lower-priced competitors and failed to adapt to changing tastes in fashion or to vigorously invest in its ecommerce business. In late 2016, Leonard Green and TPG sold J. Crew’s intellectual property—its valuable trademarked brands—to a new subsidiary in the Cayman Islands, where it would not be available to pay off creditors in case of financial trouble.

A year later, J. Crew was on the brink of defaulting on its debt. Dan Primack at Axios noted that in the subsequent restructuring, the PE firms “ring-fenced” the retail chain’s growing 132-store Madewell subsidiary, putting it out of reach of J. Crew’s creditors. The unsustainable debt remained with J. Crew’s 365 stores and factory outlets. With limited options for recovering the debt, J. Crew’s creditors agreed to take possession of the chain, and converted $1.65 billion of debt into equity of dubious value. The failure of the planned IPO for Madewell may return this division to J. Crew in bankruptcy proceedings. The fate of workers at J. Crew’s 365 stores and factory outlets is not clear, though it is likely that many establishments will not reopen.

Morally questionable actions when PE takes over a retail chain are not limited to TPG and Leonard Green. One of the more egregious examples is the tale of Sycamore Partners and fashion shoe retailer Nine West. The company’s products were once so popular that The New York Times estimated its various brands accounted for one in five U.S. shoe sales in 1997. But then it hit harder times. Nine West endured several years of lower sales after the 2008 financial crisis. By 2014 private equity firm Sycamore Partners took it over in a $2.2 billion leveraged buyout.

Just like the J. Crew saga, Sycamore immediately moved the most valuable brands and assets out of the reach of creditors. It paid itself a $40 million dividend before selling Nine West, Stuart Weitzman, Kurt Geiger, and Jones Apparel to its other funds for a total of $641 million in April 2014. The other brands were sold off, and all of he remaining debt stayed on the rechristened Nine West Holdings.

Two years after the Sycamore buyout, in April 2016, the new Nine West collapsed under the weight of its debt burden. At the time of its bankruptcy, the company’s $1.6 billion in debt equaled its $1.6 billion in revenue. In 2018, Nine West laid off its workers and closed all its stores.

Lenders were angered by Sycamore’s apparent self-dealing, alleging that the PE firm intended from the get-go to profit by selling off the most valuable brands. Despite an investigation that revealed possible misdeeds by Sycamore, the junior-most holders of Sycamore debt, with $700 million in unsecured bonds, conceded defeat in January 2019 and accepted a $120 million settlement, a little less than 20 cents on the dollar. Sycamore profited handsomely while the shoe chain failed, its stores were all closed, and its remaining 1,500 workers lost their jobs.

As an article in The Wall Street Journal observed, “With Sycamore’s strategy, it isn’t necessary to spruce up a purchased company. The firm often buys struggling retailers and sells off their most valuable pieces. It cuts costs at whatever remains, sometimes using the savings to extract dividends. The firm tells investors its returns ‘need not depend’ on successfully identifying growth opportunities for its retail targets.”

Private equity firms that have learned how to make money from the misery of distressed retailers will find that COVID-19 has presented them with a smorgasbord of companies to feast on. They can dispose of failing assets like J. Crew, stiff lenders, and then return to those same lenders for future sales. Workers may get wiped out but private equity, with $2.5 trillion in undeployed funds, will live on.

It doesn’t have to be this way. Many in Congress are calling for a moratorium on mergers and acquisitions until the pandemic is over.  Sen. Elizabeth Warren (D-MA) and Rep. Alexandria Ocasio-Cortez (D-NY) have released a bill, the Pandemic Anti-Monopoly Act. House Antitrust Subcommittee Chair David Cicilline wants a temporary ban on most mergers. The Federal Reserve and the Treasury can condition big business bailouts on a freeze on merger and acquisition activity. Longer term, passage of the Stop Wall Street Looting Act will protect the jobs of workers from being sacrificed to the excesses of greed that brought down J. Crew and Nine West.