Antony Karabus is CEO of HRC Retail Advisory, the Northbrook, Illinois, consulting firm. For more than 25 years Karabus has advised retailers, including a number that are PE-backed, on financial-performance issues.
How has the market changed for retailers?
The most fundamental changes are probably these three major secular trends. First, there is a huge shift to discount or value. There is a massive amount of growth for discount players, like TJ Maxx, Ross, Burlington, Nordstrom Rack. The total growth of retail is 3 to 4 percent, but the growth rate of these discounters is more than double the sector. They’re taking a lot of share.
Second, there’s the extreme value guys like Family Dollar, Dollar General and Dollar Tree. The three of them are adding an enormous number of stores. Third, the most fundamental change is the move from brick and mortar to the omnichannel world. As bad as it is today than a year ago, today will be better than next year. The growth rate of online and omnichannel is growing exponentially compared to the growth rate of brick-and-mortar stores.
How does Amazon play into this?
Amazon is growing 25 percent a year compared to retailers growing 3 percent year. Amazon is growing rapidly and taking more share from retailers. And the decline in market share by most traditional retailers means there is pressure on earnings.
How does this affect PE-owned companies?
You’ve got retailers that were bought by PE firms in leveraged buyouts that have debt. You have the declining ability to service the debt. In fact, not just service the debt but pay down the debt and sometimes refinance it. There are a number of PE-backed retailers that have heavy debt and are paying interest with PIK notes. This puts more pressure on retailers because their debt is getting bigger. You may save some cash in the short term, but it’s just increasing the notes. In the short term this is better, but in the long term it is not because you have more debt.
The silver lining is that this is forcing a lot of retailers with unsustainable capital structures to become stronger. It’s forcing them to be operationally stronger and more efficient. We’re talking about not just slashing costs, but becoming better and stronger retailers in order to put themselves in a better position to service their debt and be able to repay and/or refinance their debt.
What were the errors PE firms made when buying retailers?
I don’t know if there were errors per se. The transformation of retail and the pressure on retailers happened a lot quicker than people expected.
What must PE firms do to help their retail holdings survive?
We recommend that private equity sponsors try and buy more time to turn around their retailer portfolio companies in a proactive way. This includes working to try to refinance and extend the maturities of the short-term bond and other loan obligations and thereby strengthening the capital structure. This provides the runway to assess the P&L in a really substantive, bottom-up way that goes well beyond the reactive cost-cutting initiatives that we have been [seeing] over the past couple of years.
What we believe is needed is a more substantive operational assessment to identify and prioritize all value-creation opportunities, including overhead resource optimization, margin improvement, enhancing store-level service, improving customer-conversion rates, improving the effectiveness of inventory management and critically assessing high-cost omnichannel policies such as free delivery to home or stores and unlimited product returns.
Action Item: Contact Antony Karabus at akarabus@HRCadvisory.com
Photo of Antony Karabus, CEO of HRC Retail, courtesy of the firm.