Hilco’s Karabus: Five risks PE firms need to consider when buying a retailer

Retail industry veteran Antony Karabus has advised numerous big-name brands, including Neiman Marcus, American Eagle and Burlington Coat Factory. Karabus sold his retail advisory firm, Karabus Management, to PwC in 2008. In January, he became the president of Hilco Retail Consulting of Northbrook, Ill.

Karabus recently spoke to peHUB. Here are five risks he identified that PE firms should beware of when buying a retailer:

  1. Picking the right management team. PE firms need CEOs that are familiar with running a company owned by a financial sponsor, said Karabus. The growth expectations are significantly greater under a buyout shop than a strategic investor. PE firms expect to exit within four to six years, so they want to generate a premium. Any new CEO should understand this, he said. “It’s a much higher level of intensity than a regular buyer.”
    As an example, he cited the decision by Ares and CPPIB to appoint Stephane Gonthier as president and CEO of 99 Cents Only Stores. Gonthier is the former COO of Dollarama, which was owned by Bain Capital. (Bain sold its remaining stake in Dollarama in June 2011, according to press reports.) That’s direct, relevant experience at work, he said.
  2. Not having adequate operational oversight. Private equity firms often bring in new CEOs to run their portfolio companies. Sometimes these CEOs will attempt to replicate what worked at their prior jobs, and may try to change the customer profile to match their experience at the other company. “This is a risk we have often seen and has meaningful ramifications,” Karabus said.
    Sponsors should be hands-on in their choice of CEO and in their oversight of an executive’s initial strategy. But they should not micro manage. If the CEO wants to alter the company’s direction or customer base, he or she should provide very clear evidence to justify the change, he said.
  3. Understand the company you’re buying. PE firms, once they acquire a company, need to be realistic about its organizational strengths and “key growth levers,” Karabus said.
    A company typically has a moderate growth initiative pre-buyout. Once it’s sold, the sponsor will want the company to produce significant growth to support its purchase price and desired ROI. This often leads to investment in capital expenditures, as well as in key functions like e-commerce, real estate or merchandising. “The management team needs to have the fortitude to find the right complement of in-house skills and external, experienced partners to get to the finish line,” Karabus said.
  4. How old is that real estate? One of the major factors that keeps a retailer relevant to customers is the age of its real estate portfolio. The real estate will likely change over the typical four to six-year PE investment period. Buyout shops, with their much higher growth expectations, need to understand the age of the company’s fleet and how it relates to the store’s profitability. Some stores may not be relevant anymore.
    Sponsors may need to “tweak and fine tune” the real estate portfolio, which could include getting out of some leases, going to a different shopping mall or expanding some stores. Any store over 10 years is “pretty tired,” he said.
  5. Information Technology. Karabus has seen CIOs develop long-term IT strategies that were based on a ROI and other metrics from before the buyout. Once a sponsor comes in, that strategy should change and align with the higher growth and value creation requirements of the PE firm. “This is a huge issue,”he said.

 Photo courtesy of Hilco