Behind the Closed Doors
When retailers go bankrupt, the vendors feel the pain.
By Brent Felgner -- Gifts and Dec, 7/1/2009 12:00:00 AM
One evening last December, a few weeks after the economic meltdown began in earnest, several dozen top executives came together for their annual holiday get-together. They were a veritable who's who of retail failure: liquidators and close-out merchants, turnaround and bankruptcy specialists, distressed-debt players and investment bankers.
The group was just a little thinner and only slightly more sedate than in past years. Yet, as they chatted over cocktails, it was abundantly clear these would be among the very few winners in a troubled retail landscape that would see dozens of major nameplates and thousands of doors simply vaporize.
Throughout that evening in multiple conversations, there was a single refrain offered up with an almost gallows-like humor and unsettling consistency: "By this time next year, people will look back fondly at 2008 and remember the 'good old days.' "
Tidal Wave of Closings
The tsunami of major retail bankruptcies and liquidations has been remarkable: more than two dozen major filings last year across all trade classes, including the likes of Linens 'n Things, Bombay, Circuit City, Sharper Image, Lillian Vernon, Red Envelope and Mervyn's. The wave has continued into 2009 with Fortunoff, Gottschalks, Boscov's and Elephant Pharm. By virtually every account, that list will continue to grow — well into 2010.
"We lost money on Linens 'n Things, for sure — a pretty significant amount," Midwest-CBK president Rick Contino said in a telephone interview. "You don't have a lot of options if you want to continue to work with your customers; we try to reduce our exposure as best we can. But this is a small industry and people don't wander too far away. You try to do your best to protect the interests of your company as best you can. It's never simple."
Even beyond losing important segments of their sales base at retail, what has truly frightened some vendors, perhaps more than anything else, is the obvious and increasing frequency with which they are finishing out of the money — with little or no payout on their unsecured pre-petition trade debt. Worse still, there has also been an alarming reduction in post-petition supplier payouts — the period when suppliers should have administrative priority status granted by the bankruptcy code, in return for their continued support of the retailer's efforts to reorganize.
While it's difficult to quantify — the sheer weight of the bankruptcies and discrepancies in filings present the challenge — in the amalgam, those lost supplier payments number at least into the tens of millions of dollars, if not much more. Perhaps mindful of the need to appear to support their retail customers, many suppliers are loathe to address the subject publicly.
Moved to the Back of the Line
But vendors have been pushed further down the payout list by the emergence over the last 8–10 years of a second tier of secured, collateralized debt, enabling companies to lever up to the max and achieve what has been argued as the full value of their asset base including their names and goodwill.
In the process, the unsecureds have often become the butt of what must seem like a cruel joke.
"There's a lot of jockeying under the backboards and throwing of elbows among the different tiers of debt," offered Howard Brownstein, a principal of NachmanHaysBrownstein, a turnaround firm in Philadelphia, in an interview. "Some of the attorneys who represent the secureds in bankruptcies, refer to the trade as the 'great unwashed masses' — you know, they're last in line, probably out of the money and had better not be too obstreperous or they'll just get wiped out. So the power you used to see in the hands of unsecured creditors committees is nowhere near what it once was."
That's likely an understatement. With rare exception unsecured creditors committees wield precious little power today, beginning with the "cram down" provisions of a Section 363 asset sale that all but obviates the need for ratification of a formal reorganization plan and disclosure statement. Where it works, the asset purchase agreement becomes the defacto reorganization. But even those auctions have largely become casualties of the crippled economy.
"What is generally happening is that if a company is hitting a liquidity wall and needs to file bankruptcy because it's running out of cash, the only exit strategy that appears to be somewhat working is a sale," said Laura Davis Jones, managing partner of the Delaware office of law firm Pachulski Stang Ziehl & Jones. "And if a sale can't happen in a very short time period, then it's just a wind down or a straight liquidation."
One problem is that financial buyers for these companies have mostly retreated into the woodwork, leaving only a few, frequently reticent strategic buyers.
No Easy Answer
The simple, albeit naïve, answer would be for suppliers to reduce their exposure to the sinking merchants. And indeed they have — a bit. But the Catch-22 has always been finding the right balance between the suppliers' needs to make their own numbers, address their debt and liquidity needs, and protect their market share from insurgent competitors that often bide their time waiting for an opening. All while appearing to "support the trade."
"You get in deep, and then you're in too deep to get out," Craig Boucher, a partner in turnaround management firm CRG Partners, Bethesda, MD., told Gifts & Decorative Accessories. "It's a dicey situation. One thing we look at [coming in to a turnaround situation or bankruptcy] is trade support. How much can you stretch your trade and still get goods on a timely basis and on terms? If they start switching you to pre-pay or cash on delivery, cash in advance payment terms, that upsets the complete dynamic of your cash flow."
If a vendor gets too rough, the word goes out to the buyers: Find another supplier. But as sell-through becomes problematic, so too do payments and chargebacks, according to Scott Avila, managing partner of Corporate Revitalization Partners, Los Angeles.
"Vendors are getting very, very nervous, and they are far less willing to be the bank that they used to be for retailers and provide lots of credit — or offer dating and long terms. It's gotten very tough and it's going to get tougher," Avila said. "Trade credit is the life blood of retailers. It's hard for retailers to get bank credit. They can if they've got cash flow and a valuable store name, but if they're trying to borrow on their assets, they don't have receivables because it's all in credit cards. So what they really have is inventory and leasehold improvements, and maybe they have real estate. So they've really counted on the trade to finance them, and that has tightened up considerably."
But if you ask a supplier just why they continue to support a flagging retailer, the response is often the same: They'll shrug, perhaps throw up their arms and say,"What choice do we have? We've got to believe that they will survive."
Clearly, some will not, instead falling victim to the fast and easy money that suddenly dried up.
"The discipline of debt is really where it all starts and ends," said Brownstein, who was plan administrator of the Montgomery Ward bankruptcy, the largest retail liquidation in history. "It's a matter of where you put the goalposts. What was good collateral a year ago is no longer good today. If there was that much equity in the assets, why wouldn't the senior bank have loaned on it? They didn't, so someone else lined up to give another 10 percent or so on the receivables and inventory. So now we've come to our senses and said that doesn't make any sense.
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