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Since I first wrote about private equity’s looting and ultimate devastation of Mervyn’s (“On Private Equity and Real Estate” September 2012), retailer after retailer has been similarly gutted. Payless Shoes, Toys ‘R’ Us, PetSmart, Gymboree, Sears, Mattress Firm and Radio Shack — all companies owned by private equity — have since filed Chapter 11. In fact, Debtwire, a financial news service, calculates that about forty percent of all US retail bankruptcies in the last three years were private equity backed.

How do the private equiteers do it? Simple, the leveraged buyout. The LBO is the financial world’s pick and roll, that is, a highly effective play that is difficult to counter, especially if the PE firm takes the prudent first step of bribing its intended victim’s CEO into going along with their acquisition. In short, the PE firm pays top dollar for a given retailer, often even overpaying, but using as little equity and as much debt as it possibly can. It then improves the company’s profitability by cost-cutting beyond prudence and, as with Debenhams, says, “What a good boy am I,” rewarding itself with a major dividend, often recovering not only its entire initial investment, but a substantial profit to boot. A PE firm may be in good faith, it may actually use its best efforts — to be fair, equiteers sometimes succeed with their retail acquisitions — but even under the best of circumstances, retail is a difficult business, the threats from e-commerce, changing tastes and ever more nimble competitors are all too real. Here’s the PE challenge: If you’ve already got your investment plus a fat profit out of a company, how hard are you going to continue to work on bailing it out, especially when you’ve crushed its bottom line beneath a wrecking ball of expensive debt?  Read more