From time-to-time, we will call Supply Chain Matters reader attention to noteworthy industry editorials, particularly when they have supply chain implications. This particular blog applies to the retail industry and its associated supply chains and how private equity financing practices are pitting suppliers against investors.
Yesterday’s edition of The Wall Street Journal included a report, Private Equity Takes Fire As Some Retailers Struggle. (Paid subscription required) The essence of the report was that the recent wave of bankruptcies involving retailers has revived the debate about the role of private-equity investors in perhaps accelerating the problems of retailers in distress.
The WSJ notes that between the period of 2011 to 2013, many private equity takeovers occurred when money was cheap. The report cites $90 billion in leveraged loans and high-yield bonds raised for private-equity owned retail borrowers to make dividend payouts. Recent bankruptcy proceedings involving Payless ShoeSource, Gymboree, rue21 and True Religion reportedly have a similar theme of private equity firms eventually loading added debt on balance sheets while insuring dividend payouts to investment firms. The mountain of debt, coupled with reduced revenues and profits, accelerates the process towards bankruptcy. When such proceedings reach the bankruptcy courts, unsecured creditors, often suppliers and real-estate landlords, then discover that there is little remaining to settle outstanding invoice claims within the bankruptcy settlement process. Typically, in bankruptcy, lenders expect to be paid before equity owners.
Creditors are now becoming more active in filing actions against private-equity investors to provide additional monies for outstanding creditor settlements.
As our industry supply chain readers are well-aware, consignment inventory or vendor managed inventory (VMI) practices are fairly common practice in retail and consumer goods focused and other select industry supply chains. They were designed as a response by suppliers to assist key customers in their inventory and cost-of-goods sold (COGS) financial objectives. Suppliers holding inventory ownership until goods are sold is a means of lower cost inventory financing for the buyer.
To amplify the extent of this ongoing problem, in March of last year, Supply Chain Matters called reader attention to retailer Sports Authority’s disturbing twist to consignment inventory management practices. Characterized as one of the largest sporting-goods retailers, the chain was weighted down with debt from a prior leveraged buyout a decade ago. In its bankruptcy filing, Sports Authority indicated $1.1 billion in debt that included $717 million in bank loans and over $200 million in trade debt owed to suppliers. As is a common practice in retail supply chains, suppliers had consigned inventory to this retailer, expecting payment when the goods were sold to consumers. The retail chain then filed lawsuits with more than 160 of these suppliers challenging supplier claims to consigned inventories. The supplier lawsuits were apparently a means to challenge who gets the bulk of compensation when consigned goods are sold in store closings or in discounted sales. According to published reports, Sports Authority’s private equity owners as well as a consortium of banks were apparently seeking to test defects in inventory consignment agreements. The courts eventually rejected such arguments. In our March 2017 commentary, we characterized that development as a new low by private equity firms in challenging successful established business practices for singular gain. It literally challenges the notions of win-win supplier collaboration practices.
Over a year later, the situation continues, pitting suppliers against equity owners as to whom gains an equitable financial consideration when retailers are forced to go bankrupt. With each occurrence, more cynicism enters the process and efforts toward broader industry supply chain collaboration and information-sharing suffer the consequences.
An industry that continues to undergo unprecedented industry challenges, unfortunately must also deal with the effects of private-equity investors with a zeal for short-term benefits at the expense of longer-term successes.
We offer no definitive prescriptions for resolving such a problem, other than to raise broader awareness and appeal to industry participants to respect the importance of the supply chain ecosystem. Shortchanging suppliers for near-term gain may be viewed as finally innovative but it comes at a steeper longer-term cost.
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