On July 12, Kramer Levin and Debtwire co-hosted the “Retail Restructuring Outlook” panel discussion at Kramer Levin’s New York office, moderated by Debtwire’s Richard M. Goldman. The discussion covered topics including market forces that have contributed to today’s distressed retail space, key players in current retail restructurings, disputes that arise out of retail restructurings, strategies available to monetize retail assets, and options for investors to assess risk and recoveries.
Michael A. O’Hara, the founder and managing member of Consensus Advisors, delivered the keynote speech, identifying several factors causing the significant transformation and sales dislocation seen throughout the retail industry in recent years. Mr. O’Hara observed that smartphones, coupled with enhanced access to universal broadband, have enabled e-commerce businesses to take over the retail space by providing consumers with improved access to a wide selection of products and facilitating cross-retailer price comparisons. Technology has transformed retail at every step of the process by making products available with a few taps on a touchscreen, simplifying returns, and replacing traditional brick-and-mortar stores with retail showrooms where consumers can see sample goods and have them quickly delivered to their homes. While e-tailor disruption of the retail business model has been widely reported through a catastrophic lens by the popular press, the transformation creates new opportunities to invest in the retail sector.
Adam C. Rogoff, a partner in Kramer Levin’s Corporate Restructuring and Bankruptcy group, discussed trends that he has observed based on his extensive experience with retail restructurings. Mr. Rogoff noted that in the recent round of retail bankruptcy cases, companies typically seek to both de-leverage their balance sheets and achieve operational restructuring by closing unprofitable stores and renegotiating leases. This is predicated upon a current retail environment where merchants have material funded debt to reduce, as well as a bloated store footprint. Mr. Rogoff highlighted the issues facing existing investors who provide rescue capital (such as an existing equity holder who provides debt for liquidity), citing recent unsuccessful litigation in the Aéropostale bankruptcy case, where the debtors sought to equitably subordinate, recharacterize or otherwise modify the rights of certain existing investors, who had also provided liquidity to the debtors and had a material supply contract. He noted that the decision in favor of the investors set a high bar for attacking such investments. While there are opportunities to invest in retail, including distressed retail, investors should carefully evaluate potential outcomes in the event that restructuring is unsuccessful.
Erica D. Klein, a partner in Kramer Levin’s Intellectual Property group, discussed value propositions embodied by, and challenges inherent in, intellectual property and customer data assets in the context of retail restructurings. A retailer’s brand is often a major driver for recovery in the current environment. Ms. Klein pointed out that closing stores and moving to an online-only or licensing-only model can be an effective way for a retailer to maximize future business value. She pointed out a number of former brick-and-mortar retailers, including Sharper Image and Linens ’n Things, that emerged from bankruptcy successfully by leveraging the value of their brands. Ms. Klein also cautioned that when it comes to customer data, another major asset, retailers should plan ahead: By implementing terms of use and privacy policies that permit sharing of customer data in connection with corporate changes, retailers can monetize that data in restructuring transactions. In the absence of express provisions addressing such transfer, bankruptcy courts will limit the debtor’s ability to sell its customer data without consumer protections. In evaluating a potential investment, investors should consider the extent to which a company’s policies presently enable it to monetize its customer data.
The panelists also discussed the key role played by landlords in the context of retailer bankruptcies, with Matthew Bordwin, principal and managing director of Keen-Summit Capital Partners, sharing insights based on his experience in negotiating lease modifications. Given the financial burden imposed by leases for unprofitable stores, the right to terminate such leases is critical in facilitating a retailer’s operational restructuring. Mr. Bordwin emphasized the importance for a retailer of going into bankruptcy knowing which leases will be assumed, which will be rejected and which will be the focus of rent reduction negotiations. In light of the requirement that a debtor assume or reject commercial real property leases within 210 days of filing, Mr. Bordwin recommended that retailers begin negotiating with landlords prior to filing for bankruptcy.
Questions surrounding the valuation of retail assets came up throughout the discussion. Becky Goldfarb, managing director of retail valuations at Gordon Brothers, noted that lenders relying upon inventory as collateral have sought more frequent appraisals in the current retail environment. Ms. Goldfarb highlighted situations that can negatively impact valuation, such as when a retailer fails to replenish inventory or begins to “self-liquidate” by aggressively reducing prices to raise incremental liquidity. While possibly solving a short-term cash need, such aggressive pricing competes with a future liquidation sale and results in a lower overall recovery — at least when the self-liquidation occurs within a short time frame of any formal store closing process.
Steve Coulombe, a managing director with The Berkeley Research Group, summarized trends that he has observed while guiding retail companies through the restructuring process. Mr. Coulombe observed that retailers with funded debt are uniformly entering into bankruptcy with a restructuring support agreement in place, citing Rue21 and Gymboree as examples. Because some retailers are now reorganizing rather than simply selling their assets, vendors — especially vendors with a longer delivery time frame (private label merchandise suppliers) — are playing an increasingly significant role, and negotiations with vendors have become crucial to restructuring success.
Mr. O’Hara elaborated on themes raised in his keynote speech, focusing on ample acquisition opportunities in retail, including in distressed retail, citing cases where existing creditors are providing DIP funding or exit funding and converting a portion into reorganized debtor equity. He observed that the retailers that will thrive are those with strong brand equity that can adapt to new technology and the various ways that consumers “click and spend.” Retailers can position themselves for success, he noted, by stocking brick-and-mortar locations with sample sizes and colors and arranging for prompt home delivery.
The panelists agreed that the retail restructuring boom will continue. Some retailers will not be able to compete, and others will need to transform. The companies most likely to survive are those with foresight, flexibility, brand strength and customer loyalty. Regardless of what strategy a distressed retailer chooses to pursue, merchants and their debt and equity investors should plan in advance and begin a dialogue early.
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