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The Financial Stress in Retail, Post Covid
Amit Puri Associate Vice President | May 7, 2020
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I woke up on Sunday to learn about the possible death of one of my favorite department stores – Neiman Marcus.

The COVID-19 pandemic has forced the non-essential company to temporarily shut all 43 of its Neiman Marcus locations, roughly two dozen Last Call stores and its two sister brand Bergdorf Goodman stores in New York City. It has also furloughed most of its 14,000 employees, stopped accepting any new merchandise, and most importantly skipped millions of dollars in debt payments last week, including one that only gave the company a few days to avoid a default, according to Reuters. The Dallas-based luxury retailer had said on March 30 that it was exploring all options, and that includes bankruptcy, but as of writing this paper, it hasn’t happened yet.

We may not see a total disappearance of the Neiman brand post-bankruptcy (even if there is indeed a filing), the lenders who would steer Neiman through this bankruptcy could sell the business outright or close some of Neiman’s 43 department stores to continue operating in a slimmed-down form.

The closure during pandemics have caused a situation where even the best of companies need liquidity to weather through these unprecedented times. It is far more difficult for those companies like Neiman that were already cash-strapped. Neiman Marcus was in critical care even before the Covid-19 pandemic due to the enormous debt burden — about $4.8 billion, thanks to a $6 billion leveraged buyout in 2013 by the owners Ares Management and the Canada Pension Plan Investment Board and the super expensive rents for its 43 stores in the most high-profile shopping destinations.

Although online sales continue to bring in some revenue for Neiman, the retailer's brick-and-mortar store sales are a critical component of its overall business model. Even as they have worked to transform themselves for e-commerce with apps, websites, and in-store exchanges, the outbreak has exposed how dependent the department stores have remained on their physical stores.

High net worth individuals, the core customer base for Neiman are not feeling as wealthy as they did before. Consumer confidence has also been a challenge lately, led by the plummeting stock market that has eroded millions in investor wealth.

Other department store operators that have had to close their stores are also battling to avoid Neiman Marcus’ fate. Macy’s and Nordstrom have been rushing to secure new financing, including borrowing against some of their real estate holdings. JC Penney is also contemplating a bankruptcy filing as a way to rework its unsustainable finances and save money on looming debt payments . Lord & Taylor is exploring filing for bankruptcy protection after it was forced to temporarily shut all of its 38 US department stores in the wake of the outbreak. The entire executive team at Lord & Taylor was laid off in early April 2020. Nordstrom, widely considered the healthiest department store, said this month that it could be facing a distressed situation if its physical locations are closed to customers for an extended period of time. Nordstrom has canceled most of its orders and put off paying its vendors. The high debt loads on most leveraged buyouts from their private equity takeovers have made these retailers especially vulnerable in the new competitive landscape. Most of these retailers are in a situation with an unsustainable capital structure and are faced with the reality of either addressing that capital structure or to continue making these high debt payments.

A significant portion of the retailers that filed for bankruptcy in the last few years carried debt loads leftover from leveraged buyouts by private equity firms. Toys R Us, Nine West, J. Crew, Gymboree, Mattress Firm, Claire’s and there are several more.

Let’s understand how several of these iconic brands got here in the first place. During a leveraged buyout, the private equity firm uses little of its own capital. Much of the money needed to buy the retailer comes from debt the retailer itself has to issue, to fund the buyout, which leaves the retailer highly leveraged. The private equity firm then makes the retailer issue even more bonds or leveraged loans to fund a special dividend back to the firm. Other management fees and costs may also be forced upon the retailer on an ongoing basis. This form of asset stripping removes cash from the retailer and leaves it struggling under a load of debt. At the core of these transactions, is the fact the private equity is an investment firm, not a retail business. The retailer becomes the collateral rather than the actual business. An attractive collateral since retail is a cash generating business.

The retail sector business is hard. It is far more complex than people think it is. It changes fast. You have to get the fashion right, you have to pick the right merchandise, get it at the right price and at the right time, you have to be good at managing your cash flow, managing the real estate, making debt payments, managing store operations, marketing, distribution, and more. Retailers have to get all or most of these disciplines right every time to keep their customers coming back for more.

March and April of 2020 have brought a steady stream of credit downgrades in the retail world based on conditions created by the COVID-19 pandemic and the efforts to flatten the curve. For now, bankruptcy courts are eerily quiet, almost like the lull before the storm. Once the retail world re-opens, bankruptcies could start to follow as liquidity issues are going to push many companies that were on the borderline over the edge.

With essential businesses already struggling to keep up with the increased demands and protecting their front-line store associates and anxiety-fueled consumers, it's very challenging to even think of a date when non-essential retail stores can reopen. Retail stores openings should be determined by public health leaders and not by politicians. Retail workers are working tirelessly and even dying from Covid-19 to help people buy the essentials, they need to survive these times. This is tragic enough already— should they need to risk their lives over a sweatshirt? A handbag? When retail stores do open, they will be slow and careful. The fact is, retail store traffic will be slow to come back once they reopen, consumers may not be eager to go into physical locations — whether because of lingering fears of infection or as a result of the economic impacts of the pandemic. The impact on retail could mean waves of bankruptcies during the back-to-school season, more likely the holidays, the prime time for retailers to actually make some money.

The long term social, economic, and health impacts of the COVID-19 virus are still evolving. The situation is complex and a considered, well managed response by retailers will have a major impact on retail coming out of these troubled waters. The retail sector should see this an opportunity to out-perform their less agile competitors and build the foundations of a more digital, nimble business for the future. The turnaround will have to address the issue of debt restructuring since the unsustainable capital structures, high leverage, a dismal cash flow with a weak operating performance outlook will drag several department stores in the retail world closer to the grave. 

COVID-19 will have a significant long term impact on RETAIL. It's time to face that fact and start adapting retail operations and commercial decision making rapidly to reflect this new reality.

COVID-19 will have a significant long term impact on retail. It's time to face that fact and start adapting retail operations and commercial decision making rapidly to reflect this new reality.