Bain Capital destroys another retailer

[PaulKay]

In past threads we talked about how Bain Capital took Guitar Center private and saddled them with so much debt they were on verge of collapsing until they arranged to convert a bunch of debt to equity and stepped aside.

Now in 2010 Bain took private Gymboree and again saddled the company with billions in debt and left them to figure out how to generate enough revenue to pay off the debt. And its not working...again..

www.bloomberg.com/news/articles/2014-09-11/gymboree-bonds-collapse-after-sales-tumble-at-its-stores

I just find it astonishing that there are investment companies out there that literally cripple the companies they buy.  This company had no debt prior to the purchase.

[Russell Letson]

This kind of asset-stripping is nothing new--a similar process in the 1950s resulted in the collapse of a major magazine distributor, which in turn led to an implosion of the magazine market. It's one of the pathologies of a free market in publicly-owned entities.

[PaulKay]

I know there was a lot of it going on in the 80's too and many people complaining about buying companies and using their cash to pay for the purchase, then sell off the parts. This is different in that they borrow all the money and saddle the company with having to pay it off out of future profit. Not quite as egregious as the 80's.

[fauxmaha]

Being almost obsessively debt-adverse, this particular strategy has no appeal to me, but...

Other than the fundamental reasons not to have debt at all, I see nothing inherently wrong with the strategy. Gymboree was not a healthy company when Bain bought it. Bain had a plan: They could infuse the company with cash which would be used to implement their plan, which (hopefully) would generate enough incremental business to finance the whole thing. If you are looking for a villain in this, you'll probably find it among the major (pre-Bain) equity holders who used a bunch of the Bain cash to sell out their holdings.

The problem with debt (personal or business) is it lowers or even eliminates your margin for error. A guy making $60k per year with a $100k mortgage has a lot less room for error than a guy making the same money with no mortgage. Business isn't any different.

Gymboree's problems are not about their capital structure so much as they are about failing sales:

Gymboree is feeling the strain of declining traffic at shopping malls, even as it seeks to fend off competition from the Internet and other retailers. The San Francisco-based company has been unprofitable in each of the last three years, according to data compiled by Bloomberg.

I don't care what your balance sheet looks like, that sort of income statement performance is going to put you in a world of hurt. Carrying a debt load certainly makes it worse, but losing money is losing money, no matter what your capital structure.

There is little reason to think Gymboree would have made it this long without Bain or some other capital infusion.

Had Gymboree been healthy and attractive, they could have issued more stock to meet their capital requirements. That they didn't is ample evidence that they couldn't have, which is why they had to go for debt. You can ask why Bain structured this deal as debt rather than equity, but the answer is self-evident. They were taking a huge risk, and structuring it as equity only increases the risk.

The way I look a this, Bain didn't destroy these guys, the market did. Bain gave them a chance. It didn't work. That's how it goes. Not every deal is going to be a winner.

[Marshall]

It's a Blackjack poker game. If you turn up a pair, you split them and double down. It's the way to win in Blackjack. Make the most of when the odds are slightly in your favor. Over many, many such hands you'll be ahead. But you'll lose a few hands in the process.

Just the casualties of war.

[lar]

The Bloomberg story doesn't contain a lot of detail. But the story does contain a few facts that I perceive as red flags.

The Bain buyout was a leveraged deal. In the 80s, the days of merger and acquisition insanity, leveraged buyouts were a favorite financing tool. In many cases the buyer put up no cash and borrowed all of the funds required to make the deal work. It wasn't unusual that a deal was partially financed by a stock swap that represented a small part of the financing. But the vast majority of the funds were borrowed.

Press releases carried familiar buzzwords and terms; synergy, cost reduction, efficiencies of scale, etc. The whole idea was that combining two companies would result in operating cost reductions that would more than offset the debt service. The theory was sound. One way a combined company could reduces expenses was by eliminating duplicate activities. Human resources, accounting, and IT were popular targets. Theoretically the new company could also gain economies of scale via their purchasing departments. Buying in larger volumes could drive down the cost of retail merchandise or raw materials.

Leveraged buyouts contained a fair amount of risk. So the yields on the debt were high. High enough to be very attractive when compared with other investment options.

There were two problems with leveraged buyouts. The first was that in order for the merger to succeed everything needed to go according to plan. There was little margin for error. The second is that once the merger was completed management found that synergy was fine for press releases but difficult to accomplish in real life. In every merger one company is swallowed up while the other company remains mostly unchanged. It's very difficult to change corporate culture and that's what the merged companies were expected to do. It becomes even more difficult if employees are worried about keeping their jobs. The reality of centralizing redundant services is that employees will be terminated. It's the only way to achieve cost savings. Terminations are not good for employee moral.

Perhaps the most difficult of the cost reduction measures was combining IT operations. It was almost always much more expensive than the budget called for and it usually took much longer to accomplish than anyone expected.

The result, as one might imagine was that a lot of those mergers crashed and burned. There was too much debt and too little cost reduction.

I went back and looked at a press release and a couple of articles about the Bain/Gymboree merger. There were a lot of warning signs. The first is that the deal was priced at 57% above the then market price for Gymboree stock or 7.7 times earnings. By any measure that's a huge premium. Bain did the deal because Gymboree had huge cash flow. They had managed to grow without acquiring interest bearing debt. That was a plus because the cash flow would be needed for debt service. But behind that plus was a 3 year sales slowdown. The article I read said that Bain's plan was to buy the company and then sell it later at a profit.

To me what stands out in the article is that Gymboree had weathered 3 years of declining sales while increasing cash flow. That suggests that the company had managed to find ways to achieve huge reductions in operating cost. That might have been a signal that there were few if any additional cost savings available.

The killer here is that Gymboree has continued to lose sales. And that could be the straw that breaks the camel's back. Declining revenues without being able to cut costs further adds up to a reduction in cash flow. Cash the company sorely needs to survive.

This ain't a new story folks. Nor is it necessarily a tale of greed and avarice. My guess is that Bain overpaid and took a risk and then Gymboree under performed.

[PaulKay]

Feb 4, 2015 21:46:10 GMT -5 lar said:

The Bloomberg story doesn't contain a lot of detail. But the story does contain a few facts that I perceive as red flags.

The Bain buyout was a leveraged deal. In the 80s, the days of merger and acquisition insanity, leveraged buyouts were a favorite financing tool. In many cases the buyer put up no cash and borrowed all of the funds required to make the deal work. It wasn't unusual that a deal was partially financed by a stock swap that represented a small part of the financing. But the vast majority of the funds were borrowed.

Press releases carried familiar buzzwords and terms; synergy, cost reduction, efficiencies of scale, etc. The whole idea was that combining two companies would result in operating cost reductions that would more than offset the debt service. The theory was sound. One way a combined company could reduces expenses was by eliminating duplicate activities. Human resources, accounting, and IT were popular targets. Theoretically the new company could also gain economies of scale via their purchasing departments. Buying in larger volumes could drive down the cost of retail merchandise or raw materials.

Leveraged buyouts contained a fair amount of risk. So the yields on the debt were high. High enough to be very attractive when compared with other investment options.

There were two problems with leveraged buyouts. The first was that in order for the merger to succeed everything needed to go according to plan. There was little margin for error. The second is that once the merger was completed management found that synergy was fine for press releases but difficult to accomplish in real life. In every merger one company is swallowed up while the other company remains mostly unchanged. It's very difficult to change corporate culture and that's what the merged companies were expected to do. It becomes even more difficult if employees are worried about keeping their jobs. The reality of centralizing redundant services is that employees will be terminated. It's the only way to achieve cost savings. Terminations are not good for employee moral.

Perhaps the most difficult of the cost reduction measures was combining IT operations. It was almost always much more expensive than the budget called for and it usually took much longer to accomplish than anyone expected.

The result, as one might imagine was that a lot of those mergers crashed and burned. There was too much debt and too little cost reduction.

I went back and looked at a press release and a couple of articles about the Bain/Gymboree merger. There were a lot of warning signs. The first is that the deal was priced at 57% above the then market price for Gymboree stock or 7.7 times earnings. By any measure that's a huge premium. Bain did the deal because Gymboree had huge cash flow. They had managed to grow without acquiring interest bearing debt. That was a plus because the cash flow would be needed for debt service. But behind that plus was a 3 year sales slowdown. The article I read said that Bain's plan was to buy the company and then sell it later at a profit.

To me what stands out in the article is that Gymboree had weathered 3 years of declining sales while increasing cash flow. That suggests that the company had managed to find ways to achieve huge reductions in operating cost. That might have been a signal that there were few if any additional cost savings available.

The killer here is that Gymboree has continued to lose sales. And that could be the straw that breaks the camel's back. Declining revenues without being able to cut costs further adds up to a reduction in cash flow. Cash the company sorely needs to survive.

This ain't a new story folks. Nor is it necessarily a tale of greed and avarice. My guess is that Bain overpaid and took a risk and then Gymboree under performed.

...and bond holders end up taking it on the chin for taking a risk on their debt.

[aquaduct]

But they knew that going in, didn't they. That is after all the definition of "risk".

[Russell Letson]

Feb 4, 2015 21:46:10 GMT -5 lar said:

Nor is it necessarily a tale of greed and avarice. My guess is that Bain overpaid and took a risk and then Gymboree under performed.

I recall reading that buyout specialists are careful to structure their deals so that even if the restructure-and-sell deal goes south, they still make money up front via consultation fees and such. In that model, the combination of fees and working with other people's money reduces the risk considerably. The people who take it in the shorts are whatever outside investors there might be, along with (of course) the employees and creditors (and customers) of the target company. My suspicion is that the guys who put these deals together make sure that all risk and liability gets assigned to somebody else. Every poker game needs a patsy or two.

[dradtke]

Feb 5, 2015 12:52:37 GMT -5 Russell Letson said:

Feb 4, 2015 21:46:10 GMT -5 lar said:

Nor is it necessarily a tale of greed and avarice. My guess is that Bain overpaid and took a risk and then Gymboree under performed.

I recall reading that buyout specialists are careful to structure their deals so that even if the restructure-and-sell deal goes south, they still make money up front via consultation fees and such. In that model, the combination of fees and working with other people's money reduces the risk considerably. The people who take it in the shorts are whatever outside investors there might be, along with (of course) the employees and creditors (and customers) of the target company. My suspicion is that the guys who put these deals together make sure that all risk and liability gets assigned to somebody else. Every poker game needs a patsy or two.

And I read somewhere that if you haven't identified the patsy in the game after the first few rounds, it's you.

[fauxmaha]

If the argument here is that the pre-Bain version of Gymboree (which is to say, the company that had obtained its initial expansion funding from U.S. Venture Partners, experienced dramatic growth and eventually was listed on the NASDAQ) were just a bunch of innocent babes in the woods ripe for the picking at the hands of the evil Bain empire...

[Russell Letson]

[Looks around to see where the excluded middle went. Lifts all three walnut shells. It's gotta be around here somewhere.]

[fauxmaha]

I'm just a small town guy in a mid sized town, but even I know the score with an outfit like Bain.

Those guys come in for one of two reasons: You are either a young company who has demonstrated a highly promising concept and if you got a zillion bux of new money and some management help, you could quickly blow the concept out nation wide and make a gazillion bux (eg, Staples), or your are a struggling company that is failing to make money for its investors and are seeking a life-line with fresh cash to help you restructure (eg, Gymboree).

I don't think there are a lot of other squares on that particular board, and I also think anyone on the receiving end of such a transaction is a fool if they think anyone but Bain is calling the tune at that point. That's how money works. If you have it, you make the rules.

What I miss in all this is why Bain is considered the bad guy. They come in with money and a plan. Despite what you might have read, there is no way to structure a transaction where they are not taking on any of the risk. That being said, they are certainly going to structure it so as to minimize their risk relative to the other players at the table. I can't fault them for that. Would anyone here do otherwise?

[millring]

Feb 5, 2015 14:47:51 GMT -5 fauxmaha said:

Would anyone here do otherwise?

Sure. I would have the government own all business so that the risk is spread out evenly and fairly.

::nods::

[Russell Letson]

Well, just as the abstract mental maunderings of a country mouse living in an even smaller town, and with no business training to speak of, there's this set of questions:

When risk is distributed and costs allocated in ways that allow the shot-callers to make money no matter what the outcome, what exactly is the motive structure of said shot-callers?

And if a benefits are valued only in the short term, and if interested parties are seen only as those controlling capital, how do we assess the large-scale effects of financial operations that result in the collapse of enterprises that might have survived without the ministrations of operators whose benefit horizons are measured in quarters rather than, say, years, let alone decades? Is the prime value of an enterprise really to return as much money as quickly as possible to lenders or even shareholders? Somehow I don't think shoe factories or even mall gyms exist primarily to serve the interests of financial organizations.

[fauxmaha]

Feb 5, 2015 15:46:51 GMT -5 Russell Letson said:

When risk is distributed and costs allocated in ways that allow the shot-callers to make money no matter what the outcome, what exactly is the motive structure of said shot-callers?

I'm reminded of the old bit that goes "If you owe the bank $50 thousand, you have a problem. If you owe the bank $500 million, the bank has a problem".

Not sure why. It just struck me.

Anyway, I'm sure the folks at Bain would be pleased to learn of the riskless profit system you've identified. Although on the surface it sounds a lot like the late night, no-money-down-get-rich-in-real-estate guys.

And if a benefits are valued only in the short term, and if interested parties are seen only as those controlling capital, how do we assess the large-scale effects of financial operations that result in the collapse of enterprises that might have survived without the ministrations of operators whose benefit horizons are measured in quarters rather than, say, years, let alone decades? Is the prime value of an enterprise really to return as much money as quickly as possible to lenders or even shareholders? Somehow I don't think shoe factories or even mall gyms exist primarily to serve the interests of financial organizations.

I disagree with your question's premise. 

I see no evidence that Guitar Center, Gymboree or any of the others were scuttled (deliberately or otherwise) by Bain's "ministrations". I only see companies that used to make money, but due to changing market circumstances, don't make money anymore. Shit happens.

As to who's interest the shoe factory serves, you seem to have the cart in front of the horse. The shoe factory wouldn't exist in the first place without the predicate capital. 

Don't take any of this to mean that I have any particular affection for Bain or, more particularly, any particular affection for the complex web of securities and banking regulations inside of which Bain operates. I don't. But as a general matter, a system where people with money are able to direct that money into promising businesses with the expectation of profit seems to have served mankind rather well.

[Russell Letson]

There's a view of economic systems that sees them primarily as the means to produce and distribute goods and services, with the goods and services being the ends (to wax Aristotelian). In this view, capital formation is necessary for scaling up some production & distribution systems, and finance (along with money and double-entry bookkeeping and similar instrumentalities) is one of the tools that serves those ends. In this view, allowing the financial system too much control is a pathology. The primal cause for the existence of the shoe factory is the need to be shod. The banker doesn't make the shoes, he supplies one of the elements necessary for its existence, operation, and eventual expansion. He does not, however, actually keep anyone's feet warm, dry, and stylish.

A model that gives the mortgage company more credit than the carpenter, roofer, or glazier is under the delusion that a bag of money by itself keeps the rain off.

[fauxmaha]

Lets say that what we have today represents one end of the spectrum. At the other end of the spectrum is a system where no one produces anything save for their own personal consumption (ie, the logical limit of the "buy local" movement).

I would propose that the last (round numbers) 500 years or so of history have made it abundantly clear which end of the spectrum does most to reliably ease the condition of the largest number of people.

[Doug]

Feb 5, 2015 17:41:29 GMT -5 Russell Letson said:

There's a view of economic systems that sees them primarily as the means to produce and distribute goods and services, with the goods and services being the ends (to wax Aristotelian). In this view, capital formation is necessary for scaling up some production & distribution systems, and finance (along with money and double-entry bookkeeping and similar instrumentalities) is one of the tools that serves those ends. In this view, allowing the financial system too much control is a pathology. The primal cause for the existence of the shoe factory is the need to be shod. The banker doesn't make the shoes, he supplies one of the elements necessary for its existence, operation, and eventual expansion. He does not, however, actually keep anyone's feet warm, dry, and stylish.

A model that gives the mortgage company more credit than the carpenter, roofer, or glazier is under the delusion that a bag of money by itself keeps the rain off.

The rancher doesn't make shoes either he just supplies the cattle.  

Which link or links on the chain have the power depends on how easy it is to substitute that link.  Diamonds were controlled for years at the mine level, not the financial level.  The ditch digger that works on the sewer doesn't have much power because there are a lot of people who can dig a ditch.  And where the power is changes over time and different needs.  But it does seem that the financial level has acquired a disproportional share of power.  Why that is can be debatable.   

[Russell Letson]

Anybody familiar with the term "choke point"?