Bankruptcies Key to Chain Retailers Overcoming ‘The Squeeze’
By Dave Spargo, [email protected]
While many people believe the worst of the recession is already behind us, some may be surprised to learn that there will likely be an increase in the number of chain stores filing for bankruptcy this year. Although the economy has been slowly recovering, the chain retail and restaurant industries still have a long road ahead before they are on a course of long-term profitability. While filing for bankruptcy may typically not be viewed as a positive occurrence, it may be the best solution for retail businesses to right-size obligations and remain competitive.
A major factor that has led to the growth in and continued trend toward bankruptcy filings is the increase in the cost structure underlying chain store businesses. The cost of goods has continued to increase due to rising commodity and production costs. Other expenses that continue to increase include utilities, which have grown steadily due to the rise in fuel prices, as well as the annual costs associated with maintaining brick-and-mortar stores.
Unfortunately, one result is that top-line sales have not kept pace with expense increases. In the last few years, sales for most retail and restaurant companies have stabilized and are beginning to trend up. However, any apparent new growth may be artificial since sales are typically measured from a basis of lower receipts overall due to the declines experienced during the height of the recession.
A growing factor that has hurt retailers is the recent phenomenon of “showrooming” spawned by online merchandisers. “Showrooming” occurs when consumers visit a brick-and-mortar store to examine a product in person but then return home to buy it from an online retailer, often at a cheaper price. While stores have been attempting to figure out strategies to thwart this phenomenon, such as by offering products sold exclusively through certain retail outlets; it continues to present a challenge.
With the increase in pressure from online rivals and shrinking profit margins, retailers’ ability to service debt and maintain their obligations has been drastically impaired and many are feeling “the squeeze.” During the recessionary years, lenders were frequently willing to extend the terms of loan obligations to assist businesses which were struggling; thus buying the lender and retailer time for the economy to improve. In today’s market however, as a result of the availability of other options and pressures, lenders can be resistant to granting extensions.
Many banks are under pressure to clear their books of certain underperforming or non-core loans and may be willing to force a bankruptcy to enable them to be paid off (even at a discount) through exit financing options or liquidation in Chapter 7 bankruptcy.
As more and more chain stores have had to turn to bankruptcy to restructure their obligations and strengthen their balance sheets, many have become more competitive in the marketplace. Those chain stores that have not restructured may be attempting to compete in a new market in which they are unable to offer as favorable terms to their customers.
Many chain stores negotiated their debt and original lease obligations during the height of the market and made commitments that are no longer feasible. Rather than face dissolution of their organization and liquidation of all business assets, retailers should consider proactively pursuing bankruptcy and restructuring their obligation. Frequently, businesses wait too long and enter bankruptcy with a tarnished brand as a result of a prolonged lack of marketing, as well as a lack of cash resources to finance a Chapter 11. This unfortunate set of circumstances will ultimately limit the options available to a chain store in bankruptcy.
As part of reorganization under Chapter 11 bankruptcy, retailers have the opportunity to restructure their business while continuing to operate; frequently without having to hand over control. Their financial obligations are automatically stayed (frozen) while the optimal method of repayment is determined. Repayment plans are negotiated usually at a reduced rate or over time.
While vendor contracts may be renegotiated in a relatively straightforward manner, multi-chain retailers may face more complex decisions when it comes to maintaining their branches. Consolidating a major chain retailer by closing selected stores can be the best way to increase profitability. The transfer of sales from closed units to those remaining, and the elimination of overhead as a result of those closures can lead to increases in top line unit sales and improved margins. An in-depth analysis of the company portfolio must be undertaken to determine which stores are to be closed and under what terms their lease and other contract obligations can be renegotiated in order to achieve maximum profitability.
From the debt perspective, businesses will have to convince lenders that agreeing to a plan of reorganization under Chapter 11 is going to be more beneficial for all concerned than a forced sale or liquidation under Chapter 7. As part of a reorganization, there are typically two main options for debtors. The first is to secure exit financing from an outside lender to pay off the debt owed to the existing lender under more favorable terms or at an acceptable discount. The second option is to modify the terms of the debt with the existing lender. Regardless of which option is chosen, the debtor will have to demonstrate to the court that the plan provides more favorable terms than liquidation.
Retail businesses that are faced with “the squeeze” from relatively flat sales and rapidly increasing costs may need to consider restructuring their obligations through bankruptcy. For businesses that are locked into unsustainable long-term leases and other obligations, reorganization may allow them to renegotiate these contracts while continuing to run their companies. Following reorganization, retailers may be able to gain a renewed foothold in the marketplace in order to better compete with online retailers. By becoming more competitive in the marketplace, chain stores, in turn, pass on these benefits to increasingly savvy and demanding consumers.
Dave Spargo is a founding principal with Huntley, Mullaney, Spargo & Sullivan, Inc., a financial restructuring firm. He can be reached at [email protected] or (916) 787-2060.