Tuesday, October 7, 2008

Wall Street's Arrogance is Confounding

Originally published: Sunday, March 09, 2008

As I walked through Fortunoff's in the Woodbridge Mall today, I was amazed that the department store chain was bankrupt. It had great looking merchandise and customers. By those standards alone, any retailer would be successful. Yet the company is reorganizing under Chapter 11. This is not really surprising when you consider that a private equity firm bought control of it from the founding family.
Many of the people on Wall Street think they are smarter than people who work in other industries. This is despite the fact that these Wall Street gurus never really operated anything and their real world business experiences constitutes looking at a spreadsheet. In a perfect world for private equity firms, they buy a company from pooling together a portion of the purchase price from institutional investors (pension funds, hedge funds, investment banks) and borrowing the rest to seal a deal. They collect a fee from completing a deal. The private equity firm and its partners own the business, but plan to cash out at some point for more money when they list the company on a stock exchange.
However, the business world is rarely that smooth. Risk is sometimes mispriced; consumer tastes change; companies borrow too much; and sometimes the wrong people are left in charge. Eddie Lampert took over Sears and brought Kmart out of bankruptcy. Now he's finding out how hard it is to compete against Wal-Mart. He might end up tarnishing his legendary status on Wall Street because of the struggles at the retailer. Will Sears go bankrupt? I doubt it, but their Sears Essentials store in my area looks like its having a tougher time than Fortunoff. It's surrounded by a Target, a Wal-Mart, Lowe's, Home Depot and a Macy's. I'm sure South Plainfield is not that much different than the rest of America's retailing climate. Trimaran Capital Partners and the Kier Group bought a majority stake in Fortunoff from the founding family in 2004. The Fortunoffs hoped that the firm would turn them into a national department store and still held a stake. Published reports listed Fortunoff's debts exceeding $300 million in November and assets of $268 million. This indicates risky capital structure that is vulnerable to downturns in consumer demand. A bankruptcy court and a new owner could give the company a chance to create a better capital structure. Trimaran and Kier Group's troubles with Fortunoff are not that unique in retailing. Levitz filed for bankruptcy again. Catalog retailer Lillian Vernon and gadget seller Sharper Image recently filed.
Wall Street firms have a pretty good history of mismanaging retailers. Macy's was taken private in a leveraged buyout in the late 1980s and that led to a bankruptcy. You might be impressed with some of the big salaries these private equity types collect. If they start prowling around your company, be very afraid. The pedigree of a Harvard MBA associated with these Wall Street gurus is not a guarantee that they know how to keep retail customers happy or the shelves of these stores well stocked.

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