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Conventional wisdom is that the failure of major grocery chains in recent years like Marsh Supermarkets, A&P/Pathmark, and Tops is due to their inability to keep up with “disruptors”.
Conventional wisdom is wrong.
As Eileen Appelbaum and Rosemary Batt explain in a new article scheduled for American Prospect, Private Equity Pillage: Grocery Stores and Workers at Risk, the seven large grocery chains that filed for bankruptcy since 2015 all were victims of private equity firms overloading them with debt, which in turn kept them from investing in updating stores and their product lines. No similar publicly traded grocery chain suffered a similar fate during this period. And as the authors and others like your humble blogger have pointed out, private equity firms extract so much in fees relative to their meager equity investments in the funds they manage that they profit even when they drive the companies they bought into a ditch.
Appelbaum and Batt tell the story of three of these bankruptcies in detail. Southeastern Grocers, Tops, and Fairway. I can attest that two of the stores in the Southeastern portfolio that my family once shopped at, Winn Dixie and Piggly Wiggly, got much less of their business over time. They pretty much abandoned Winn Dixie, when they once shopped there occasionally. It’s an old-looking store, not great housekeeping standards, with mediocre fresh foods. The nearby Piggly Wiggly has done better by virtue of being owned locally. It had a very good wine section in the middle of an otherwise uninspired store; a relocated store has much better produce and carryout foods and added flowers. But otherwise, Publix is the grocery chain in the area to beat. From the article:
The bankruptcy of Southeastern (SE) Grocers, owned by private equity firm Lone Star Funds, provides a classic example of how PE drives companies into bankruptcy while extracting millions of dollars for themselves and their investors. It is the owner of well-known brands BI-LO, Fresco y Más, Harvey’s Supermarket, and Winn-Dixie, located in seven southeastern states…
Lone Star first bought out the predecessor of SE Grocers, BI-LO, in 2005 in a leveraged buyout and took the company private. It ran the company into bankruptcy by 2009 and emerged from Chapter 11 in 2010. It tried to sell the chain to publicly-traded Kroger and employee-owned Publix Super Markets, but they were not interested. After 6 years of ownership, Lone Star was overdue in paying promised outsized returns to its investors. So it executed a ‘dividend recapitalization” – meaning that it loaded the company with even more debt and used the debt to pay dividends to itself and its investors. Between 2011 and 2013, it paid itself and its investors $838 million in dividends – money that could have been used to make the stores more competitive. The struggling company, meanwhile, became saddled with interest payments on these loans. One loan of $475 million used to pay dividends required SE Grocers to pay $205 million in interest between 2014 and 2018. Lone Star’s owner, John Grayken, is a billionaire who famously renounced his U.S. citizenship to avoid paying taxes.
As if this wasn’t enough debt, Lone Star sent SE Grocers on a buying spree rather than invest in existing stores. In 2012, it bought out Winn-Dixie for $590 million, adding 660 stores and 63,000 employees. In 2013, it added another 165 stores (Harveys, Sweetbay, and Reids) in an LBO worth $265 million, as well as 22 Pigggly Wiggly stores in an LBO worth $35 million. Lone Star renamed the company ‘Southeastern Grocers’.
By 2014, the company had an unsustainable debt overhang of $1.32 billion due to dividend payments and leveraged buyouts. Looking for cash, the company sold the real estate of a distribution center for $100 million and several stores for $45 million, and then required the affected entities to pay rent on the buildings they used to own – further undermining their financial stability – referred to in financial parlance as a ‘sale/leaseback.’ In need of more cash, Lone Star managed to obtain a series of revolving credit loans and debt financings between 2014 and 2017, but the loans weren’t enough to keep it going.
By March 2018, SE Grocers filed a ‘pre-packaged’ Chapter 11 bankruptcy…When the company exited bankruptcy in June, 2018, about 2,000 workers had already lost their jobs. The deal reduced debt from $1.1 billion to $600 million, with creditors swapping debt for equity, and the company agreeing to close 94 stores affecting thousands more workers’ jobs.
In the case of SE Grocers, the sale of real estate and then its leaseback at an inflated price played only a marginal role. It was central to the demise of Marsh Supermarkets:
In the case of Marsh Supermarkets , private equity cashed in on its rich real estate before throwing it into bankruptcy. The private equity buyout dates to 2006, when the Indianapolis-based company with 116 groceries and 154 convenience stores was up for sale due to losses it incurred during the ‘grocery wars’ of 2005. Prospective buyers were thin until a footnote in one of the company’s financial reports showed that Marsh’s real estate was worth $100 to $150 million more than listed on its financial statements….by September 2006, Sun [Capital Partners] took Marsh private in a leveraged buyout. Soon after it acquired the chain, Sun did a sale-leaseback deal for the real estate of many of Marsh’s stores, raising tens of millions of dollars for itself and obligating the supermarket stores to pay rent on locations they had previously owned. Sun also sold Marsh’s headquarters building and saddled the grocery company with a 20-year lease to 2026 at an annual rent of $2.8 million, scheduled to increase 7 percent five years later.
Over the next decade, the supermarket chain struggled. Finally, with only 44 stores remaining in 2017, it went bankrupt, auctioning off the majority and closing 18. Richard Feinberg, professor of consumer science and retailing at Purdue University noted that Marsh might have remained competitive, like other smaller chains that managed to perform well. But this, he said, “would have taken an additional investment that Sun clearly did not want to do”.
Appelbaum and Batt stress that grocery stores are essential for communities; indeed, when poor urban neighborhoods are trying to redevelop, a grocery store (as opposed to a convenience store whose idea of produce is a few apples, oranges, and bananas, and if you are lucky, a tomato) is a critical piece. Even the little story I found about the relocation of a Piggly Wiggly near my mother’s house, in an upscale area where everyone has a car and can easily drive to shop, shows how much people value having a store close at hand:
Owners Andy Virciglio and brothers Basim and Naseem Ajlouny hoped to re-open in Crestline Village after they had to shut down their store at the corner of Euclid Street and Oak Street in November 2014 because the landlord chose not to renew their lease. Piggly Wiggly had been tenants there for 30 years. A CVS/Pharmacy has since opened at that location…
“We were fortunate to be able to find this property,” Naseem Ajlouny said. “We’ve had good support from the city, from the board of education and school system and from residents. People were there to support us.”
The old Crestline Pig didn’t go quietly before closing. A Facebook page called “Save the Pig” quickly earned thousands of “likes,” and community members gathered at the Emmet O’Neal Library to share memories of the store.
“Community support has been humbling,” Ajlouny said. “They needed and wanted this store to come back.”
The article describes how the new store has enlarged its wine section, now has the best craft beer selection in the region, added more organics and improved its store labeling of organic and non-GMO foods. Appelbaum and Batt describe how most grocery chains face similar pressures to update their selections:
Grocery chains employ 2.77 million workers, distributed in small towns and cities across the country. They still account for the majority of food at home purchases and are an important source of jobs in local communities. Their continued presence is important to the local economy and to a sense of community in the neighborhoods they serve….
What next for regional supermarkets and the jobs of workers in this sector in the coming years? Heightened demand for one-stop-shopping, organics, a wide variety of healthy products and services, online ordering and delivery, and more. Grocery chains find they must race to emulate the most innovative products and services while containing prices. This takes deep financial pockets.
Yet as with SE Grocers, private equity owners don’t want to spend the money. The authors compare the trajectory of the biggest grocery chains Kroger,s to number two, Albertsons, which is owned by Cerberus. Albertsons carries a vastly higher debt load than Krogers or Publix. Albertsons has lost money for three of the last four years. Moody’s downgraded Albertsons debt twice this year. Cerberus tried to take Albertsons public in April 2018, but cancelled the deal, as it had a fall 2015 IPO attempt. Cerberus then tried to have Albertsons do a reverse merger with Rite-Aid, but large Rite-Aid shareholders were opposed, so that deal was scuttled too.
Appelbaum and Batt argue that Cerberus could continue to bleed Albertsons or could invest to restore its chains and exit at a higher valuation as a result of improved performance. They quietly chide public pension funds like CalPERS for sitting pat:
The answer may hinge on what public pension funds do. These funds have increasingly invested in private equity, despite its unsavory and anti-worker practices, lured by the promise – if often not the reality – of higher returns. The question of whether the big pension funds should avoid private equity, or use their investment to reform its practices, has been hotly debated. (Pension funds cling to the hope of high yields despite the reality that half the private equity funds launched since 2006 have not beaten the stock market and many more have failed to provide returns high enough to compensate for the added risk of these illiquid investments.). CalPERS – the California Public Pension fund has a large stake in Albertsons via its investment in the Cerberus fund that owns the supermarket chain. Will CalPERS, which has responsibility for managing the retirement savings of California public sector workers, many of whom live in communities served by supermarkets Albertsons owns, insist that Cerberus abandon attempts at a quick exit, extend the time they are willing to hold the grocery chain, and commit to making investments that will improve store operations and increase profits?
The authors describe how Kroger, which has kept investing in its business, has not only been investing in its plant, but in improved online shopping, digital displays, employee training, and faster checkout. It is also increasing worker wages and benefits and devoting a billion dollars to bolstering its pension fund.
Appelbaum and Batt set forth a series of reforms to prevent private equity firms from pillaging companies:
Limit total debt leves, including capitailzed leases. The authors don’t recommend how to achieve this; a simple way would be to restrict the tax deductibility of interest expenses plus operating lease charges above a certain level.
Prohibit the payment of dividends for the first two years after a private equity purchase. This rule is already in place in Europe.
Require private equity firms to disclose all fees and expenses that they and their affiliates charge
Stop treating private equity owners as passive investors and acknowledge their role as joint employer along with the operating companies they own. The notion that portfolio company management has any independence from their overlords is a fiction to everyone but the courts, which allow private equity investors to escape from liability under the WARN Act (which requires 60 day notice of a facility shutdown) and under ERISA for termination of a pension plan.
It may see that bringing private equity to heel is an impossible task. But the great trusts of the Gilded Age and early 20th Century were even more dominant, yet the were eventually leashed and collared. The more the public understands how often their behavior is self-serving and destructive, the more support there will be for prohibiting those practices.