Another Demise of a Storied Business at the Hands of Private Equity: Fairway

I’m a bit late to discuss the bankruptcy, or more accurately, the second bankruptcy, of the well-loved New York City grocery chain, Fairway. As we’ll discuss, while some Fairway stores may continue under their current format, the suburban ones don’t appear to have a possible buyer in the wings and may be shuttered. And even for the New York City operations that are currently slated to remain under the Fairway banner, its workers, which many observers argue was part of the store’s appeal, are slated to lose union protection and face probable pay and benefit cuts, particularly cuts of their existing pensions.

Fairway was iconic enough to merit a New Yorker requiem by Adam Gopnik when the bankruptcy was official and the magazine has continued to chronicle what happens, with an insider update last week. Private equity maven Eileen Appelbaum made the sad demise of Fairway the centerpiece of a new piece in The Atlantic, demonstrating clearly that the chain’s slide into distress and failure was the direct result of too much debt in combination with misguided expansion plans.

Fairway was emblematic of an older, more egalitarian Manhattan, and it had adapted to the increasing affluence of the city until private equity started calling the shots. I moved to the Upper West Side in the early 1980s, right before it became a cool place to live. Back then, stooped, presumed Jewish old ladies were a common sight, particularly around Fairway’s shabby section of Broadway. The store had large crates of bargain-priced fruits and vegetables outside, and sawdust-strewn floors indoors. That Fairway always seemed chaotic, overcrowded, both with goods and with people, with the buzz of a bazaar, but the “we can’t be bothered with presentation” was deceptive. As Gopnik explained:

Fairway is one of those odd original New York institutions that grew up organically, on the sidewalk, unlike the Whole Foods and Trader Joe’s stores that have competed with it in recent years, which were dropped down on the street from a retail empire headquartered elsewhere. No less a magus of social history than Simon Schama once wrote of Fairway that if it were possible to award the congressional Medal of Honor to a food market, Fairway would already have won one for its service to appetite, and that its cheese department alone turned “Rabelaisian excess into a stationary New York festival of aroma, color and texture.”

Born in the early nineteen-thirties as a fruit-and-vegetable stand on the Upper West Side, Fairway was originally the multi-generation property and obsession of the Glickberg family, starting as a more down-market variant of Zabar’s, which is still in business up the street. Fairway’s magic, as one of its former partners, Steven Jenkins, wrote in a lively and lovely memoir of his years there, “The Food Life,” lay in the juxtaposition of grungy, discount-minded practicality with genuinely inspired and discriminating product choices. The store, with its proudly garish packaging and bags and an elevator that bore a sign boasting of its bad functioning, is stuffed with the usual supermarket staples, but it also offers some of the finest of fine things in the city. The olive-oil counter alone is worth the price of admission: seven or eight styles—Spanish, Italian, and Greek—to sample, with sliced baguettes on hand, around which a father and daughter could arrange a weekly tasting, while a mother shuddered at the unsanitariness of it…

The democratic energy of the place was so extraordinary that someone coming home to New York from a place like, say, Paris—where the division between the gastronomic and the generic, the élite and elementary is still strong—would be knocked sideways by the coexistence of those seemingly contradictory principles. As Jenkins wrote about his own emigration there, from a “classier” downtown boutique, “I had essentially been ripped from the urbane, everything-has-its-place, serene, haughty world of fancy food and thrust headlong into a peasant-like, sawdust-on-the-floor, ‘We’ll sell anything that sells’ commoners’ market.” That market engendered anecdotes. A friend remembered having been called away from her shopping cart the day before Thanksgiving and, wandering back into the store a few hours later, finding it still full, pushed and prodded like a bumper car among the throngs.

Fairway was also egalitarian on the managerial side. It was unionized, and not only provided health care but even a pension plan. The Fairway employees in the just-about-always busy Upper East Side store I later frequented were on the ball and usually good spirited.

Fairway had been losing money for some time and was rumored to be headed for a Chapter 7 bankruptcy, a liquidation. Even though the store’s owners opted instead for a Chapter 11, which in theory could also a leaner, meaner, probably smaller and less debt burdened Fairway to survive, that is not in the cards. Fairway stores are still open, but the most likely fate of five Manhattan stores and the Fairway warehouse is that they will be purchased by Shoprite, which among other things operates three Gourmet Garage stores in New York City. The fate of the stores outside Manhattan is under wraps.

So what dirty deeds did private equity do to Fairway? A retiring founder wanted to cash out in 2007 and a second of the three founders joined him. Sterling Ventures, a private equity firm that targets mid-sized and small companies, usually family owned, acquired a controlling stake.

Sterling both loaded the company with debt and went on an expansion binge. $87 million of the $137 million purchase price was borrowed, and Sterling had Fairway borrow even more between 2009 and 2012. By 2016, Fairway had 16 stores in the New York metro area, one of which it closed after a mere two years.

Eileen Appelbaum describes how the company started losing money in 2010 as a result of its debt load, but nevertheless managed to launch an IPO in 2013 based on the notion that Fairway could go national with 300 stores. But the IPO was yet another exercise in looting. Per Appelbaum:

Fairway went public at $13 a share, bringing in about $177 million ostensibly to the benefit of the grocery chain.

Tucked away in the IPO filing, though, was a paragraph detailing how Sterling would be able to use the proceeds to pay itself a dividend of nearly $80 million. PitchBook, a highly regarded source of data on private equity, reports that Sterling investors also paid themselves and their management team an additional $17 million from Fairway’s funds.

Former Fairway employee Hannah Howard gave the insider’s view in New York Magazine:

“The beginning of the end started in 2007,” the employee says. “[Sterling] raped and pillaged the company.” They opened stores in “places they had no business opening,” and the urban idiosyncrasies didn’t quite translate in Stamford, Connecticut, or Nanuet, New York.

Everyone seems to agree that Sterling was, at best, incompetent, or, at worst, outright evil. They simply “siphoned money out of the company and paid themselves,” says a source close to the firm, loading the company with an impossible amount of debt. (Bloomberg reports that Fairway’s “directors — a number of them Sterling executives — were paying themselves absurd amounts of money: $12.1 million in 2013, according to the company’s 2014 proxy.” Sterling co-founder Charles Santoro “took down $5.4 million that year.”)

“They just spent money like drunken sailors,” says the corporate staffer, sacrificing the company and the employees whose life’s work was making it something truly special.

It didn’t help that Fairway was facing more competition from the likes of Trader Joes, Whole Foods, and Fresh Direct. I could see a decline in the busyness of my local Fairway when a Whole Foods opened a mere four minute walk away. The traffic largely rebounded, at least during my normal shopping hours, within a month or so. But who knows how much in revenues that Fairway lost, and whether that skewed towards high margin goods.

Sterling left the scene in 2016 but Fairway was no better served by its new owners. Fairway did emerge bankruptcy with less debt and with one-time debt investor, Blackstone’s GSO Partners, as owner of 45% of the equity. GSO sold it position to Goldman in 2018.

More important, new investors did not install better management. From Howard:

After Sterling left in 2016, the new regime proved equally disastrous. Kenneth Martindale, a director of the board, brought in his close friend Abel Porter to run Fairway as CEO, and another friend, Erwin Koenig, as the executive vice-president of sales and merchandising. “Ernie and Ken’s connection dates back to Pathmark and Rite Aid, and now GNC,” a corporate employee told me. “It’s interesting to see that all three companies have gone bankrupt. It’s a pattern; it’s not an accident.”

It was Martindale’s wife, Sharon Aulicino, who oversaw a $2.5 million rebranding project. Among my former co-workers, Fairway’s 2018 “Place to Go Fooding” campaign was especially embarrassing. It was a far cry from the genuine passion for quality ingredients we had once worked hard to source, sell, and celebrate.

I remember those banners in the store. Gah. They had stereotypical smiley TV actor types stuffing their faces. You could only see generically what they were eating, like “sandwich” or at best “sandwich made from a baguette.” It felt really wrong in Manhattan, where locals have weight fetishes and diet neuroses. The photos by contrast looked like they belonged in an “all you can eat” buffet.

And not surprisingly, the numbers got uglier. From Appelbaum:

Despite ridding itself of $140 million of its loans in the bankruptcy process, Fairway soon found itself again loaded with debt and struggling to stay afloat. By 2019, its sales had grown to $643 million, but the burden of the leases on its stores and the interest payments on its debt led the grocer to lose a whopping $68.8 million. Late last month, with $227 million in debt and another $67 million in unfunded pension liabilities, Fairway again filed for bankruptcy.

Finally, Fairway proves Tolstoy to be wrong. Unhappy families, at least when made miserable by private equity, are considerably alike. Crushing debt loads, particularly for retailers, create vulnerability to economic downturns and deny businesses the cushion they need to make investments to adapt to changing tastes. And even in less inherently fragile industries, too much debt turbo charges private equity’s native short-termism, too often leading companies to cut costs and in so doing, alienate customers.

Appelbaum wants private equity to be forced to curb its company wrecking for fun and profit:

A lack of transparency disguises private equity’s role in the retail apocalypse. When General Motors in November 2018 decided to halt production at five North American plants and cut up to 15,000 jobs, Congress summoned the company’s CEO, Mary Barra, to answer for its decision. In contrast, few people outside finance know what Sterling or KKR or Blackstone is. Even after companies owned by private-equity firms go bankrupt, the investors suffer no public approbation or damage to their professional reputation. They can still raise money from pension funds and other institutional investors to buy out other companies under the guise of saving them….

If private-equity firms cannot be socially responsible stewards of capital, then Congress will need to act. One possible reform would involve fully taxing the advisory and other fees that private-equity investors extract from the companies they own. Another potential reform would impose restrictions on dividends paid out in the two years following a buyout. Since the current system allows private-equity firms to reap much of the positive gains from successful acquisitions, they could also be required to bear some of the liability for a company’s debt when the buyout ends in bankruptcy.

Elizabeth Warren has made a much more aggressive call for private equity to eat its bad cooking by ending limited liability for private equity bankruptcies and effectively putting the controlling persons of the private equity firms on the hook. The time is long overdue to put an end to private equity’s “Heads I win, tails you lose” deal.

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36 comments

  1. AbateMagicThinking But Not Money

    When people die there is a post mortem in some cases. That should be case for every company, big or small, because as I understand it, they are treated as persons now, and their demise is usually not without victims and executioners.

    As I understand it shell Corporations are a contradiction in terms (companies without a company of people) and should be a prime source of post mortem funding.

    Pip-Pip!

    Reply
  2. jackiebass

    Another example of so called Vulture Capitalism. Come in, loot the business of anything of value, pile up huge debt, then move on to the next target.

    Reply
    1. flora

      It’s almost like profiteering against the company. Anti-profiteering rules like those proposed in the post are an excellent idea.
      Thanks for this post.

      Reply
      1. inode_buddha

        Last I heard, there are anti-profiteering rules in place for contractors supplying the Defense Dept. put in place by FDR during WW2. Which is why the Vietnam “war” never happened. Instead, they called it a “police action”. See? change the name of it to get out from under the rules….

        Some people need to be nailed down so they can’t wiggle out, that is why the law books are so thick — they have to cover every possibility.

        Reply
  3. Sound of the Suburbs

    I am a banker and my only real product is debt.
    Who can I load up with my debt products?
    This is how I earn a living, and I’ve got to shift these debt products

    Another happy customer.

    Reply
    1. LawyerCat

      When the bugs get your cotton, the times they are rotten,
      I’m jolly banker, jolly banker am I.
      I’ll come down and help you, I’ll rake you and scalp you,
      Singin’ I’m jolly banker jolly banker am I.

      – Woody Guthrie – Jolly Banker

      Reply
  4. Justin

    I don’t see any difference between the founders and private equity. Sure they helped build the business, but at the end of the day they cashed out—the business and employees be damned.

    Let’s put in more controls against private equity and make them responsible. And for what? So we can have pretty profits and payouts? A ‘successful’ business more obsessed with making money than providing goods or services? The wheel goes round and round and everyone wants a slice of cheese.

    Reply
    1. J7915

      It saddens me, IIRC after WW2 the USA was instrumental in re-organizing German business and there came the requirement that employees held 50% of the board seats. How about setting that rule in the US.
      Limits crossbreeding and inbreeding of boards. No bonuses, consultant fees etc etc, unless it comes out of clear profit. Finally put teeth in sorbonne-oxely sp? All it means is that the signer atests to the truth of the shareholders report. Unless the understanding is that only with Sorbonne oxley will the report be legitimate and honest? What do you want the numbers to say?

      Sorry no cafe yet. Essentially my take of laws is: law is 90% public, perception, and 10% what legal oracles can divine out of antiques words in a modern world.
      akin to: theguy who hits you from behind is the guilty party,

      Reply
    2. PKMKII

      Publix has shown that a grocery store chain can operate competently as an employee-owned ESOP. Too many owners, though, are looking for that big windfall sale, and PE offers a lot more cash and more upfront than structuring loans for an ESOP, some form of co-op, or other more holistic ownership models. As long as the regulatory institutions enforce neat and dry financial factors, and even those they don’t do adequately, and do not factor in larger impacts to workers and community, we’ll continue to see maximizing payouts instead of maximizing effective management.

      Reply
    3. Jeffk

      No “difference between the founders and private equity”?
      Lets not sully the distinction between these two with a glib perspective of profiteering. Ask yourself – who are the stakeholders? The founders served the interests of the communities and their employees. Their success depended on the services they provided in context with the broader economy. Private equity is obligated to serve shareholders. They will figure out a way to profit regardless of the success of their acquisitions or the community at large.

      How a community regulates profit-taking through the agency of government, and does so while still guaranteeing civil freedoms is the hard part. When monopolies financed by private equity both control the marketplace and fund political campaigns then we are standing just inside the margins of the jungle where everyone is a predator or parasite. Then we’ll all be buying processed food-like substances from the gas station mini-mart – both the shareholder and the stakeholder.

      Reply
    4. Yves Smith Post author

      Wowsers. You have no idea what soft promises Sterling made when they bought Fairway.

      It is common, in fact close to pervasive that when PE companies specialize in buying stakes from founders make a great show that that they will preserve the founders’ vision and operations. But those promises are never incorporated into the contracts.

      Before you point fingers at the sellers, I suggest you read the classic “Barbarians at the Gate,” on KKR’s acquisition of RJ Reynolds. There’s a scene where Kravis and Roberts are wooing the board. In no time, they have them eating out of their hand. They are convinced that Kravis and Roberts embody their values and will act out of them once they’ve done the deal.

      Later, the board members comment how they were betrayed.

      PE pros are masters of emotional manipulation. Don’t underestimate them.

      Reply
      1. flora

        The old days of doing business on a promise and a handshake are over, unfortunately.
        If it isn’t written in the contract, it doesn’t exist.

        Reply
          1. notabanktoadie

            It went out with God and the expectation of judgement hereafter?

            Someone shot themselves in the foot by (to some extent) abolishing God in the public consciousness?

            Reply
      2. PKMKII

        Question is, if this sort of grift keeps happening time and time again with PE, at what point do we say that the sellers are being negligent in their due diligence by falling for the slick PE presentations? The prevalence of these shenanigans is moving out of the finance world alone and is becoming part of the general zeitgeist, so it’s not like potential sellers can claim ignorance with any validity.

        Reply
      3. Sancho Panza

        Yves, you should write up a mock HBS case study on this and post it to your site and send it to the Dean. It would be pure satire of course but hopefully biting enough to get some attention. Kind of a how-to manual on deep-sixing a perfectly valuable company in the name of shareholder value. Teacher’s notes would show how the proformas worked out beautifully even though the company went B/K. Maybe some interviews with employees and others from the community who were negatively affected would send the message home further. I am implying of course that the school shares some responsibility in all this.

        Reply
  5. Frank Little

    Reading this reminded me of that disappointing hearing on private equity from a few months ago, which I only knew about because it was posted here. I guess I shouldn’t have been surprised, but it was beyond galling to watch the private equity people there guffaw at the idea that they were running these companies into the ground despite constantly accumulating evidence to the contrary.

    I know these hearings are theater, but it would have been nice to see someone asked why it made sense for ToysRUs to give up real estate that they owned only to turn around and rent it again. Or how a private equity company can pay itself fat consulting fees while the company inches closer to oblivion.

    These are not complicated financial instruments or some arcane part of the financial system (not that either of those should get a pass). It’s class warfare, plain and simple. I guess you don’t even have to bother seeming contrite if everyone in charge is fighting on your side.

    Reply
    1. J7915

      Lord and taylor in NYC? why didn’t the rent to wework the top floors? When you own the RE in a recession you only need to pay utilities and taxes, Employees are regrettably more variable cost. When you rent…employees are still the one variable cost.

      Reply
      1. chuck roast

        Utilities and taxes…that seems like a rather large amount to me. Why are there all these empty storefronts in Manhattan? I don’t get how these people think. It’s like RE people have a blind spot about opportunity costs.

        Reply
  6. Amy Fargochar

    Capital, these days at least and maybe always, is purely a predator. Private equity especially and especially this example reminds me of that episode of the Sopranos where Tony and his crew take over a guy’s (Davey Scatino’s) business (Ramsey Outdoor). The degenerate gambler owed Tony and his crew a sizable gambling debt. It was a sporting goods store and they used it as a way to gorge themselves until the operation collapsed under a mountain of debt. They sucked it dry and ruined the poor sap who thought he could hang with the big boys.

    Justin raises an excellent point. Getting back to basics, organizations should be community-based and community-managed and community-owned. The community should have a vested interest in it and if an organization doesn’t want to abide by that, well, a community really doesn’t need it, does it? There should be organizational restrictions about trading ownership shares and mitigating outside ownership, i.e. private equity firms and other financiers.

    Parasite

    Seriously, what’s going on in that clip is effectively what’s going on in this story about Fairway and most every private equity acquisition. Except when private equity does it, versus Tony Soprano and his goons, it’s legal.

    Reply
  7. Sancho Panza

    Sad story. Thanks. Like the others who have posted I’m scratching my head to figure out why there aren’t more naturally occurring corrective mechanisms to such bad behavior by PE. Like, if the prospectus noted an $80m dividend would be paid out to management from the IPO does this mean BUY side investors are just stupid, or don’t care?

    Reply
    1. John Wright

      One has to wonder if the consumers of these IPO’s are pension funds that believe they don’t have to be concerned about the performance of individual stocks because they are spreading their money over many different investments.

      A rising overall market could counter a few turkeys in the pension fund’s portfolio.

      One group that probably does read these prospectuses would be short sellers.

      But they would not be able to sell short for a period after the IPO was launched.

      Reply
      1. Sancho Panza

        Yes, that makes sense. Thanks. I was also trying to put myself in PE’s shoes, and, assuming they don’t see themselves as evil, they could approach every deal with an upside scenario of growth as the nominal goal while at the same time having a loss salvage strategy that includes asset stripping and restructuring/ B/K. B/K would seem to be a put option of sorts…a last resort. I’m not justifying the behaviors just trying to understand it. I once asked a PE investor why he had put so much debt on a company and he said it makes the employees work harder.

        Reply
  8. chuck roast

    And no mention of the workers pension fund, typically stolen in bankruptcy. We always see one vulture capitalist buy the looted carcass out of bankruptcy from another vulture capitalist. It’s like “our thing.” Pension funds are icing on the cake. The bankruptcy laws should be changed to protect workers pension funds and allow workers first dibs to form a co-op to bring their broken workplace out of bankruptcy

    Reply
    1. Jim A.

      Of course then the PE folks will write themselves into the pension funds, as “managers” of the company, giving themselves golden parachutes, justified by the need to “attract the best employees” to manage the company.

      Reply
  9. notabanktoadie

    $87 million of the $137 million purchase price was borrowed, Yves

    Borrowed or lent into existence by a member(s) of a government-privileged private credit cartel?

    Not that it matters which, I suppose, since interest rates are unethically determined and steal by inflation and/or deflation from the general public.

    But the general public are potential customers and does it really make sense to steal from potential customers as well as from one’s own employees?

    Not that the buyers in this case were interested in the welfare of anyone but themselves but why enable them with unethical finance in the first place?

    Reply
    1. Andrew W. Park

      I co-authored the Atlantic piece.

      There needs to be a more focused discussion about the issue of moral hazard as it pertains to the current private equity business model.

      Notice how the private equity owner (Sterling) only had to put up $50 million of its own capital initially, but the additional $85 million borrowed to acquire Fairway is the responsibility of the company itself.

      As a former grocery store founder told me after the story ran. The grocery business is its own beast in understanding how to micromanage every step of the chain in dealing with highly perishable goods and having the ability to disintermediate others in the supply chain for a historically low margin business. And simply cheap access to capital and “expertise” in running other non-related businesses does not qualify someone to run a grocer.

      Clearly that started to become evident from 2007 to 2013, but it’s stunning to see how the PE owner was able to salvage a profit by paying itself dividends of $80 million on top of the millions in management fees and “additional expenses” onto the company. There’s a reason why venture capitalists and private equity GPs often refer to the IPO as “an exit”, exit for them, unsuspecting new shareholders and employees are left holding the bag.

      Reply
      1. notabanktoadie

        Yes, I agree with the need to abolish limited liability for private equity and for publicly traded equity too if the ownership is concentrated enough*.

        *such that externalities do not affect the owners sufficiently that they rein in the behavior of the company they own.

        Reply
  10. smoker

    Very sad. How much of Fairway’s money woes had to do with skyrocketing rents?

    I’ve been witnessing increasing Silicon Valley shutdowns of well loved businesses due to obscene lease increases. One small computer repair shop had his rent doubled on him.

    Reply
  11. verifyfirst

    This might be another such tale, I don’t know anything about it, except I do know Van Elslander singlehandedly resurrected the Detroit Thanksgiving Day Parade 10 or 20 years ago.

    “Art Van Furniture’s private-equity owner is exploring its options of possibly selling the company and filing for bankruptcy to ensure it can continue serving communities.

    Boston-based Thomas H. Lee Partners bought Art Van in February 2017 for $550 million, a year before the death of its founder Van Elslander in February 2018”

    https://www.detroitnews.com/story/news/local/michigan/2020/02/15/report-art-van-furniture-explores-sale-possible-bankruptcy/4766649002/

    .

    Reply

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