Rising to the Challenges Ahead
C-level executives from retail, consumer-product, food and restaurant companies joined professionals from the financial-services sector at the second annual Main & Wall conference, hosted by David N. Deutsch & Co. and Chain Store Age.
Held Feb. 11-13 at Miami’s exclusive Mayfair Hotel and Spa, attendees exchanged insights and experiences during a number of educational forums and relaxed social gatherings.
The overarching theme of the conference—that 2008 will be a year of challenges—was underscored with a tone of cautious optimism for growth-oriented middle-market retailers and consumer-product companies.
David N. Deutsch, conference chair and founder and president of the distinguished New York City-based investment-banking firm that bears his name, opened the conference with a short summation of current economic conditions and an overview of capital markets.
“Public-equity markets saw huge gains over the last five years, but the last six months have been scary. IPO markets set records in 2007; but in January of this year, 17 planned IPOs were pulled. M&A (mergers and acquisitions) activity is flattening. For most companies, acquisition/sale values expressed as multiples of EBITDA (earnings before interest, taxes, depreciation and amortization) peaked in 2007; they’re probably at the highest levels we’ll see for awhile. Debt-capital markets are on shaky ground and it’s hard to say if they are starting to recover or the worst is yet to come. There are many smart Wall Streeters on both sides of that fence.”
“The good news,” he continued, “is that financing for middle-market retail and consumer companies is still available. Financial leverage among retail and consumer companies, expressed as a company’s total debt to EBITDA, was at the highest level we’ve seen in years. No one is sure what will happen in 2008, but asset-based lenders, those that lend on the basis of collateral values as well as cash flow, are licking their chops as cash-flow lenders begin backing down.”
This year’s “View from Main & Wall” presented a sharp contrast to the 2007 theme of financial markets flush with opportunity. If not completely dry, markets that were described last year as “dripping with liquidity” are now struggling to stay afloat. Turning to his fellow panelists in the opening Main & Wall session, Deutsch asked for their views of the general economic environment.
Cheryl Carner, managing director, retail finance of Boston-based CapitalSource Finance, a lending, investment and asset-management business and sponsor of the Main & Wall conference, stated, “Whether the economy meets the technical definition of a recession or not, we all see what has been happening and companies across all sectors are being challenged.”
Citing the decline in housing values and the volatility of the stock market, Jeffrey Bloomberg, principal and managing director, office of the chairman of Gordon Bros. Group, Boston, agreed. He characterized the prevailing economic mentality as a psychological recession that has impacted consumers at every income level, even the wealthy feel reservations about spending, and this psychological phenomenon is contributing to increased uncertainties throughout the financial sector.
Gordon Bros., a platinum sponsor of Main & Wall, along with its real estate company, DJM Realty, provides advisory, financial and operating services to companies that are experiencing growth or restructuring.
Echoing Bloomberg, San Francisco-based Michelle Cherrick, partner and co-director of consumer investment banking, Thomas Weisel Partners, said, “There is an unprecedented psychological factor affecting consumer spending, and I don’t think we’ll have any real data to tell us if this is changing until the back-to-school season.”
What’s next? Defining the current state of affairs set the stage for addressing the more pressing questions that were on everyone’s minds.
Asked “Where are we going over the next 12 to 24 months and how should companies adjust their strategies?,” Bloomberg responded, “Retailers should use this period to take their foot off the pedal and correct mistakes. Since December, there have been more than 900 announced store closings and there is a lot of pressure on malls.”
The silver lining in this perfect storm, he predicted, would be opportunities to “cherry pick locations at better rates,” and retailers might find they are able to negotiate for more concessions with landlords.
Cherrick agreed this might be a good time for retailers to be opportunistic with real estate deals. However, she noted that even retailers committed to growth have cut their expansion plans—in some cases by 50% or more.
“Opening stores is the most expensive way for retailers to grow; they need to focus on growing their multichannel presence with direct marketing and e-commerce,” she suggested.
Growth through mergers and acquisitions may also prove trickier this year, Cherrick advised, “because it is difficult to get a board of directors to adopt more children when the children at home need so much attention—they are reluctant to bring more [stores] into the fold.”
However, tough times for some will certainly create opportunity for others. In the same vein that prime real estate may come available, companies may go on the selling block that normally would not be offered.
“Acquisition opportunities will be more prevalent and varied than before,” suggested Deutsch, “and retail and consumer companies, with ‘slow’ prospects for organic-growth in a tougher economy, may be wise to consider them.”
Arguably, the issue is not whether or not there are good deals for the taking but rather whether there is financing available to support these transactions. Carner said there is money for retail growth—provided you know where to look, you’re shopping for the right amount, you have a proven track record of success and realistic goals for expansion.
“In general, financial leverage is less available, but not to the degree that transactions cannot be done; there is debt capital available,” she advised. “If you are trying to raise $150 million, that would be really challenging, but smaller amounts—$40 million, $60 million or even $75 million in debt—that just takes a few institutions and we can get a transaction done.”
“What people are looking to invest in,” she continued, “are stable performers, retailers that are successful at getting consumers to part with their money. Growth is fine; it’s the magnitude [of expansion] that makes the difference. How many units are you adding and how much capital do you need?”
Although it is possible to finance growth, Cherrick cautioned retailers to beware the fate of recent success stories that have faltered. “Many people are surprised at where Chico’s, PacSun and Hot Topic are now, but I would argue they are victims of their own success and of the fact that we are over-stored in America,” she stated.
In a faltering economy with consumer spending down significantly, markets that could once support multiple store locations are more susceptible to being overstored. When they can’t maintain or grow comp-store sales, retailers resort to expense reductions, but that rarely compensates for sluggish performance.
As Bloomberg explained, “Unless a retailer can grow its top line, cutting expenses will take you only so far. The way a retailer can grow its top line is not by expanding its store count but by expanding the productivity of each store.”
Panelists agreed that mall-based department stores are among the hardest hit, and as an overall sector, perhaps have the grimmest prospects for recovery. The domino impact on other retailers in B and C malls is likely inevitable.
“When one department store anchor leaves a mall, the landlord brings in a Home Depot or Target,” observed Bloomberg. “When a second anchor pulls out, they bring in restaurant pads. But when a third anchor goes, the developer has a really difficult time getting someone to take that spot.”
Deutsch lauded Steve & Barry’s University Sportswear, which often moves into defunct mall anchors, for its opportunistic growth strategy. However, Bloomberg countered that retailers such as Steve & Barry’s had better be “careful what they wish for.”
“Steve & Barry’s has found they don’t have the human capital or the financial controls to support their growth,” Bloomberg said.
Growth potential: If one of the fastest-growing, hottest retail concepts in the industry is potentially at risk, what retail sectors have the most viable growth potential?
Carner answered the question with a barbell analogy. “Opportunities exist on the luxury end and the true-value end,” she said.
Retailers and sectors that continue to perform well despite economic downturns are those that are responsive to their consumer base and to prevailing trends. For instance, restaurants historically suffered because consumers would eat out less when money was tight.
“Unlike prior economic downturns, this is not true in the current climate,” noted Cherrick. “We have a generation of consumers who don’t know how to cook and the quick-service restaurants (QSRs) have responded well to consumer interests, like McDonald’s addition of salads and yogurt to its menu.”
It is premature to predict how well popular but slightly pricier quick-casual restaurants (QCRs) such as Chili’s will weather economic fluctuations, but consumer preferences both for eating out and for convenience bode well for QSRs as well as QCRs.
Todd L. Hooper, principal, private-equity services of Kurt Salmon Associates and also based in San Francisco, identified environmental sustainability as another key trend impacting consumer spending.
“We’ve reached the tipping point on environmental [awareness] and it is now part of the consumer mind-set and a reality in a much bigger way,” he said. “Businesses with a constituency for whom this is important will thrive. In general, this is the [mind-set] of a younger consumer, who has longer purchasing power.”
Challenging times are like flush economies in one respect: Retailers that engender customer loyalty are the ones that also attract the most interest from investors. “Specialty retail done right can always grow,” stated Deutsch.
However, 2008 may be the year to postpone dramatic shifts in financial structure. Retailers that watched stocks soar over recent years, only to plummet in recent weeks, might consider delaying corporate sales and equity financings—although such transactions, particularly private-equity financings, remain viable in the middle market if handled carefully.
Main & Wall panelists agreed the financial pendulum swings too far in both good times and downturns. As businesses that were over-valued struggle to accept the new reality, Deutsch said we have entered “a period of adjustment.”
Sellers who don’t want to lower their prices or expectations will have to wait it out and private companies considering an IPO should do the same. Cherrick predicted, “The IPO class of 2008 is looking instead to debut in 2009, although a few stellar performers may go public after Labor Day.”
Having set the stage with an overview of the current financial markets and the challenges ahead, the conference progressed with detailed discussions of growth management, exit strategies and opportunities to leverage untapped resources.