Don’t blame J.Crew’s bankruptcy on Covid-19 — Quartz

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The J.Crew clothing chain has filed for bankruptcy protection. Like many other retailers, the hawker of preppy classics has seen its business suffer during the ongoing Covid-19 outbreak. Fashion has been particularly affected. In March, clothing store sales fell more than 50% compared to the previous year.

But the pandemic has just compounded J.Crew’s problems that have their roots in 2011, when two private equity firms bought the american retailer for $3 billion in a leveraged buyout. This left J.Crew carrying an immense debt that he could never escape. When the pandemic hit, the burden was too much to bear – a scenario likely to repeat itself at other retailers before the crisis subsides.

“It was not because of the pandemic. It was because of the debt,” says Eric Snyder, a partner at Wilk Auslander law firm and chairman of its bankruptcy department. He calls private equity “the two dirtiest words in retail” and says the industry has seen more and more private equity-backed companies fail due to debt.

Leveraged buyouts have become common among private equity firms looking to back companies they believe offer good potential for return on investment. It’s about buying a business using debt, much like taking out a loan to pay for a major purchase. Except in this case, it is the acquired company who is liable for the debt, while the acquirer gets a share of ownership. Often, private equity firms are looking for a quick return on investment and will support the business for three to five years before looking for an exit, such as an IPO or sale.

But the process can leave the acquired business grabbing a quick turnaround under debt it can’t sustain, making it difficult to secure new financing and pushing it toward bankruptcy. The buyer, on the other hand, might still have recovered its initial investment before this occurs, or profited in other ways.

J.Crew’s announcement said he had $1.65 billion in debt, compared to $1.6 billion in total assets on February 1, with current assets of $497 million. He was unable to fix sales to its eponymous brand, and recently suspended his plan to raise funds with an IPO of his successful denim brand Madewell. Unable to manage the debt, J.Crew is now selling ownership of the company to its creditors, including Anchorage Capital Group, GSO Capital Partners – a division of the Blackstone investment group – and Davidson Kempner Capital Management. The companies are also providing J.Crew with $400 million in new funding to support it as it restructures.

Other examples of retailers being pushed out of business by private equity include Sports Authority, toys r us, Barneys and Payless Shoes. A July 2019 Report (pdf) by progressive non-profit and labor advocacy groups said 10 of the 14 biggest bankruptcies of 2012 so far involved chains purchased by private equity.

Private equity advocates say it’s no different than any other way to raise capital and is unfairly maligned. These companies have certainly all had serious problems in their businesses related to structural changes in retail more broadly.

But Snyder argues that the leverage of a buyout can be difficult to manage even if the company is otherwise stable. A downturn like the pandemic “makes that impossible,” he says.

A number of other private equity backed companies carry debt such as Belk, guitar centerand Neiman Marcus, who seems likely to file the balance sheet any day.

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