Private Eye: Retail meltdown trips up operations-focused CD&R

Clayton, Dubilier & Rice was one of the first buyout shops to emphasize its operational chops; two of its co-founders, Gene Clayton and Martin Dubilier, had been crisis-management consultants before starting the firm in 1978. But so far the New York buyout shop hasn’t been able to revive the fortunes of specialty retailer David’s Bridal.

It’s an unusual misstep for the mega-buyout firm. CD&R’s long list of banner deals includes Kinko’s, Hertz, Lexmark and Sally Beauty; its recent investment in U.K. discount retailer B&M European Retail Value S.A. generated a 5x investment multiple, according to a source close to the firm; and its latest fund, the $10 billion Fund X, closed nearly a year ago, saw some $20 billion in demand. Fund VIII, in which David’s Bridal resides, has been a big home run for the firm.

I have no great insights into retail, let alone specialty retail. But I can appreciate some of the factors that must have drawn CD&R to David’s Bridal when it teamed with fellow buyout shop Leonard Green to buy the company for $1.05 billion in late 2012.

One of those factors: The company’s previous owners are successful buyout firms themselves — retail specialist Leonard Green and TPG — and Leonard Green, in a vote of confidence about the company’s prospects, was sticking around for a second bite of the apple. While CD&R cut a check for $251 million, or 75 percent of the $335 million in equity, Leonard Green made up the balance.

Other signs looked favorable for the business. Many couples don’t mind splurging on an expensive wedding dress, given the fanfare surrounding weddings, and their once-in-a-lifetime quality. At the time of the deal the U.S. economy was only a few years into its rebound from a bad recession. And CD&R could look forward to demographic tailwinds in the form of a surge of millennials tying the knot.

The Conshohocken, Pennsylvania, retailer, operating more than 300 stores in North America, was generating run-rate revenue of $740 million, according to Moody’s Investors Service. In its analysis of the deal, Moody’s did note a pro forma debt/EBITDA multiple of well above 7x (suggesting the company was generating EBITDA of upwards of $100 million at the time). That’s a big multiple. But an analyst with the credit-rating firm wrote: “Given the company’s history of consistent cash generation, we believe credit metrics will gradually improve over time.”

If that ever happened, the trend has since reversed, despite the company’s recent efforts to improve the presentation of merchandise in its stores, to better manage costs and to engage with brides on Pinterest.

In a news release this September, Moody’s said the company’s debt/EBITDA multiple had grown to 9.25x as of midyear 2017. It downgraded David’s Bridal’s corporate-family rating to Caa2, meaning investors in the roughly $790 million of term loans and unsecured notes should consider the company a very high credit risk.

“While Moody’s expects earnings to improve and projects adequate liquidity in the next several quarters, any growth may not be sufficient to reduce leverage towards a sustainable level of 6 times in the near term,” the firm wrote.

Numbers cited by Moody’s in the same news release suggest the company has experienced flat growth under CD&R’s ownership: for the 12 months ended July 1, 2017 the company had generated about $738 million.

Earlier this month, ratings company Standard & Poor’s weighed in with a more discouraging report. It downgraded the company’s corporate-credit rating to CCC, with a negative outlook, suggesting vulnerability to default. And it offered this assessment in a news release: “The negative outlook reflects our view that the company could pursue a distressed exchange or debt restructuring in the next 12 months to address its October 2019 term loan maturities, as challenging market conditions persist and our expectation for worse operating performance.”

So what went wrong with David’s Bridal? I was unable to reach executives at the company or Leonard Green for comment, and an executive at CD&R did not wish to comment for this piece.

But the analysis provided by Moody’s and S&P in their news releases provides an outline of the story. S&P points to “competition, price transparency, and changing bridal habits” as pressuring sales and margins. The latter includes fewer people than expected getting married and a trend toward them becoming more casual, less formal affairs.

Moody’s got even more specific, observing that “execution issues, catch-up digital investment and growing online competition have driven market share losses and a cumulative over 30 percent decline in earnings since the peak in 2012.”

The over 30 percent decline in earnings since 2012 suggests at least a 30 percent loss in enterprise value, and CD&R has “significantly written down” the investment, according to our source.

Needless to say, CD&R isn’t alone among buyout shops in seeing a retail bet sour in the past several years. PE-backed retailers hit with ratings downgrades in the past few months include Charlotte Russe, a dress retail chain backed by Advent International (the company said it launched a debt restructuring this December); and PetSmart, a pet-supply retailer backed by BC Partners, Caisse de dépôt et placement du Québec and StepStone (Moody’s this month downgraded the company’s corporate family rating to B2, with a negative outlook).

The pain is widespread and still spreading. In a recent retail report, Moody’s, while noting the picture should brighten later in the year, said “retail and apparel are bracing for more defaults and downgrades in the next couple of months after emerging from a particularly difficult year.” The ratings firm predicted that in light of the investment needed to stay competitive, retailers will need “stronger balance sheets than in the past.”

A highly leveraged company like David’s Bridal doesn’t fit the bill. But given its roots in crisis management and operational focus, CD&R isn’t likely to give up on the company without a fight.

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