A financial virus is killing our favorite brands
The coronavirus is deadly. It changed our way of life. COVID-19 is also a catalyst for the disappearance of certain brands. They will not survive. These brands could have survived the pandemic had it not been for the brand-destroying debt burden generated by excessive debt accumulation. Excessive debt has proven to be a financial virus that has wiped out the brands we know and love.
Accumulating debt is deadly for brands. Brands thrive on renovation and innovation by responding to customer needs and problems. Brands need compelling actionable insights generated by reliable market research and creative synthesis of multiple data sources. Brands need talent that reflects a diversity of thought. All of this costs money. But if revenue is needed to pay interest on debt or to pay down debt, the money won’t be there to keep brands relevant and differentiated. Raising to fund dividends and share buybacks are monies that are diverted from building strong brands in the hands of shareholders.
Is it just bad management? Is it simply a balance sheet riddled with financial shenanigans? Why is this important?
It matters a lot. When we leave our homes, we want the world we discover to be a semblance of familiarity. We want to turn to brands we trust. But the scourge of debt inflicted on our favorite brands is draining our current and future world of familiar brands.
Toys R’ Us was one such brand. Think how badly we need Toys R’ Us today. We crave board games, puzzles, finger paints, dress-ups, educational toys and anything interesting to entertain families and ourselves. However, financial magic set the stage for the mark’s grave, ending this wonderful mark by burdening it with debts that could not be repaid. The joy of this mark is now lost to all of us as several groups of financial wizards wanted to make a lot of money fast.
Payless ShoeSource was a godsend for people who needed shoes at very affordable prices. With so many millions out of work facing an uncertain world without a financial safety net, Payless could have been such a relief. Payless could have put shoes on the feet of the kids and on the feet of all those frontline heroes. In 2017, under the shock of over-indebtedness, the brand filed for bankruptcy. Emerging from bankruptcy, Payless ShoeSource struggled for two years and finally succumbed to yet another Chapter 11 filing. All stores in the United States and Canada were closed. In January 2020, the brand planned to reappear, but this time as an online supplier. However, when you log in today, you are directed to Amazon. Addiction to excessive debt virus hurts more than branding; it hurts us all.
There has been much discussion in the business press around the issue of share buybacks, both for and against. But, stock buybacks cannot be possible without the money to pay for the buybacks. As John Plender wrote for FinancialTimes“…(the increase in indebtedness) was most striking in the United States, where corporate debt rose from $3.3 trillion before the 2008 financial crisis to $6.5 trillion in 2019 One of the main drivers of this accumulation of corporate debt has been the phenomenon of share buybacks.”
The financial virus of corporate debt accumulation is truly insidious, killing our favorite brands. This debt becomes part of a vicious vortex from which it is difficult for a brand company to extract itself.
For example, there is the sad story of Romano’s Macaroni Grill. If you’ve never eaten at Romano’s Macaroni Grill, it’s one of those restaurants offering family portions of simple, flavorful Italian dishes served in a friendly, inviting environment a little noisier than Olive Garden. Romano’s Macaroni Grill was the epitome of abundance – plenty. Romano’s Macaroni Grill has been bought and sold four times since its launch in 1988, three sales in 9 years. Three of its last four owners were private equity firms looking to make quick money on their investments.
The restaurant’s initiator, Phil Romano, sold the franchise rights to Brinker in 1989. Brinker is the company that owns Chili’s and Maggiano’s (another Italian restaurant chain). In 2008, Brinker sold a majority stake in Romano’s to Mac Acquisition LLC, a subsidiary of Golden Gate Capital. In 2013, Golden Gate Capital sold Romano’s Macaroni Grill to Ignite Restaurant Group. And, then in 2015, Ignite sold the restaurant to Redrock Partners LLC. It was a “fire sale” – the purchase of Ignite was a $55.0 million all-cash transaction; he sold the brand to Redrock Partners LLC for $8 million. On October 18, 2017, Romano’s Macaroni Grill filed for Chapter 11 bankruptcy. The brand still has restaurants in 18 US states, but it’s a shadow of its former self.
If Romano’s Macaroni Grill were to decline as a brand, at least whether it was because the brand couldn’t compete or the brand lost relevance. But no, it was decimated because of the debt contracted by the financial aggressors.
Now J Crew has filed for Chapter 11. Again a piece in the The ex column for FinancialTimes commented as follows: “The litany of retailers bought and sold by private equity owners has earned a new name, J Crew. In the end, the holes in the balance sheet proved too big to fix. With total debt of $1.68 billion, a legacy in part of a $3 billion leveraged buyout in 2010 by TPG and Leonard Green & Partners, J Crew was sick before the virus forced the closure of its nearly 500 stores. As the column points out, J Crew was actually profitable at the operational level. It was the repayment of $146.7 million in interest charges on the loans generated by the acquisition that killed J Crew: the debt was too heavy.
It is true that J Crew has lost its panache and its relevance. But these problems can be solved. Brands can be revitalized. But, brand revitalization needs resources, and debt eats resources for breakfast.
Gold’s Gym is also in dire straits. Gold’s Gym is an iconic brand, a brand with cult status generated because the brand became the “mecca of bodybuilding” in the 1970s. It was the gym featured in the classic 1977 film pump iron. If you wanted to compete in Mr. America, Gold’s Gym was the perfect place to train.
The brand opted for Chapter 11 to help it restructure its debt. In 2004, the branding business became part of Dallas-based TRT Holdings Inc.. TRT Holdings Inc. led a group of investors that bought Gold’s for $158 million. (TRT also owns Dallas-based Omni Hotels & Resorts.) Although The Dallas Morning News reported that bankruptcy does not affect franchisees who own about 90% of the stores, the corporate center of a franchise organization is responsible for many of the programs that franchisees rely on. Not every gym-goer wants a Soul Cycle or a yoga studio. Bodybuilding is a big deal and Gold is tied to that culture. But he also has the debt bug.
And then there’s Neiman Marcus, the 112-year-old purveyor of incredible luxury goods and extraordinary luxury services. Neiman Marcus’ Christmas catalog featured stunning, envy-inducing, sometimes extravagant items worth well into five figures. In the space of eight years, Neiman Marcus has suffered two separate takeovers, burdening the brand with enormous debt. In 2005, Warburg Pincus and TPG purchased the brand for approximately $5.1 billion to resell it to Ares Management and the Canada Pension Plan Investment Board in 2013 for $6 billion. The upshot is that currently Neiman Marcus is $5.5 billion in debt and has just entered Chapter 11. Neiman CEO says bankruptcy will allow the brand to begin eliminating at least $4 billion of its outstanding debt. He said the fight against “massive interest payments” was going well until the coronavirus pandemic. In the meantime, the fate of 13,200 employees is at stake.
Here is the problem for brands. Financial wizardry does not unlock brand value; it leverages brand value for short-term benefit. These managers are extractors of value. But, there can be no sustainable profitable growth on the bottom line unless leaders create quality revenue growth on the top line.
Life is uncertain. When we leave our homes and return to our neighborhoods, we hope that we recognize the landscape. The brands we know and care about will provide some semblance of normality; a feeling that life goes on. The virus of excessive debt is creating a world where we will see lots of empty storefronts instead of front doors.
As destructive as the debt virus is to brand health, there is a way forward. Brands can be managed for brand health. Brands can fight back after being beaten, belittled and broken. Brands don’t have a natural life cycle. Brands don’t need to liquidate like Neiman Marcus, Toys R’Us or J Crew. With good management, brands can live forever.
The current pandemic is laying bare the destructive nature of excessive debt accumulation. Hopefully, this learning will be a lesson for C-suite leaders in brands and businesses. Hopefully this lesson will make our post-coronavirus life better and more familiar.