March 15 (Bloomberg) -- In the years before the recession, private-equity firms put so much faith in the future of U.S. brick-and-mortar retailers that they spent $36 billion on them.
That hasn’t worked out so well, especially for the era’s biggest spender, Bain Capital LLC. The firm started by Mitt Romney inked four deals valued at $17 billion from 2004 to 2007 and still owns all of the purchases. The largest of the bunch was Toys “R” Us Inc., which posted a drop in sales during the holidays, followed by Chief Executive Officer Gerald Storch stepping down.
The private-equity model -- load up an acquisition with debt, cut costs and take it public -- hasn’t gone according to the usual script with most of Bain’s retail acquisitions. That’s largely because the firm, which has $67 billion in assets under management, doubled down on specialty retailers just as they were about to be pummeled by the likes of Amazon.com Inc.
“There isn’t anything special about specialty anymore,” said Leon Nicholas, an analyst for Kantar Retail in Boston. Their advantages on product assortment, expertise and price have disappeared, he said.
Bain tried to take Toys “R” Us public in 2010 and then postponed the offering.
Of the eight largest retail private-equity buyouts during that period, only Dollar General Corp., a chain of discount stores acquired by KKR & Co., has gone public. Among the specialty retailers that remain private: Apollo Global Management LLC’s Claire’s Stores Inc.; the Sports Authority Inc., controlled by Leonard Green & Partners; and Petco Animal Supplies Inc., owned by Leonard Green and TPG Capital.
The fortunes of several large publicly traded specialty chains have only raised more doubts about these companies reaching an IPO. Borders Group Inc. and Circuit City Stores Inc. didn’t make it out of the recession. Many of the survivors have dubious futures and depressed stock valuations. Barnes & Noble Inc. and Best Buy Co. are losing money and aren’t increasing sales. While Staples Inc. made money and boosted sales last quarter, it has lost about a third of its market capitalization in two years.
“You look down the list of companies and the evidence is there” that the business model is in trouble, said Chris Bertelsen, who oversees $1.7 billion as chief investment officer of Global Financial Private Capital in Sarasota, Florida.
Alex Stanton, a Bain spokesman, declined to comment, as did Kathleen Waugh, a Toys “R” Us spokeswoman.
Toys “R” Us and Bain’s other chains -- Burlington Coat Factory Warehouse Corp., Guitar Center Inc. and Michaels Stores Inc. -- were part of the specialty retail boom that took off in the 1980s. By offering a broader selection than smaller, independent shops and department stores, the business model dubbed “category killer” flourished.
Bain Capital helped invent the business model, co-founding Staples in 1986. The office-supplies chain spawned more than a dozen copycats and paved the way for specialty to be applied to almost every product niche imaginable.
That gave U.S. consumers oodles of choices and mall owners plenty of renters and reasons to build even more shopping centers. Best Buy, Circuit City and Barnes & Noble flourished, dotting the suburbs.
Then came the recession and newly frugal U.S. consumers flocked to the Web for its ease and lower prices. Online price transparency weakened a specialty chain’s profit margins because consumers can comparison shop at will. The advantage specialty used to have on selection doesn’t exist with the Web’s endless aisles. Their expertise often pales in comparison to the online research shoppers can do on their own.
That left a chain like Toys “R” Us, which has 1,500 stores, struggling to increase sales, and put off an exit for Bain and its partners. Revenue at the world’s largest toy-store chain declined 4.7 percent in the U.S. from November to December. That came after revenue had dropped companywide, including both the U.S. and overseas operations, for five straight quarters.
Bain along with KKR and Vornado Realty Trust bought the Wayne, New Jersey-based retailer in a deal valued at $7.54 billion, including net debt, in 2005. At that time, the chain was losing market share to the lower prices at Wal-Mart Stores Inc. and Target Corp. and the U.S. toy industry wasn’t growing.
Not much has changed in the interim. It may have gotten worse. Toy sales in the U.S. are declining as kids spend more time on mobile devices. Amazon has its own toy site, yoyo.com, and baby portal, diapers.com, to compete with Babies “R” Us, the baby chain Toys “R” Us started in 1996.
“It’s a tough game to play now,” said Paul Swinand, a retail analyst for Morningstar Inc. in Chicago. “They are getting pinched on all sides” with discounters like Wal-Mart offering cheaper prices and Amazon’s selection and service, he said.
In 2006, the company hired Storch after he left Target, where he was vice chairman. He improved profitability by closing stores, selling others and cutting thousands of jobs. He increased sales by revamping merchandise and taking a page from Target by offering more exclusive items. That year, same-store sales gained for the first time in six years and profit surged 40 percent in the fourth quarter.
Since deciding not to go public in 2010, Toys “R” Us has tried a variety of tactics to remain relevant, from opening pop-up stores to price-matching to lay-away programs. None of it stopped the decline in same-store sales. The company has said slowing sales of video games is largely responsible.
Asked whether he could consider buying a public Toys “R” Us, Bertelsen said he “wouldn’t touch it with a 10-foot pole.”
Bain’s other retail investments have uncertain futures, too. Burlington Coat Factory and Guitar Center, both of which the firm purchased on its own, are losing money. Burlington, acquired for $1.9 billion in 2006, did increase sales 6.8 percent to $1.32 billion in the quarter ended Feb. 2. Guitar Center, bought in 2007 for $2.1 billion, posted a gain in revenue of 1.6 percent to $496.2 million in the quarter ended Sept. 30.
Michaels Stores, which Bain bought with Blackstone Group LP in 2006 in a deal valued at $5.5 billion may be in the best shape of the four. The world’s largest arts-and-crafts retailer filed to raise $500 million in an initial public offering in March 2012. In the fiscal year ended Feb. 2, sales rose 4.7 percent to $4.4 billion and net income gained 22 percent to $214 million. The company named Chuck Rubin as CEO last month. He left the CEO job at Ulta Salon, Cosmetics & Fragrance Inc.
For now, Toys “R” Us has enough liquidity to keep operating, but an IPO is off the table with Storch leaving and its lack of growth, said Kim Noland, a credit analyst with Gimme Credit LLC in New York.
“They aren’t on a cliff, this is no Blockbuster,” she said, referring to the movie-rental chain that went bankrupt in 2011 and now is a unit of Dish Network Corp.. “It’s not like something bad is going to happen immediate here. It’s just kind of a long, tired slog.”
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