Private Equity Parasites and the Lesson of Mervyn’s

Private Equity Parasites and the Lesson of Mervyn’s


This month Mervyn’s, a popular chain of middle-class retail clothing stores, is just about finished with its going-out-of-business sale, its departments so ransacked the hottest deal-making is for their shelves and display tables. We can and must glean economy-wide universal lessons from this unnecessary bankruptcy, lessons with concrete policy implications.

Was Mervyn’s worthless when Cerberus Capital Management bought it from Target in 2004 for $1.2 Billion? Was it a doomed entity in 2005 and 2006 when it had a combined 300 million in profit, even despite being hit by Cerberus’ vastly increased lease payments they forced the retailer to pay for its own buildings?

You see, when the three Private Equity (PE) firms, Cerberus Capital Management, Sun Capital Partners, and Lubert-Adler acquired Mervyn’s, they split it into two entities, the retailer, and the real estate. Then they bled Mervyn’s dry with increased lease payments, debt, and dividend payouts. As an introductory proposition we should expect PE firms to layoff workers when they make an acquisition. But another common practice is to load it with debt.

This is being played out in the Sam Zell-Chicago Tribune parasite-victim relationsip, where that media company was also saddled with disproportionately enormous debt and quickly driven into bacnkruptcy.

To give you some idea of the debt’s disproportionality, “At their peak in 2006 they (PE firms) acquired 667 companies worth $372 billion. But debt levels soared: From 2005 through the third quarter of 2008, private equity firms loaded a staggering $741 billion of debt onto their companies' balance sheets.”

Besides layoffs and debt, the strategy includes high dividend payouts to the acquirer and/or other forms of forced extractive payouts (e.g. the real estate entity in the Mervyn’s deal). According to BusinessWeek, the “private equity firms took a total of $137 million in "distributions" directly from company coffers” in the Mervyn’s deal.

Overall, Mervyn’s charges the PE firms “stripped it of real estate assets, nearly doubled its rent, and saddled it with $800 million in debt while sucking out more than $400 million in cash for themselves.”

And Mervyn’s is not alone: Linens ‘n Things, Sharper Image, Goody’s Value City, and many others went bankrupt shortly after being bought out. “Of the 105 big U.S. companies that have filed for bankruptcy this year, 66 have been owned by buyout shops or been spun off by them.”

So one can safely say that easily half the major corporate bankruptcies are of firms recently bought and owned by PE firms.

So, what gives? Is the PE firm a parasite that buys firms with real products, real customers, profits, employees, and real estate, and systematically shuts them down? In a word, yes. Exactly. They favor short-term gain over long-term viability. Mervyn’s has laid-off 30,000 workers since 2004, when Cerberus acquired the store.

Is there a difference between how Cerberus (who also own Chryler) ran Mervyn’s and how Mervin G. Morris, who founded the company in 1949, ran Mervyn’s? Think about the time periods: Mervyn’s went through lean times and fat for almost six decades before they were fatefully acquired by a crony company that had no intention to run it, only a zeal to gut it for quick personal gain – sending them careening into bankruptcy.

The broadest point is this – in the Public vs. Private sector comparison, we can stipulate that the private sector will run some activities more efficiently than the government, despite infinite case studies to the contrary (Medicare and Social Security program administrative costs being vastly less than their private counterparts, public vs. privately owned prisons, the military vs. the mercenaries, etc).

However, if the laissez-faire/ privatization proponents want to put forward the private sector as a replacement to some government-run activity, they will have to first admit that the private sector can not possibly do a better job than government unles they first actually run the business, as opposed to buying it with the purpose of systematically bleeding it dry as quickly as possible, as if job one was firing all employees and closing all retail branches.

And these PE firms’ business practices are not unique in the narrative of businesses being bought in order for the private sector to destroy them and shut them down as fast as possible. General Motors went around the country in the first half of the last century, bought out and shut down major municipal streetcar systems (in what is known as The Great American Streetcar Scandal) for the purpose of replacing clean efficient public transport with dirty, smelly buses and more importantly, profitable passenger cars. Battery patents key to the electric car have been owned at various times by big car companies and oil companies, both of which just lock away technology so that it never will see the light of day.

Now, what is left of Mervyn’s is suing their former owners, Cerberus. This will be an important case to see if the courts will put curbs on PE firms’ behavior. If they fail to do so, it will be left to Congress and, conceivably, State Attorneys General to quell these destructive parasites.

Is there something else lost in this unnecessary bankruptcy? Mervyn’s was a place middle-class shoppers could pick up clothes that were above the quality you often find in Target or Ross, at prices that were reasonable. In many cities and towns, there is no close replacement. Even here in populous San Jose, I can’t name an interchangeable source. Macy’s is much higher priced, and mall boutique stores are worse. Target and Ross, as mentioned, are, like Marshall’s, hit-and-miss and harder to navigate for what you really want, and Wal-Mart is multiply objectionable.

But these are the concerns of real people in the real economy, like the 30,000 Mervyn’s employees tossed aside by Cerberus. People who own and manage Cerberus like Bush I’s VP, Dan Quayle, and Bush II’s former Treasury Secretary John Snow have other concerns: short-term extraction and personal enrichment at the expense of long-term sanity, equity, or widespread economic health.