From Starbucks’ Teavana to Macys to Gymboree, the number of high profile US retailers announcing significant store closures and seeking bankruptcy protection is growing at record rates.

There is no shortage of finger pointing at ecommerce. But there’s far more to the story.

Two decades ago in the US, retail emerged as one of the most popular types of leverage buy-outs. Private equity funds could buy a retailer, make the business more operationally efficient and rapidly expand its footprint. Aggressive store openings were facilitated by unusually cheap credit and a surge in retail construction; between 2000 and 2008, new retail space averaged 160 million square feet per year in the US, nearly triple the amount of new retail space developed in 2016.

Rolling out hundreds of cookie-cutter stores emerged into a core strategy. It easily drove top-line growth, and primed retailers for attractive IPOs.

The real estate boom also allowed private equity funds to turn retail investments into real estate plays. Retailers could be acquired and stripped of their assets, requiring them to lease back their real estate at substantially higher rent due to soaring market rates.

The perpetual roll-out of malls and shopping centres resulted in a significant oversupply of commercial real estate. Today, the US has 24 square feet of real estate per capita, roughly six times the retail space per capita in Europe. To make matters worse, online shopping took off at the same time commercial real estate growth boomed. Retailers are now left with expensive, over-expanded estates and under-invested digital technology.

Retail will not simply vanish in the US. The fact that online only pure-plays such as Amazon and Everlane are opening physical stores indicates that offline retail isn’t dead.

However, extracting value from the retail sector will require a different approach going forward:

  1. Distressed retail assets cannot be saved with financial engineering alone. The objective should be to buy an asset as cheaply as possible, and identify the right areas for investment
  2. Growth strategies should not focus on expanding the size of an estate. In fact, generating a return will likely require closing some physical stores.

Potential retail owners need to:

  1. Identify propositions that still have strong resonance with the consumer, and evolve the proposition in line with customer requirements. Sycamore Partners purchased the intellectual property rights to Coldwater Creek after it filed for bankruptcy. It focused on winning back its once-passionate customer by getting merchandising right, closing more than 400 stores and re-launching its infamous creative, storytelling catalogue. The relaunch grew online sales by more than 400%
  2. Develop strategies to drive efficiency and invest in strong digital offerings that seamlessly complement a stimulating offline offering.

US retail isn’t dead, but the way PE invests in it has indeed changed.

Kristin Graham