As we digest news of Colorado Group’s collapse, let’s go back to 2006.
It was a gentler time. The economy was booming, the banks were lending like there was no tomorrow and consumers were spending like their credit cards had no limits.
In the business world, big deals were the order of the day. And no one was doing bigger deals than the new takeover kinds — the private equity players.
Their model was simple. Buy up well established companies using large amounts of debt, get in and slash costs and then offload the thing within three to five years. What could be easier?
Back then, the price private equity paid for a business was always justifiable. And so it was when Hong Kong’s Affinity Equity Partners made a play for Colorado Group.
Usually, private equity deals were done in back rooms, away from the prying eyes of the public markets. But after failing to get a deal after three months of negotiations, Affinity launched a hostile takeover, the first ever from a private equity firm.
It would eventually pay $430 million for this business and end up with an estimated $440 million in debt.
The timing really couldn’t have been worse. Within two years, the world was plunged into the GFC and while the Australian economy came through in good shape, Australian consumers were shaken to the core.
After propping up retailers in 2009 by spending Kevin Rudd’s cash handouts, households began pulling back, shopping only when they absolutely had to — and then only when they could secure big discounts.
Many of the private equity firms that borrowed large amounts to buy retail chains were probably hoping they could have sold out now, but find that they are still stuck with these investments.
Bras N Things, Witchery, Mimco, Godfreys and Collins Foods are just some of the businesses being shopped around by private equity at present.
There have already been reports that the private equity firms will receive far less than they hope for and today’s collapse of Colorado — which comes so quickly after the collapse of the private equity-owned book seller RedGroup Retail — is unlikely to inspire anyone other than bargain hunters.
Investors will also be keeping the performance of Myer since it was floated by private equity firm TPG in 2009 in the back of their minds — the company has never traded above its $4.10 issue price and is trading today at $3.16.
The questions remains: do episodes such as Colorado and RedGroup suggest private equity firms are bad at running retailers, or were they victims of circumstances?
I’d suggest that the private equity players are suffering from a horrible post-GFC hangover, brought on by over-exuberance (they simply paid too much for many of these assets at the height of a bull market), a lack of foresight (how these brilliant types didn’t see the retail sector transforming is hard to understand) and an over-reliance on debt.
The problem is, this hangover can’t be solved with some take-away food and a good night’s sleep.
The rapid rate at which retail is being transformed — particularly by the new mindset of consumers and the internet — means the pain will continue for some time for many of these private equity investors.
*This article originally appeared at Smart Company
Witchery is not loaded up with debt and neither is its private equity owner Gresham. This purchase was made with real equity, not debt. There is no lender to force a firesale. The business will be sold or floated and the market will determine the value, but no-one lost their money here.
Godfreys, really? The vacuum cleaner sellers? Have you been in there lately? They are shockers! It’s like walking into a combination of a real estate agency, a second hand car sales yard and a very, very bad kebab shop. They sell crap. And just try to get a refund… Save yourself the trouble and buy a Dyson. Everything they say about them is true. So, to anyone with any private equity aspirations… don’t buy (or buy from) Godfreys.
Let’s not forget the infamous proponent of private equity, the former CEO of Qantas, Geoff Dixon. He (and the Chairman) were eagerly urging shareholders to flog off the once great national carrier to a US-based private equity group.
It’s anybody’s guess what would have happened to the airline by now if the deal hadn’t been stymied on a technicality at one minute to midnight.
Retailing is tough these days. The ACCC is W E A K and their management is weaker.
The Federal Government scares consumers with all these new ill conceived taxes and levies.
The near monopoly with shopping centre owners.
The poor infrastructure.
Australia Post (thanks to Gillard / Swan / ACCC) jacking up parcel post 16.66% in 20 months. Way ahead of CPI or inflation. The Secret Gillard Tax on business and consumers. Crickey you need to cover this issue.
Please see Dambisa Moyo, “How the West was Lost”, 2011. Criticizing the failures of various forms of equity capital to evaluate and price the risks they were taking is looking in the wrong direction. It was the credit markets that lent money to them that mis-priced risk.
Capital runs on greed and fear. Greed is driven by equity capital, which bears limited downside liability and unlimited upside, so its natural inclination is to grasp as much credit as it can and take as much risk as it can for the highest return.
Fear is driven by credit markets, or it should be. Credit stands to lose more than it stands to gain, so it watches equity like a hawk and penalizes profligacy by raising rates, lowering credit ratings, or cutting off access to credit capital.
What has happened over decades is that US and other western governments have taken over the role of credit markets, telling equity do this and don’t do that, and either explicitly or implicitly underwriting credit risk. Credit providers have responded to this by discounting risk and going to sleep on the job, safe in the belief that government is watching over their money.
But governments are not there to price credit risk. Governments are there to win votes from people who want houses, people who want to retire on the value of their houses, and rentseeker lobbyists who influence donations and voting blocs.
Now they are responding to the crisis and the bailouts by imposing more stringent rules on what equity can and can’t do with credit capital. All this will do is make the credit markets more complacent about pricing credit risk appropriately.