A few years ago, two large U.S. grocery store chains merged. Parts of the combined chain were acquired by a much smaller regional grocery chain, which was declared the “winner” in the sale of locations that the combined company needed to divest to comply with a Federal Trade Commission order and allow the merger to be consummated.
The terms set by regulators required that all the divested stores be sold to one buyer, which restricted the universe of potential acquirers and most likely suppressed the value of the assets to be sold. This was the first complication in what would become a retail workout. It is critical for a lending syndicate in such a scenario to take early actions to ensure that it is well-positioned if a bankruptcy filing seems inevitable, and in that regard, there were lessons to be learned from the situation involving the grocery chains.
For the small regional chain, the ability to grow its business tenfold overnight likely seemed like a great opportunity. Creative financing, utilizing an operating company/property company structure and a series of sale/leaseback transactions, allowed the operating company to obtain a standard asset-based loan to provide financing for the store transformations and working capital. The stores were to be converted from their previous owners’ banners to the regional chain’s branding on a rolling basis. This required significant capital expenditures and transition dollars, and every bit of it would be expended under a line provided by a syndicate of lenders. It was a big bet.
The larger combined company would provide support for the inventory being purchased, and another food distribution company would provide the back-office support to allow the smaller regional company to absorb the stores.
As it turned out, challenges arose along the way, and the conversion did not go as planned. Additional staffing to handle the increased back-office functions became problematic as they were being handled by the distribution company, and getting information to the syndicate of lenders under those circumstances was challenging. Delays in routing shipments to the converted stores, variances in inventory levels, accusations of misleading advertising, and pricing and system issues further contributed to the challenges.
Further, the regional chain did not make its last payment to the combined company on the final group of purchased stores, withheld capital expenditure payments owed to contractors for store conversions, and experienced negative public reaction to the converted stores. Added to that, lawsuits were filed by both sides.
It all added up to quite a mess, and the regional grocery chain eventually needed to file for bankruptcy protection. The question for an asset-based lender that finds itself in such a scenario is, can it get out? Would the liquidation of collateral produce sufficient funds to cover margined advances plus expenses? Normally a lender hopes its liquidation analysis shows there’s a chance to see a positive number in the end.
In the case of the regional grocery chain, there were unexpected expenses and required disbursements, such as payments to employees who were let go for paid time off they were owed, pension obligations, and Worker Adjustment and Retraining Notification Act (WARN Act) payments. Additional disbursements were required for U.S. Bankruptcy Code Section 503(b)(9) claims to vendors, suppliers cutting trade terms (some requiring c.o.d.), and a lower-than-expected inventory. This all translated into the lender ending up with less collateral than was anticipated and greater expenses than were expected, creating the need for it to fund into an overadvance to get through the liquidation.
Sometimes the best option is to close the doors and liquidate the inventory, and as the bankruptcy unfolded, a series of store closings began involving locations for which it was apparent that there was no feasible path to resuscitating them. This first round of store closures reduced some of the overadvance. Some of the leases picked up in bankruptcy as part of the collateral package to provide the debtor-in-possession (DIP) financing proved to have significant value.
Lenders in retail finance have often said that supermarkets usually don’t liquidate but instead are sold. In considering lease value, building new 40,000-square-foot boxes with parking lots in dense urban areas is nearly impossible. Thus, the number of potential buyers for such leases may exceed a lender’s initial expectations. Given that other grocers, hardware chains, or the odd specialty retailer may be looking to expand, there may be a robust market for these locations in some instances.
As it turned out, there was significant interest by other retailers in taking over some of the grocery store chain’s leases, which reassured the lenders that there was ancillary value in some assets outside of their traditional borrowing base. However, it became apparent that there was no buyer interest in the chain beyond a group of 30 or so core stores located in the regional chain’s home territory and that the liquidation of the remaining stores was necessary.
There are always lessons to be learned. What may appear to be a good plan in theory and on paper will not always turn out as expected. It’s better to anticipate some bumps in the road, detours from the original plan, and a flat tire or two along the way. The downside models lenders run in analyzing credits don’t always take into account so many variables all going so far sideways and at the same time, as happened with the regional grocery chain. Thus, if someone says, “Don’t worry. It’s not like the wheels are going to just fall off,” it’s a good idea to trust that they can.
Another great lesson to keep in mind is to listen to what the advisors, counsel, and liquidators are saying but to question them. A lender should never be afraid or ashamed to question the professionals involved, especially to ask, “Why?” In most cases the professionals know exactly what they are talking about, but occasionally a question may propose a different slant on a situation that they hadn’t considered.
Finally, the value of collateral isn’t always what it may have appeared to be. In many cases, a retailer files bankruptcy, liquidators bid close enough or more than the appraised value, and the lenders move on. Most importantly, operationally sound supermarkets often do have enterprise value. Once the chaff is stripped away, the core stores could prove to be valuable to a few entities looking to expand their footprint.
This isn’t always true, but in this case the regional grocery chain’s brand name lives on as part of the combined successful company’s family of banners, the lenders were paid in full, and a lot of good lessons were learned.