How Private Equity Buried Payless (The New York Times)

Neil Irwin in The New York Times’s Upshot (January 2020) on how seven years of private-equity and hedge-fund ownership left Payless ShoeSource unable to survive, and what that says about financialized capital allocation.

Why it was kept

Kyle saved 18 passages: no single cause of failure, the question of whether financial efficiency produces a dynamic economy, Dunkin’ as the counterexample, research on PE buyouts, how dividends paid out of debt left Payless fragile, and what healthy competitive markets look like.

As Kyle captured it

• How Private Equity Buried Payless Private Equity Payless #Retail
  • The financiers who had taken over Payless ShoeSource didn’t have much experience selling low-priced footwear, but they had big ideas about how things ought to be done.
    • Connect to Steve Jobs “find smart people and they tell us what to do.”
    • Warren Buffet quote about the same
  • **As in any corporate failure, there is no one cause. **Over seven years, Payless went through a wringer of private equity and hedge fund stewardship that left it with inadequate technology, run-down stores and no financial cushion to survive an era of upheaval in retail.
  • What if the masters of financial efficiency are making choices that don’t actually create the more dynamic, productive economy they promise?
  • The difference between economies that thrive and those that falter boils down to two related factors: how effectively capital is deployed, and how well corporations are governed. Capital Allocation
  • But there is no single answer to the question of what form of capital allocation and corporate governance works best. The United States has typically relied on stock and bond markets to determine which companies get money to invest, and on independent boards of directors to govern companies. Western Europe relies more heavily on banks. Japan and South Korea have relied on **conglomerates in which families of companies help finance and govern one another. **Holding Companies
  • Many malls and shopping centers were entering a death spiral, with falling foot traffic, store closings and underinvestment. People were increasingly buying shoes online, along with most everything else. Payless had underinvested in its information technology infrastructure. #Malls
  • Mr. Jones had seen up close both the strengths and weaknesses of this form of financialized corporate control. “They’re incredibly valuable on the financial metrics of understanding how to get costs out of the business, how to be more streamlined, how to think about the organizational structure differently, how to find nickels and dimes throughout the organization,” and at getting maximum value out of real estate, Mr. Jones said. “But they do not, do not, know how to operate a retail company,” he said.
  • Dunkin’ Donuts is an example of a company that emerged from private equity ownership stronger than it went in.
  • The Carlyle Group, for example, took over Dunkin’ Donuts in 2006 and spun it off to public markets in 2011 financially stronger and with 2,800 more stores worldwide. The hotel group Hilton Worldwide nearly doubled the number of rooms it managed from 2007 to 2018, while under control of the Blackstone Group.
  • Steven J. Davis, an economist at the University of Chicago Booth School of Business, and five co-authors analyzed thousands of private equity buyouts between 1980 and 2013. Among other things, they found that in the two years after a firm was bought out, labor productivity — the revenue generated per employee — rose by 7.5 percent more than at otherwise comparable firms that were not acquired.
  • The American economy has become markedly less dynamic. Fewer businesses are being started, and the newcomers are having less success unseating incumbents.
  • Workers are less likely to change jobs, which suggests labor is not moving toward the most productive forms of work. Rise Against Authority
  • For every dollar that came in the door of the company in that span, it paid out $1.09 to its owners and 26 cents to its lenders. That left the company with less of a financial cushion to ride out any future challenges.
  • But it was the financial structure of the company that made it possible for a labor disruption to push the company into that vortex. “Yes, taking out the money, in hindsight, made the business more vulnerable, susceptible, and in an environment of so much uncertainty that nobody understood,” Mr. Jones said of the dividend paid to shareholders. “In hindsight, we shouldn’t have done it.”
  • Moreover, a riskier corporate balance sheet might be fine when things are going well, but increase the risk of a catastrophic failure when things go wrong — essentially hollowing out whatever productive capacity made the company successful to begin with.
  • “What they thought was that people who live here are stupid, and that’s the way they treated us,” said Meghan Shreve, who was a manager in corporate communications. “It didn’t matter how great you were in your field or what other stuff you had done, it was, ‘You live in Kansas, so you’re an idiot.’”
  • Payless wasn’t hopeless, said Beth Goldstein, a footwear industry analyst at NPD Group: “It would have needed significant investment and right-sizing, and it wouldn’t be up to the level of what it was 10 years ago, but there would still be a business.”
  • What do the most successful markets look like? They feature lots of rivals in constant competition, always testing new strategies as they compete for workers, suppliers and customers. That’s what makes a truly dynamic economy, the kind where creative destruction of all types can occur. #Competition