Hey Mrs. B. What Were You Waiting For The Hard Lesson of the Bradlees Saga
Wistfully watching Bradlees's going-out-of-business commercials on television, one can't help but wonder if the sad final chapter of its five-year odyssey through retailing hell could have been avoided. Undoubtedly, Bradlees never could have made it on its own after emerging in early 1999 from its first venture in bankruptcy. Regional discounters who lack the requisite scale to compete with national chains are slowly on their way to extinction. But surely, Bradlees could have obtained better value for its stakeholders had it chosen to pursue and embrace any legitimate opportunity to sell the company's coveted assets earlier in the turnaround process while it still had some negotiating leverage. Rumors of potential suitors interested in Bradlees persisted throughout 1998 and 1999. Theoretical lease values were validated by real transactions: Retailers were paying top dollar for large store leases in high-traffic suburban locations in the space-constrained Northeast corridor. That no transaction for Bradlees was consummated prior to its latest bankruptcy filing remains a puzzling non-event, propelled largely by the misguided notion held by its senior executives that they could create greater going-concern value as a stand-alone chain than what a third-party buyer would be willing to pay. Bradlees learned the hard way that going-concern value is genuine value only when a real buyer takes out his checkbook.
In retrospect, there is ample evidence to suggest that Bradlees badly overestimated its long-term operating prospects while it underestimated its liquidation value—i.e., the value of its operating leases and inventory. In fairness, much of this evidence did not manifest until after Bradlees's reorganization plan was approved in late 1998. However, by the time Bradless emerged from bankruptcy in early February 1999, circumstances had changed considerably for the worse, and its senior executives had to know that the clock was ticking on Bradlees's existence as an independent entity.
How Did It Come to This?
Bradlees discount department stores have been a retailing fixture in the Northeast for more than 40 years, but its December decision to liquidate following a futile two-year effort to re-establish itself as a force in discount retailing came as little surprise to those who follow retailing in the region. Spun-off by Stop & Shop in 1992, Bradlees struggled for the better part of the early '90s to stay competitive in a region replete with discount retailers. Among its direct competitors were the national discount chains Wal-Mart and K-Mart, and regional rivals Ames and Caldor. Beginning in the mid-'90s, Target stores, a Midwest chain of discount stores, expanded into the Northeast as well. Bradlees's department store competitors included J.C. Penney and Sears, and more recently, Kohl's.
Trouble Brewing. The ongoing encroachment by national discount stores, namely Wal-Mart, into the New England area during the early '90s posed a serious threat to Bradlees. In discussing the root causes of its operating downturn in the three years preceding its June 1995 chapter 11 filing, Bradlees stated the following in its October 1998 Disclosure Statement: "During this period, Bradlees developed profound and fundamental problems. Indeed, before Bradlees filed their chapter 11 petitions, Bradlees's businesses had lost focus. Rather than appealing primarily to middle-market consumers—as Bradlees had successfully done during the 1980's—Bradlees drifted further and further into the realm of the low-end discount retailers (such as K-Mart and Wal-Mart) without the attendant benefit of a low-cost operating infrastructure common to such retailers."
As it struggled with issues of identity and value to consumers, Bradlees saw its operating results deteriorate rapidly between 1992 and 1994. Its EBITDA (earnings before interest, taxes, depreciation and amortization) margin fell almost 30 percent—down to 4.7 percent in 1994 from 6.5 percent in 1992—while EBITDA fell to $90 million from $120 million. The company eked out a net income of $5.3 million in 1994 on sales of $1.9 billion. This was the last year Bradlees would ever generate net income.
Drastic Measures. At this pivotal juncture, Bradlees' senior leadership decided that drastic measures were in order. In early 1995, under the stewardship of newly appointed CEO and Chairman Mark Cohen, Bradlees embarked on an ill-fated new merchandising strategy by which it sought to reposition the company between department stores and traditional discount retailers. This strategy embodied higher-price points, the elimination of certain basic convenience and commodity items typically sold in discount stores, a costly promotion of the Bradlees credit card and the elimination of its layaway program. Mr. Cohen believed that competing head-on with the redoubtable national discount chains was not a winnable battle, and aimed to make Bradlees a bit more upscale. The gambit failed miserably. It confused and alienated Bradlees's core customers, and resulted in massive operating losses that hastened its first chapter 11 filing in June 1995, as well as Mr. Cohen's dismissal in December 1996.
New Leadership. Peter Thorner replaced Mr. Cohen and wasted little time undoing the strategic initiatives implemented by his predecessor. The new initiatives of early 1997 once again defined Bradlees as a discount retailer, placing it squarely back in the crosshairs of Wal-Mart, K-mart and Target. Furthermore, 30 stores out of 134 were shuttered between 1996 and 1999, and $100 million in annual operating expenses were wrung out of a bloated infrastructure. An emphasis on soft-line goods—a highly successful Bradlees strategy during the '80s—was expected to distinguish the company from the national discount chains. The company's operating results stabilized in 1997, Mr. Thorner's first year at the helm. EBITDA was a modest $26 million, or almost 2 percent of Bradlees's $1.4 billion in sales. Gradual improvements continued through 1998. Notwithstanding this progress, Bradlees's operating performance would remain well below levels it achieved early in the decade, as indicated in the charts at right.
Bradlees emerged from bankruptcy on Feb. 2, 1999, after three and a half years as a debtor-in-possession. About $165 million of distributable value (including $85 million of new equity) went to creditors with $550 million of pre-petition liabilities subject to compromise. Trailing EBITDA was $32 million at the date of emergence.
The Final Chapter—Chapter 22. Bradlees's demise as a going-concern became a virtual fait accompli on Jan. 23, 1999, when debtor-in-possession Caldor, its close regional rival with several overlapping locations, announced it was not able to reorganize and would liquidate its 145 stores. For many analysts, Bradlees's long-term prognosis as a stand-alone entity became terminal that very day. Caldor auctioned off a majority of its store leases to competing retailers by mid-1999, including Kohl's (33), K-Mart (13), Wal-Mart (12) and Ames (9). Ironically, the liquidation of Caldor presented Bradlees with a one-time boom in 1999, as the former Caldor stores were closed for six to eight months while undergoing renovation and conversion. Bradlees' sales shot up 12 percent to $1.5 billion, driven by low double-digit growth in comparable store sales. EBITDA jumped to $46 million in 1999 from $32 million the previous year. Of course, it was understood that these strong results could not be replicated thereafter. By mid-2000, the former Caldor stores were reopened under their new banners, the economy began to cool off, and Bradlees's operating performance went into a death spiral. Bradlees's post-emergence life lasted all of 23 months.
Could Bradlees Have Done Better for Its Stakeholders?
Corporate Finance 101. A basic tenet of capital budgeting theory tells us that a property should always be utilized in its best suitable purpose. Say, for example, that Retailer X has some vacant retail space and is confronted with the following choice: It can open a new store in this location that generates $8 per square foot of EBITDAR (the "R" is rent) annually, or it can lease the space to Retailer Y and collect gross rent of $10 per square foot annually. Even if opening a new store were a positive NPV (net present value) transaction for Retailer X, capital budgeting theory would still insist that X lease the space to Y because that is clearly a more profitable use of the property. Of course, real life imposes additional considerations. Retail executives fancy themselves as merchants, not landlords. Great brand names are built on large store bases, not rent checks from tenants. Executive bonuses are linked to operating performance. Nonetheless, suffice it to say that if an asset of yours, be it a machine or a fee interest or a lease, is worth more to somebody else than it is to you, then you'd better have a darn good reason for holding on to it.
Bradlees's executives just never grasped this concept. They insisted on operating a modestly profitable chain of stores with a murky future despite mounting indications in early 1999 that its store leases were valuable, highly coveted assets. Two comparable transactions were especially revealing in this respect.
Comparable Transactions. In November 1998, Ames Department Stores announced it had reached an agreement to acquire Hills Stores, a struggling chain of 155 discount department stores located primarily in the Great Lakes and Ohio Valley regions, for $330 million (excluding the value of working-capital assets acquired and liabilities assumed). Hills reported successively worse operating results between 1994 and 1997. In the year ended Jan. 31, 1997, its most recent fiscal year preceding the Ames transaction, Hills reported sales of $1.77 billion and EBITDA of $80.3 million. Hills's operating results deteriorated further still in 1998, with EBITDA running close to zero through October 1998. Ames had no intention of operating these stores under the Hills banner. After the transaction closed in March 1999, Ames proceeded to liquidate existing inventory and re-fixture, re-merchandise and re-banner the stores under the Ames name, a process that took more than half a year. Hills clearly had no going-concern value, yet that did not dissuade Ames from agreeing to pay approximately $300 million above and beyond the fair value of all Hills's tangible assets, or about $2 million per store, for the right to step into Hills's leases.
Shortly thereafter, the liquidation of Caldor's store leases in early 1999 produced some truly eye-popping lease valuations. Kohl's paid $142 million for 33 Caldor leases, an average of $4.3 million per store. Overall, 72 Caldor leases sold to other retailers fetched $323 million, or $4.5 million per store.
Given the similitude of Bradlees' store sizes and configurations, rent obligations, and store location settings, it would not have been unreasonable to assume that the approximate value of Bradlees's leases at that time was somewhere within the range of these transactions. It would never materialize. Rather than capitulate to the inevitable and secure some reasonable value for its assets, Bradlees chose to plug along until the bitter end. Perhaps Bradlees's executives deluded themselves about the company's prospects following the fortuitous event that led to strong operating results in 1999. Perhaps the wrong management incentives were in place—rewarding operating performance rather than encouraging a transaction.
Conclusion: Too Little, Too Late—Too Bad
Two weeks after Bradlees filed for bankruptcy and said it would liquidate, Stop & Shop made a stalking-horse bid of at least $150 million (possibly more, depending on terms of subsequent sublease transactions) for the lease designation rights on all Bradlees retail properties. The eleventh-hour bid for the leases, at an average value of $1.35 million per store, was accepted and received court approval. Subsequently, Kohl's, Home Depot and Wal-Mart came forward with a collective bid for 35 of Bradlees' store leases, rumored to be around $115 million. These are respectable bids given Bradlees's moribund condition; indeed, some were surprised at the size and scope of the initial Stop & Shop bid. What Bradlees might have received for these assets in an arm's-length transaction negotiated under less desperate circumstances will never be known. Certainly, it is reasonable to conclude that Bradlees's liquidation value was always far closer to its ephemeral going-concern value than the company had ever calculated. Bradlees's failure to monetize its assets far sooner and for greater value was a costly misjudgment of its abilities and operating environment and, ultimately, a disservice to its stakeholders.
Thursday, March 1, 2001