Needless Mark-up
I hear that Neiman Marcus is likely to declare bankruptcy soon as the latest signal that the retail business sector is the next in what promises to be an ongoing array of zombie business segments in the new normal. This morning I heard a retail analyst talking about it. He was actually quite balanced about it all. Clearly Neiman Marcus is an iconic brand that has been around for 113 years. It originated out of Dallas, Texas and makes me want to note that it parallels the rise and fall of the hydrocarbon (a.k.a. Oil, black-gold, Texas-T) industry. The two are not directly linked, but its hard not to think of the old TV show Dallas when you think of Neiman Marcus. Who shot J.R.? Well, who shot N.M.?
To begin with, remind yourself that Neiman Marcus owns another iconic retail brand, Bergdorf Goodman. Bergdorf is a decade older than Neiman Marcus and has its roots in New York. Strangely enough, the two stores had very different cultural DNA even though they are both high-end retailers. Bergdorf was a specialized ladies tailoring operation that had its roots on the famous Ladies Mile of lower Manhattan. While they positioned themselves on Fifth Avenue, it was originally on lower Fifth with an entrance that was really on 32nd Street, what most people today know in New York to be the heart of the garment district. Their success eventually drove them to their location on Fifth and 57th with the surprising strategy of owning only two stores that sit across Fifth Avenue from one another. Meanwhile, Neiman Marcus was set up in Dallas to specifically serve the nouveau riche of the oil boom. It might be fair to say that Neiman Marcus was a copycat of Bergdorf Goodman to make Dallas matrons of wealth feel that they were every bit as good as those hoity-toity New York City matrons. As so often happens in life, Neiman Marcus prospered to the point of being able to acquire Bergdorf Goodman in 1987 and prove the dominance of oil over finance.
Ever since the leverage buyout craze took root in American finance in the early 1980’s, retailers have been a target of restructuring and refinancing. In 1983 I was reassigned from having launched the Bankers Trust futures and options business (which eventually gave birth to the Derivatives Department that came to dominate finance in the following decade), to running what we called the New York City Division that handled all the big multinational companies in New York City. It was the biggest merchant banking division in the “white shoe” commercial portfolio of Bankers Trust. Running the New York City Division (albeit at the ripe age of 29 years old) was the plum of all managerial plums at Bankers Trust. Our clients were IT&T, Revlon, Singer and so many more iconic American brands. But that business was quickly becoming the dodo bird of banking next to the firebrand start-up operation with which we shared the floor (the Third Floor of the Bankers Trust Headquarters building at 280 Park Avenue between 48th and 49th Streets). That business was the MBO or LBO unit (Management and Leveraged BuyOuts).
Buyouts were, for all intents and purposes, the purest form of corporate finance the world had ever seen. It was baseline financial engineering using the simplest and most effective lever of debt applied to the existing cash flow of a currently thriving (usually peaking) business. Retail was the perfect test bed since revenues were high, margins were narrow, but reasonably steady, and it required a great deal of efficiently-priced capital to keep that revenue and margin flow coming. The best thing about LBO’s was that they were all about Darwinian fitness in a business sense. Business was forced to be more efficient and deploy the rarest of inputs, equity capital, as little as possible in favor of the far more tax-effective capital called debt. Why was this possible? Simple, petrodollars. The world’s oil boom that came to the front pages of the world in the 1970’s had accumulated so much money in the hands of people who didn’t really understand or even believe in equity. They believed in debt and the control that comes with this contractual first claim on a company. They had already tried giving all that money to the best-rated borrowers, sovereigns, since as Walter Wriston, the big-time builder of Citibank as a global powerhouse liked to say, “Countries don’t go bankrupt”. Oops, that was not technically true as the Global Debt Crisis of early 80’s proved.
So, these petrodollars needed a place to be deployed and that is when some very bright financial engineers figured out that if you bought large retailers, whose owners were ripe for picking since these juggernauts were proving to be a lot of work to manage, you could make a bundle. The big retail LBO that got done and redone in those days was Macy’s. It felt like every year, my neighbors on that Third Floor were releveraging Macy’s in the next iteration of the recycling of those wandering petrodollars. Later in the 80’s, the LBO monster came knocking at Neiman Marcus’ door. There is irony that the store borne of oil wealth was being bought out by petrodollars, but there you have it. And what’s better than one LBO? Answer: a roll-up LBO that combines several retailers like Neiman Marcus and Bergdorf Goodman. There is nothing an LBO maven likes more than iconic brands to milk and exploit until they are empty shells of their former self. Remember that most LBO sponsors make most of their money upfront and the bondholders (those owners of the petrodollars) are left to reap the consequences of raped and pillaged brands over time.
But wait, there is one more chapter in the Neiman Marcus story. Guess who owns Neiman Marcus (and by extension Bergdorf Goodman)? As big pension funds watched Wall Street make billions on private equity, the more brave of the breed said they could do this better by themselves by hiring some expensive financial engineers. Such was the case of CPPIB, the Canadian Pension Board. Now CPPIB is known for being smarter than most pension managers…maybe the smartest. They are so smart that they tend to co-invest with big groups likes Ares Management to do their own buyouts….like Neiman Marcus.
Like many old and passé industries, retailing is thought to have strong asset values imbedded and sometimes hidden in its real estate holdings. Think of the railroads when they were past their prime. Their land holdings fed the owners of those assets quite handsomely for years and years. Eddie Lampert tried to do that with Sears, but oops, not so easy. But the beauty of Neiman Marcus is that its real estate is in much stronger urban locations where property values were strong. And then, enter Coronavirus. Come on, you knew that every story has a Coronavirus ending to it in this day and age, right? So, Neiman Marcus looks to be positioned for bankruptcy and it is being touted as due to having to close operations due to the Coronavirus pandemic lockdown. That’s a very real and serious hit to a large retailer, but ESPECIALLY to a large leveraged retailer. There is none of that equity cushion left to see them through the rough patches. But I suspect that what this bankruptcy really says is that the owners (CPPIB and Ares are no slouches) have come to realize that urban real estate, no matter how well positioned it seemed to be a few months ago, has lost lots and lots and lots of its value.
Every one of my stories these days always seems to have either a Coronavirus or Trumpian angle. OK, so, I suppose you think I am now going to tell you that this Neiman Marcus bankruptcy bodes ill for all urban high-end property owners like, say, Trump and Kushner. And you would be right. We all knew that sooner or later the world would recognize a Needless Mark-up.