Private Equity Pillage: Grocery Stores and Workers At Risk
Since 2015 seven major grocery chains, employing more than 125,000 workers, have filed for bankruptcy. The media has blamed “disruptors”—low-cost competitors like Walmart and high-end markets like Whole Foods, now owned by Amazon. But the real disruptors in this industry are the private equity owners who were behind all seven bankruptcies. They have extracted millions from grocery stores in the last five years—funds that could have been used to upgrade stores, enhance products and services, and invest in employee training and higher wages. As with the bankruptcies of common household names like Toys “R” Us, private equity owners throw companies they own into unsustainable debt in order to capture high returns for themselves and their investors. If the company they have starved of resources goes broke, they’ve already made their bundle. This is all perfectly legal. It should not be.
The bankrupted private equity–owned grocery chains include East Coast chains A&P/Pathmark, Fairway, and Tops; West Coast chains Fresh & Easy and Haggen; the Southeastern Grocers chains (BI-LO, Bruno’s, Winn-Dixie, Fresco y Más, and Harveys); and in the Midwest, Marsh Supermarkets. We could find no comparable publicly traded grocery chains that went bankrupt during this period.
The future of regional supermarket chains is a major concern for consumers, vendors, local communities, workers, and their unions. Grocery workers are by far the most unionized of all retail workers. The United Food and Commercial Workers International Union (UFCW) has 1.3 million members in the United States and Canada, with 60 percent working in supermarkets and another 15 percent employed in meatpacking and food processing. Most UFCW members (two-thirds) are employed by the top five supermarket chains, with Kroger and P.E.-owned Albertsons-Safeway clocking in at first and second respectively in market share and accounting for the lion’s share of unionized supermarket workers.
P.E. firms, famously, have no commitment to the long-term sustainability of the companies they buy; their time horizon is three to five years until, ideally, they exit these investments. The heart of the private equity business model is the “leveraged buyout” (LBO). This is a deal in which a P.E. fund uses capital supplied by pension funds, endowments, wealthy individuals, and other investors as a down payment, and buys out a company using high levels of debt that it loads on the company—typically in the range of 70 percent of the purchase price. Post-buyout, P.E. firms often add on more debt in order to pay themselves a dividend, or they sell off assets or real estate, reducing financial stability. Strangled by debt and newly obligated to pay rent, these grocery chains have neither the ability to cut prices to compete with low-cost chains nor the resources to invest and compete with upscale markets. And in an industry like grocery, where profit margins are thin, a small drop in revenue may undermine a P.E.-owned supermarket’s ability to keep up with interest payments on the debt.
Debt Sucks the Life Out of P.E.-Owned Companies
The bankruptcy of Southeastern Grocers, owned by private equity firm Lone Star Funds, provides a classic example of how private equity drives companies into bankruptcy while extracting millions of dollars for themselves and their investors. Southeastern is the owner of well-known brands BI-LO, Fresco y Más, Harveys, and Winn-Dixie, located in seven southeastern states. While all supermarket chains face intense competition and thin profit margins, Southeastern’s regional competitors, such as Publix Super Markets, have survived and flourished.
Lone Star first bought out Southeastern’s predecessor, BI-LO, in 2005 in a leveraged buyout, and took the company private. It ran the company into bankruptcy by 2009 and emerged from Chapter 11 in 2010. It tried to sell the chain to publicly traded Kroger and employee-owned Publix Super Markets, but they were not interested. After six years of ownership, Lone Star was overdue in paying promised outsized returns to its investors. So it executed a “dividend recapitalization”—meaning that it loaded the company with even more debt to pay dividends to itself and its investors. Between 2011 and 2013, it paid itself and its investors $839 million in dividends—money that could have been used to make stores more competitive. The struggling company became saddled with interest payments. One loan of $475 million, used to pay dividends of $458 million to Lone Star, required Southeastern’s BI-LO to pay $205 million in interest between 2014 and 2018. Lone Star’s owner, John Grayken, is a billionaire who famously renounced his U.S. citizenship to avoid paying taxes.
As if this weren’t enough debt, Lone Star sent Southeastern on a buying spree rather than invest in existing stores. In 2012, it bought out Winn-Dixie for $561 million, creating a chain of 690 stores and 63,000 employees. In 2013, it added another 165 stores (Harveys, Sweetbay, and Reid’s) in an LBO worth $265 million, as well as 22 Piggly Wiggly stores in an LBO worth $35 million. Lone Star renamed the company Southeastern Grocers.
To offset the growing debt due to dividends and LBOs, the company sold the real estate of a distribution center for $100 million and several stores for $45 million, and then required the affected entities to pay rent on the buildings they used to own—further undermining their financial stability—referred to in financial parlance as a “sale/leaseback.” In need of more cash, Lone Star secured a series of revolving credit loans and debt financings between 2014 and 2017. In the meantime, between 2011 and 2018, Lone Star took out a total of $980 million in dividends from Southeastern Grocers, according to Moody’s Investors Service.
By March 2018, Southeastern filed a “pre-packaged” Chapter 11 bankruptcy. Once used for unique situations, private equity firms now treat them as a staple in their bankruptcy proceedings, allowing the P.E. owners to fast-track the process by working out a deal with senior creditors before the bankruptcy filing. Unsecured creditors—mainly vendors, suppliers, and workers who are owed back wages, vacation pay, health insurance, and other payments—have little time to respond and are often left out in the cold. When the company exited bankruptcy in June 2018, about 2,000 workers had already lost their jobs. The deal reduced debt from about $1.1 billion to $600 million, with creditors swapping debt for equity and the company agreeing to close 94 stores, affecting thousands more workers’ jobs.
This all too familiar story is not about “disruptive” new competitors or price wars—it is about private equity extracting wealth and driving companies into bankruptcy. The same playbook drove Tops Markets into bankruptcy only a month before Southeastern Grocers. The northeastern chain of 170 grocery stores was bought out by Morgan Stanley Private Equity and Graycliff Partners in an LBO worth $310 million in 2007. Morgan Stanley pursued a number of LBO add-ons between 2007 and 2012, and then financed the buyout of the company, including all of its debt, by Tops management in December 2013. By that time, Morgan Stanley had loaded the company with $724 million in debt—more than twice the original purchase price. That included some $377 million in dividends that Morgan Stanley paid to itself and its investors—equal to 55 percent of the total debt that had accrued. This does not include advisory fees charged by Morgan Stanley nor the future interest payments that Tops had to shoulder.
As in the case of Southeastern Grocers, the debt overhang left Tops with little wiggle room to reduce prices or resources to invest in store upgrades, new products, and online services needed to be competitive, as it reported itself in its bankruptcy filing. At the time of the bankruptcy, it had 14,800 employees, with 12,000 represented by UFCW and 700 by the Teamsters. The company used the bankruptcy process to substantially reduce the pension benefits for members of both unions by withdrawing from the unions’ defined benefit pension plans and replacing them with 401(k) plans. In January 2018, the S&P Global Ratings agency downgraded Tops’s credit rating from CCC+ to CCC, eight levels below investment grade. In August, one day before it announced its plans for emerging from bankruptcy, the company closed ten stores. The bankruptcy plan will reduce Tops’s debt from $700 million to $435 million, and its interest payments from $80 million a year to about $36 million.
The future remains uncertain, however, as Tops’s financials are still fragile. Despite the reduction in debt, Tops expects its interest expenses will wipe out nearly all its operating profits for the next three years. It projects a loss of $13 million in 2019 and expects to just about break even in the following two years.
Fairway Market, a small chain of upscale specialty grocery stores mostly in Manhattan, faced a similar struggle for survival. Acquired by private equity firm Sterling Investment Partners for $150 million in an LBO in January 2007, the grocery chain found itself with $100 million in debt—a very high debt load for a small company in the cyclical grocery industry. But its private equity owners weren’t done loading Fairway with debt. Five further rounds of debt financing occurred between December 2009 and December 2012, including a leveraged recapitalization in January 2010 to pay down some of the chain’s existing debt and to finance the purchase of additional stores. Industry observers characterized the expansion as “aggressive and miscalculated.” The chain grew to 15 locations in the New York City area.
In April 2013, Sterling returned Fairway to the public markets via an initial public offering (stock sale), but retained a large portion of the stock, giving it control of about 80 percent of the voting power in the chain. Fairway’s shares sold at $13 a share, above its expected range of $10 to $12. The IPO raised $177.5 million, most of which ostensibly went to the chain; only $3.2 million went directly to its P.E. owners. However, the chain used the proceeds from the IPOto pay affiliates of Sterling Investment Partners $76.8 million in accrued dividends on their preferred stock, $9.2 million in connection with the termination of the monitoring fee agreement, and $8.1 million in bonuses to certain members of the management team. So Sterling and its investors extracted even more money from the actual grocery operation.
Things did not go well for Fairway following its IPO. Burdened by significant debt obligations and recurring interest and principal payments, Fairway was far less able than other specialty shops to respond to the increased availability of organics in mainstream supermarkets or to the entry of Whole Foods in the neighborhoods it served. By July 2015, its share price had plummeted to $3 a share from its IPO value of $13, and by December it was down to 70 cents. As with Southeastern Grocers, efforts to sell the highly indebted chain failed, and in May 2016 Fairway initiated a pre-packaged Chapter 11 bankruptcy reorganization. In the prepackaged bankruptcy, the company’s senior lenders exchanged some of the debt for equity, reducing Fairway’s debt from nearly $280 million to $140 million and its annual debt service by $8 million a year. Suppliers and vendors who were owed $21 million to $27 million would be kept whole and not suffer losses.
In sharp contrast to bankruptcies in other P.E.-owned businesses, Fairway pledged to respect collective-bargaining agreements with its 3,400 unionized workers—85 percent of its employees—who were primarily represented by UFCW. Fairway’s legacy of positive labor-management relations and investment in human resources management practices predates its acquisition by Sterling Investment Partners. It had traditionally hired a full-time workforce and provided workers with employer-sponsored health insurance and a defined benefit pension plan. Management attributed the chain’s ability to cater to its high-end clientele to the quality of its customer service. Remarkably, the P.E. owners left this in place even as the company sank into bankruptcy—but the creditors absorbed the losses.
In July 2016, a couple of months after seeking Chapter 11 protection, Fairway was bought out of bankruptcy by GSO Capital Partners (a unit of private equity giant Blackstone Group) and a consortium of Wall Street investors through yet another LBO for an undisclosed amount of money and debt. As the cycle of added debt and bankruptcy continues, worker pay could well be next.