What does Sun Capital Partners look for in a retail investment?
It's very much what we look for in other underperforming companies. We look for companies that are strong in their niche, that have had historical profitability that was at least as good as—or better than—their peers, and companies that we think deserve to survive and can get back to historical profitability with the proper leadership, merchandising and strategy. That's what flows through anything we do. That is our strategy. We don't have a “retail” strategy per se. We have an operational turnaround model.
How is real estate a factor in Sun's retail deals?
We don't want to own real estate. We use real estate to finance companies and to get the appropriate capital structure in order to create the amount of leverage that allows us to realize good returns. In the ShopKo Stores transaction, we did what we've been told is the largest sale-leaseback in history. We brought in excess proceeds over the loan that we took out to finance the real estate; this reduced the company's debt and provided our management team with greater flexibility to go through the restructuring and capital investments we need to execute. It's a financing vehicle, not an end in itself. We don't look to real estate to create returns. We look to real estate to enhance our returns by unlocking the value in the real estate and enhancing our investment returns over the long run.
Essentially, our investment strategy is to develop an operating strategy that will maximize cash flow from the execution of the portfolio company's core competency, not its fixed assets. To that end, we attempt to unencumber our investments of fixed assets wherever possible, so that investment capital is placed in productive, revenue-generating activities whether that core competency is retailing or manufacturing.
What do you look for in a real estate partner?
I think it differs based on the opportunity. If we just need to understand the value of the real estate, because the stores are all profitable and we'd need to know what sort of financing we can get, we'd go to a financing partner, either a debt provider or a saleleaseback partner like Spirit Finance in the ShopKo situation
If the real estate is more valuable “dead than alive”—meaning if marked to market the store would never support the market rent post sale-leaseback—then you need someone more like a Lubert-Adler. They can work with you on repositioning the real estate, on redeveloping the real estate and in executing more complex real estate strategies, which are more in-line with redevelopment than just selling to the highest bidder. That's really valued-added and requires very different skill sets than a financing source. A financing source values the real estate at market, as is, providing a financial solution and evaluating your credit as a tenant, versus looking at real estate you're probably not even going to be operating anymore and that you'll have to reposition and possibly redevelop.
In the Mervyn's case, Lubert-Adler was a great partner because a lot of that real estate needed to be redeveloped and/or sold. And they understand how to reposition real estate. In the ShopKo transaction, there was much less of that, because ShopKo was actually doing well. It was an underperformer in that sales were declining, but the EBITDA was quite stable. There are very few stores we need to close because the company is quite healthy.
Is the deal evaluation process different for a specialty retailer like Wickes Furniture than for a discounter like Mervyn's?
I don't know that they are that different. My understanding is that the Wickes stores were pretty tired and poorly merchandised. We had to reinvigorate the franchise. So what did we need to do? We needed to re-merchandise and make the stores more attractive. We needed to have the right merchandise at the right price. Sourcing product was also important: Getting the right merchandise at the right price and quality, so you're at the right price point for your consumer base. It really comes down to knowing your customer.
Under its former ownership Mervyn's was sort of a lost child: the Mervyn's customer was different from the Target customer and the merchandise in the Mervyn's stores was not working. It's all about knowing your customer and merchandising appropriately. Management is important, so occasionally you need to replace management. I don't think the evaluation process is that much different company to company but the core customer may be different: retail is all about execution, detail, understanding your customer and marketing appropriate products to him or her. The success formula doesn't really change from company to company, even though the markets and products are different.
Is there more competition in the retail space from other buyout groups?
I don't think so, at least in terms of the nature and size of our investments. There are a lot of buyout firms that won't do retail at all, usually because they've had bad experiences. For companies that are distressed or underperforming, we don't see a significant increase in competition. It's still a select few that look at companies that are troubled and require a turnaround. Our key competition is the strategic buyer. On the financial side, I don't see a huge increase in competition for the kinds of deals we do.
Do you think there will continue to be opportunities in the retail space?
Since we are willing to buy retail companies and a lot of other buyout firms aren't, we will get a call on almost anything, including things that aren't appropriate for us. But yes, I think we'll continue to be active.