Thursday, September 7, 2017

Is Amazon Really Killing Brick & Mortar? Maybe Not

Which is a greater threat to brick and mortar - Amazon or private equity?

The financial news media likes simple answers to complex questions. So when yet another brick and mortar company faces bankruptcy they drag out Amazon as the whipping boy.  No one can compete with the colossus that is Amazon, or so the financial press claims.  But there is more to the story than merely people buying things online.

In recent years, a number of companies have gone private, with equity firms buying out companies and leveraging them with debt in order to buy them.  As a result, there are fewer stocks to buy these days which some prognosticators claim is one reason stock prices are going up.

The latest brick-and-mortar chain to face the bankruptcy court is the toy store Toys R Us.  The media argues that companies like Amazon have undercut Toys R Us prices.  Moreover Walmart has far lower prices than Toys R Us as well as a bigger footprint and thus is driving this traditional brick-and-mortar store out of business.

But if you scratch the surface you find out that that narrative is completely wrong.  A recent Reuters article waits until the last paragraph to mention that, oh by the way, the private-equity firms of Bain Capital (Mitt Romney's company), Kohlberg Kravis and Roberts (KKR), and the Vornado Realty Trust all took the company private and loaded up with 5 billion dollars in debt.

The problem for Toys R Us is not Amazon or even Walmart but the fact that the company is sagging under its debt load.  Since it has to service this debt, their overhead is much higher which means their prices have to be higher which means they can't compete with Amazon, Walmart, and other stores. People quickly figure out where prices are higher and stop shopping there and go to places where prices are lower.

Now granted, single-purpose stores may be on the way out. We recently visited Walmart here in Syracuse and they've already geared up for the holiday season and the toy department is overflowing with all the latest toys at very reasonable prices.  And Walmart is famous for cutting prices, which makes it even harder for Toys R Us.

I think Amazon is less of a threat, as toys or something that you really have to put your hand on and also Christmas shoppers tend to buy at the last minute.  Walmart will do just fine this Christmas season I am sure.  But then again Walmart hasn't been loaded up with staggering amounts of debt by private equity firms, either.

This entire concept of taking companies private by leveraging them with debt almost seems like it should be illegal.  In a way, it is sort of like how we bought our office building after the real estate bubble burst. We walked in and told him to hand us the keys and we'd sign a bunch of promissory notes, take on a bunch of debt, and we'd own it.

These private Equity deals work sort of the same way.  People show up one day and say "nice company, I think I'll buy it - but I'll use your money."

The problem with this approach is that if a company is worth say five billion dollars, you have to add five billion dollars worth of debt in order to purchase it using this nothing down approach to private equity. You've basically zeroed-out the value of the company.  You have to hope you can find some amazing cost savings in order to increase profitability dramatically in order to service these radical debt loads.

And what we are seeing is that private-equity is falling down on the job.  There is not a lot of headroom in traditional retail or restaurants or other brick-and-mortar companies, where you can take out huge profits to pay off these staggering debts.

And yet as each company trots off the bankruptcy court, the financial media trots out the same old tired story that Amazon is destroying brick-and-mortar and that Walmart is taking over the world.  This is not to say they aren't factors, but they are not the entire deal, but in fact the debt load really is the main thing.