Every cloud has a silver lining, and it seems that if there's a bull market lurking anywhere in this grim economy, it's in the "Going Out of
Business" business.
Bankruptcy filings by businesses were up 41.6 percent through the first half of 2008 from the same period a year earlier, according to the U.S. courts, and a punishing consumer-spending environment has meant catastrophic results for retailers in particular.
More than 20 major merchants have already filed for bankruptcy this year, including The Sharper Image, Levitz, Boscov's, Mervyns, Steve &
Barry's, Linens 'n Things, and Circuit City.
And, thanks to the frozen credit markets, many of those filers have been forced into Chapter 7 liquidation rather than mere Chapter 11
restructuring, with merchants scrambling to produce cash owed to their creditors.
That's where retail liquidators come into play.
Specialty firms such as Hilco Merchant Services, Gordon Brothers Group,
Hudson Capital, SB Capital, and Great American Group are some of the major players acting as clean-up crews, competing for the task of shutting down stores and liquidating assets on behalf of retailers (see a list of current liquidations).
Here's how it works: Once a company decides to close some or all of its stores, retail liquidators bid against each other for the job of appraising and selling off store inventory, real estate, fixtures, machinery, equipment…the works. The winning firm (or firms) then manages liquidation sales usually lasting six to 10 weeks—longer in the case of large chains.
According to Jim Schaye, C.E.O. of Hudson
Capital Group, retail liquidations come in two varieties: equity deals and fee-based deals.
In equity deals, a liquidator such as
Hudson Capital will use complex models to estimate how much money can be recovered by selling store inventory and assets, subtract what it will cost to run the stores for the duration of the liquidation sale, and offer the retailer a fixed dollar amount to take control of the stores and their inventory. Once Hudson liquidates the assets, it pockets whatever extra money remains.
In fee deals, the retail liquidator does not bid for control of the assets, but rather gets paid a fixed fee (usually with performance incentives and penalties) to sell off merchandise and assets on behalf of the store's creditors.
"We've never seen anything like this," says Schaye.
"Business has increased tenfold in the past year, and we're involved in over $3 billion of liquidation at this point."
Sandy Feldman, a vice president at Great American Group, says that today's unusually large deals have given rise to more consortiums involving multiple liquidation firms in a single deal, simply to assemble the financial resources and manpower necessary to handle liquidations as large as
Linens 'n Things and Steve & Barry's.
In the case of
Linens 'n Things, Hilco, Gordon Brothers Group, Hudson Capital, SB
Capital, Great American Group, and Tiger/Nassi Group are all cooperating to run the sales.
But while retail liquidation may seem at first blush like the perfect recession-proof business, today's economy is leaving the companies facing their own challenges.
Rick
Kaye, a Hilco spokesman, points out that the lack of consumer demand that doomed merchants to begin with has also made it harder to attract buyers to close-out sales.
The current economy has also meant a shrinking demand at companies such as Gordon Brothers and Hilco for things such as retail consulting and M&A advisory.
Great
American's Feldman also stresses that perhaps the biggest challenge created by the rapidly declining state of retail is in making liquidation returns difficult to model—being off by even a fraction of a percentage point on its bid can cost the liquidator its entire profit margin.
"We go by sales trends from previous years and previous months to determine our offer, and with things changing so rapidly, it has become more challenging to design models for how much inventory will go for," says Feldman. "At this point, it's guesswork."
From Portfolio.com: News and Markets
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