A US economic snapshot in the middle of 2018 — not all is well

Let’s take a quick look at the US economy and where it may be headed in the near term.

While unemployment is said to be very low, the rate is still artificially low due to the uncounted Americans no longer in the workforce because of chronic joblessness.

Producer and consumer pricing are rising — not because of tariffs as the left will cite — due to the excessive capital washing out of the stock and bond market. The stock price run up over the last three years was engineered by the Federal Reserve’s quantitative easing capital finding safe haven in stocks and bonds.

Now that capital is exiting the security markets and finding better treatment with private equity firms that are buying out manufacturing and consumer brand companies, which drives up prices in order for the new owner — the PE firm — to make money from the investment through putting the brands deeper into debt to make special payments to them.

So this capital is not from the average American, but the repercussions are being felt by these average Americans through higher prices. Look at the biggest PE firms raising record amounts for new funds.

Taking a quick look at the US bond market to see where the real problems are. The difference in return rates between lending Uncle Sam money over 2 years versus 30 years.

The 2-year return is 2.61%, the 30-year interest rate is 2.96%. The delta between these two 0.35 percentage points return over 28 years. This is what is called a flat yield curve, since the interest curve is very shallow.

In the environment of the bond market capital is not treated well at all with artificially low returns, so this is pushing additional big money out of the public capital markets and into the private funding markets.

What is the down side of this move? Look at the number of bankruptcies in the retailing sector over the last year. These stores: Toys R US and a dozen or so women’s apparel stores are all closed or limping along because these companies were so leveraged up on debt that they could not pay off their huge debt levels imposed on them by their private equity owners.

But don’t worry about these PE firms because they took their money upfront and more than likely owed some of the companies bonds, which were paid off in the bankruptcy.


Forget Amazon, private equity is decimating US retail

Many reports put the demise of large US retailers lay blame at Amazon, because it makes for a nice, simple narrative.

Takes very little reporting and you can get enough quotes from analysts to back up the premise. However, there’s another villan, which takes a bit more reporting and can be backed up by the old adage of “follow the money.”

Private equity firms, which are the money men for the 1 percenters as well as large pensions and insurance companies, have been feasting on retailer debt for the last three years.

In simple terms a PE firm will do a Levered Buy Out of a firm or what is called “taking it private.” When it does this to a publicly trade company it buys out the shareholders at a premium to the stock price.

The firm puts little of its own money into the buyout, since it will load the company with debt to finance the stock purchase and in turn own the debt, which it will get paid for servicing.

An extreme example of this in retail is Eddie Lampert’s ESL PE firm. Lampert owned K-Mart and then bought Sears in 2005 for roughly $5B. Today Sears is worth maybe $1B but Lampert has made a nice profit from selling off or licensing most of Sears brands as well as the fees he gets from Sears and K-Mart.

Most PE firms hold positions for 5 years or less. If there is anything salvageable after that they may spin the company back to the public markets in an IPO or if there is little left sell it to a bottom feeding PE firm, which will “strip the copper out of the firm” and put it in bankruptcy.

Most of the time all these firms are making big money despite what the balance sheet looks like.

The retailer bonds backed by private-equity are yielding four times as much as their peers without PE money, which provides a better return for the funds.
Now the problem is when retailers can’t service this growing debt levels since revenues are not keeping up with bond payments.
Through the retailers defaulting on the debt, these PE firms sit in the catbird seat. They can put the company in bankruptcy and take control of the company or they can force a sale.
Bankruptcy allows these PE firms to cash out and get paid first after liquidation with the selloff of stores and products.

What does a retailer look like that has been infiltrated by private equity firms?

A brand will show up in your neighborhood, that you have never heard of prior. It will take out plenty of advertising to get its name out. The product looks good and the pricing is pretty good as well. The company may offer decent financing terms unless you are late with a payment.
But once you buy the product you will be disappointed with the quality, since the principal reason this company became a PE candidate was because it found a cheaper way to do what traditional retailers are selling at a lower price point.
An excellent example of the above in the New York metro area would be Bob’s Furniture stores.

Below is a list of PE firms that have profited handsomely from the retail debt binge bankruptcy cycle in the past year or so.

  • Apollo Global Management: Claire’s
  • Sycamore Partners: Aeropostale
  • Sterling Investment Partners: Fairway
  • Leonard Green & Partners: Sports Authority
  • Standard General: American Apparel

Other big names in the industry are: Ares Management, Starboard and Jana Partners