How Private Equity Failed North America’s Oldest Retailer

Even before Canada or the United States existed, one intrepid retail company was trading in the wilderness of North America. Founded in 1670, The Hudson’s Bay Company is the oldest joint-stock company in the English-speaking world and largely responsible for pioneering both the North American fur trade and what would become, hundreds of years later, the British colony of Canada.

By the 20th century Hudson’s Bay was a staple in almost every downtown Canadian shopping district and suburban mall, earning a reputation as a provider of quality products backed by solid customer service and guarantees for Canadian families. Growing up, most of the things in my family home, from appliances, furniture and clothing to electronics and toys, had come from a Hudson’s Bay store.

For 350 years Hudson’s Bay (or The Bay as it came to be known) was not only a part of Canada’s retail economy but also a part of the country’s national fabric, both figuratively and literally by virtue of its iconic multicoloured Hudson’s Bay wool blankets.

On Mar. 7, that all came to an end when the company filed for creditor protection in a Canadian court. In its filing, Hudson’s Bay documented that it is shouldering nearly CAD$1 billion ($700 million) in debt, much of which will ultimately be swallowed by creditors, suppliers and landlords. When The Bay eventually closes its doors, roughly 9,000 employees will lose their livelihoods. As for their customers, the company announced that the more than $58 million in loyalty rewards are now worthless.

Death By Debt

I’ve spent the last several weeks participating in news interviews commenting on the reasons for the company’s demise and the various environmental forces that brought it to its knees. There have been a number of issues that have undoubtedly played into the company’s troubles — online shopping, the contraction of Canada’s middle class, the Trump administration’s tariffs on Canadian imports and waning relevance of shopping centres in the lives of shoppers.

But there is one other malignancy the company suffered from that has received far less attention, although I would argue that it played a primary role in its demise. And that is private equity ownership.

In 2008 Hudson’s Bay was acquired by NRDC, an investment firm controlled by Richard Baker, in a leveraged buyout.

Leveraged buyouts in the retail industry have a track record of bankruptcies just like the one The Bay has fallen victim to. In fact, studies, like one conducted in 2019 at California State Polytechnic University have shown that 20 percent of large companies acquired through leveraged buyouts fail within 10 years, compared to only 2 percent of companies acquired through other means. In fashion, the victims behind such statistics include J. Crew, The Limited, Neiman Marcus and Payless Shoes.

The Private Equity Scheme

The modus operandi of private equity companies is similar to that of real estate flippers. That is to buy assets using other people’s money, quickly make the asset more valuable and then flip it to a new buyer for a profit. At the time it acquired The Bay, Baker boasted publicly that his sharp dealmaking had enabled him to capture more than $5 billion worth of real estate holdings for little more than 20 percent of its market value.

But unlike a real estate flipper, private equity companies like NRDC actually make money whether they improve the asset value or not. To strain the real estate analogy a little further, private equity can even burn the entire house down and still make money, while leaving everyone else behind to put out the fire.

They do that in several ways, beginning with investors. About 80 percent of the funds used in leveraged buyouts typically come from private investors. Not only does the private equity firm use these funds to acquire the target company, but they also charge investors a management fee, normally about 2 percent of the total value of the investment.

Second, they take a portion of any gains that might be realised from that investment, in the form of a performance incentive, which is usually about 20 percent of any profits. But it gets better. Debt the private equity company uses to complete the deal immediately transfers over to the acquired company’s books, immediately saddling it with what are often debilitating interest payments. Meanwhile, on top of all that, the private equity firm also begins charging the newly acquired company a fee, as compensation for the management knowledge and skill they bring to the equation.

Once this basic flow of funds is in place, private equity firms will often set about financial engineering and asset stripping. Financial engineering often involves, among other things, offering significant incentives to company executives to ensure debt payments are covered and that company funds are not wasted.

Asset stripping may involve selling trademarks, real estate, unwanted leases or anything else deemed of value. Under Edward Lampart’s ESL Investments, Sears, for example, sold off its well-known Craftsman trademark in 2017 to Stanley Black & Decker for $900 million. The sale of such assets serves to bolster the balance sheet, making the company appear better on paper. Sears filed for bankruptcy in 2018, and operates under a dozen stores today, down from thousands at its peak.

In addition, the PE company will also often begin eliminating competing retailers by buying them up. NRDC acquired Lord & Taylor in 2006, before buying Hudson’s Bay, and taking the combined entity public in 2012. HBC acquired Saks Fifth Avenue in 2013. Lord & Taylor shut down in 2020, and Baker took HBC private the same year. He also set his sights on Saks’ biggest rival, Neiman Marcus, completing the deal last year, creating by far the largest luxury department store operator in North America. In theory, by owning all competitors in any given market the company can reduce its costs and push prices upward.

So why do these deals fail?

First, due to the inherent burden of debt placed on the company along with the enormous financial incentives given to management to restrain spending, the company will often neglect essential operational expenditures.

To put a point on that, for approximately the last 20 years Hudson’s Bay stores have failed to maintain even the most basic standards for repair, cleanliness and housekeeping in their stores. Stained carpets, broken floor tiles, haphazard merchandising and non-functional escalators are just a few of the sorts of deficiencies that greeted shoppers.

Second, this singular focus on constraining expenses naturally leads to staffing cuts that in turn dramatically impact customer service levels, which further dampens sales.

Third, all the financial engineering in the world doesn’t alleviate the need for a cogent go-to-market strategy and customer experience design, key strategic aspects often completely neglected by or outside the skillset of private equity management.

Instead, what often ensues is a revolving door of executive leadership, each promising their own revolutionary strategy. In 2008 for example, ex-Lane Crawford executive Bonnie Brooks took the helm of The Bay and worked to recast the ailing department store as an upmarket destination for designer fashion brands. Not a bad idea. The problem, however, was that the dilapidated state of its stores along with scant staffing levels belied the upmarket fashion message entirely.

Ultimately it proved to be not much more than an ad campaign masquerading as a turnaround strategy. By the time Brooks departed in 2013 there appeared from the outside to be no coherent plan beyond endless discounting and further leveraging of real estate assets.

A decade-long death spiral ensued.

One final piece of financial engineering took place in December, when a restructuring cleaved Hudson’s Bay off from Saks and Neiman Marcus, creating a standalone entity prior to its bankruptcy filing. This enabled Baker to walk away from the wreckage of Hudson’s Bay and carry on with the US business as though nothing had happened, leaving workers, landlords, suppliers and even hapless consumers to pick up the pieces.

There will be hard-nosed businesspeople who will see this as simply one losing hand of cards in the private equity casino — a casino where the PE dealer still wins most of the time. I see it somewhat differently.

If this were just the work of a private businessperson, someone who had invested their own money in a venture, mismanaged it and then lost their own fortune it would be easier to reconcile. “Easy come, easy go.” That’s just the nature of business.

But what is difficult to rationalise is that a company that used other people’s money to deplete, debase and destroy one of the world’s oldest and most historic businesses will simply walk away, more enriched than any other stakeholder.

And even worse, they remain financially incentivised to do it all over again.

Doug Stephens is the Toronto-based founder of the global consultancy Retail Prophet and the author of three books on the future of retail, including “Resurrecting Retail: The Future of Business in a Post-Pandemic World.”