2008 Was Rough, But What Exactly Will 2009 Look Like for the Industry? (Year in Review)

A lack of credit availability is expected to send many vendors and retailers scrambling to preserve cash flow to avoid landing in bankruptcy court. Although the emergence of distressed situations may present some golden opportunities for companies to swallow up competitors on the cheap, overall M&A is expected to be crippled by the freeze.

Meanwhile, consumer spending appears to face a long lull. Wracked by worries over their jobs, their stocks and their home values – as well as their own credit issues – American consumers are unlikely to return to their old spending shopping habits even after the United States climbs out of its current financial crisis.

Here, a few financial and industry experts attempt to make sense out of the financial situation.

Dick Heckman, chairman and CEO of Heckmann Corp., and former CEO at K2 Inc.: “[The credit situation] is affecting every industry. It’s clearly going from the end consumer all the way back to the manufacturer. You can’t borrow money to expand at the manufacturer level. Retailers are trying to watch their inventory because banks are tough on inventory lending and the consumer is getting it from the credit card companies. So I think that it’s a world that has run on credit and it has now hit the wall.

“You’re going to see the weak players either fail or be bought by the stronger players in the industry. You’ll see a lot of consolidation because people are going to run for help and there are a lot of companies in the sporting goods business that are overleveraged and can’t get financing. They’re going to have to find a home and it won’t be private equity. The only way you survive this is to cut your expenses, hoard your cash, and hunker down and do what every household does when somebody loses their job. You stop spending on stuff that you don’t absolutely need.”

Scott Case, managing director and partner, VMG Partners, private equity fund and owner of Timbuk2: “More companies are looking for minority financing transactions from PE rather than the typical change in control transaction. Either companies are feeling the slowdown and looking for capital to shore up their payment structure, or others are growing and finding it difficult to get debt to finance that growth. Traditional bank lines are getting less flexible. Cash is king.

“The danger in this industry is excess inventory, not lower margins. So the focus should be on inventory turns and keeping the product moving. There will be some short-term pain. But if you can get through it and keep those brands fresh and exciting, there will be benefits on the other side.”

Jay Duke, president at Karhu and a former investment banker at Morgan Stanley: “In the near term, fewer PE equity deals will get done and more strategic deals. There are great valuations now to be had by a smart strategic buyer, but there are fewer strategic buyers. So M&A activity will be skittish. Consumers are going to be more discerning. If they’re going to pay up, they’re looking for brands that mean something for their personality or lifestyle and that they gain a lot of value out of. Surviving the climate is really managing cash flow. It’s an obvious one and it’s an easy one but it’s the right one.”

Dick Baker, president of SIMA: “The single biggest difference, not only to 2001 but any previous recession we’ve been through, is the credit situation. CIT factors the majority of all the credit out there and literally you have companies that are completely cut off. Even companies that are middle-sized to new-that are really growing their business-are somewhat hindered by the credit market because of who they are doing business with-the retailer paying its bills. So it’s a circular problem that continues to find no answer.

“Are there deals being done? Absolutely. But they’re very non-controversial. Nobody’s dramatically overpaying for anything. Nobody’s really stealing something. It’s just a quiet underbelly of some M&A activity.”

Gilbert Harrison, chairman at Financo, Inc.: “There’s zero financing. People want to do things but the banks are closed for business. There will be strategic deals where the buyer has bank financing, like Foot Locker’s acquisition of CCS. A deal like that can be done where you have a buyer that has an established credit line and wants to do an add-on acquisition.

“There will be fire-sale opportunities. The problem is that companies are going directly from litigation to liquidation. You can’t get the financing and, with the changes in the bankruptcy law, it takes longer to finish some of these things up.

“The consumer has never been as frightened as they are now. They’ve seen their home values diminish. They’ve seen their 401(k)s go down. They don’t know what to think. Cash is king and you have to develop product that differentiates yourself. If you look recent sales of The Buckle, you can see that if the consumer is given the right offering, they’ll buy.”

Jim Cyr, president at The Cyr Group: “Retailers have to reduce inventory. Floor assortments need to be presented in a visually stimulating way and create a feeling of choice and abundance to generate consumer interest. They will also have to aggressively promote key items to build traffic. Vendors, manufacturing facilities, material suppliers and everybody across the supply chain are going to have to figure out a way to shorten lead times because retailers are not going to take any risk.”            

Tom Hicks, managing director, Renaissance Partners, L.C.: “Expect to see increased bankruptcies and liquidations as over-storing is corrected to fit consumer demand. Companies should maintain positive cash flow, even during down seasonal periods, and aim for self-sufficient funding. They should focus on core business components – product categories, customers, vendors, four-wall profitable stores – and on enhanced productivity and performance. Finally, focus on the customer. You want to exceed the customer’s expectations every day, in every way, and elevate the customer’s mind to think of your business first in its designated niche.”

Matt Polsky, managing director, Net Worth Solutions: “Banks are looking to decrease the amount of exposure to consumer-product-oriented companies. At the first opportunity, whether it’s at the end of a term or contractual period, banks are saying, ‘We don’t want to continue to lend to you.’ So there’s a lot of musical chairs right now because banks are listening to a different set of music in their earphones.

“A company should be acquisitive, not just simply to acquire more gross margin dollars and achieve synergies through back office consolidations, but they should be looking for ways to extend their product lines and customer relationships. They should broaden their customer base via acquisition because sometimes it’s a lot easier get on the matrix if you’re already there.

“The consumer psychology is exacerbated by the negative press that this recession is getting. People whose jobs and lifestyles aren’t at risk are being affected. People are reacting like Chicken Little.”

Tom Cove, president, SGMA: “While October and November were really bad and truly scary, there had been a cautious pervasiveness several months before that. And there is a real concern about a self-fulfilling prophecy if you’re over-worried about inventory. Nobody wants to spend for brand recognition at a time like this. But if you’re not bringing in new product and not aggressive about marketing, you’re probably not putting forth an exciting kind of feeling about this segment.

“The consumer starts feeling that this is all there is. So, while inventory management will be critical, retailers have to continue to build a relationship with consumers so you’re not falling off the map.

Matt Powell, Senior Retail Analyst, SportsOneSource Group: “There will be an astonishing number of bankruptcies after the first of the year, when retailers are flush with cash and have not yet paid their holiday bills. There will be many big and medium players involved but the real tsunami will come from the independent mom and pop retailers who simply cannot get the credit they need to run their business, even if they are profitable.

“Banks are cutting back on new card solicitation, reducing credit limits and raising interest where they can. This will have a massive chilling effect on consumer spending, which again may re-set American consumption to a new lower level. I’m afraid that consumers will show no interest beyond essentials (shoes, kids’ sports equipment) through 2009.

“My greater worry is that we will see consumption reduced permanently as the American consumer examines their over-consumption that was a part of this collapse. We likely will see American consumption more closely resemble European and Asian, buying fewer good things and making them last.”

              
Jim Duffy, managing director, equity research, Thomas Weisel Partners: “In recent years, the capital was more easily available for deals, thus the high volume of leveraged buyouts. These leveraged buyouts inflated valuations, often pricing strategic investors out of the deals. The combination of distressed debt from the recent wave of LBOs, and the challenges in the capital markets, will limit private equity activity and thus pressure valuations. Strategic investors with big war chests on platforms to deliver synergies will be the most active in the near future but there will likely be a lag in activity until valuation expectations get reset.

“Consumers are becoming more selective and price sensitive. For retail in general, we are seeing this with the shift of shopping volume towards value retailers like Wal-Mart and Costco. In sporting goods, innovative products that offer competitive advantage will continue to perform but, in categories with less innovation, retailers will need to have a price/value message to compete.”

Gary A. Kiedaisch, Executive Chairman, Igloo Products Corporation: “Having been through the process of acquiring The Igloo Products Corporation this past year, I can share that the road ahead will not be easier, but the opportunities will be abundant. Not to state the obvious but, when times are good, all companies do well.

“As we enter a challenging marketplace and credit is tight, under-managed or under-capitalized companies will do poorly and could fail. Properly capitalized companies, with management teams that have proven executive experience with a strong and industry-specific talent bench, will do very well and win out. These companies will win because they know their consumer, the retail channels and know how to provide compelling, differentiated, high-value products time after time. They will also be the beneficiaries of those who fail and, indeed, we will be back to a strong market with strong brands and companies providing exciting new products soon, if not already.”

John Pinto, managing partner, Brightleaf Partners (a hedge fund): Between 2001 and now, you’ve had a significant increase in square footage for retailers across various categories. It is not just outdoor but also footwear and clearly all the brands put up their own vertical storefronts and so the environment is clearly over-stored.

“Nobody has the capital to do any significant acquisitions. At this point, they’re cutting back on growing stores, cutting back on doing marketing, so any M&A will be either be very small tuck-in acquisitions where large companies are buying tiny little ones; or where it’s a distressed situation and somebody’s just handing over the keys.

“Most likely a number of retailers will go out of business, market share changes will occur and retailers will realize that extending their reach into certain retail trade areas was probably not a good strategy. They’ll have to go back and make sure they tighten up their demographic targeting and focus on who their true customers are and not continue to assume that they can continue to expand their customer base.”
Anthony Karubus, CEO of Karabus Management, a division of Price Waterhouse Coopers: “There is too much inventory in most cases and the inventory is sold at meaningful markdowns. So for retailers, getting adequate inventory financing is more difficult because the inventory is worth a lot less than it used to be. 
       
“A lot of retailers are deferring real estate commitments for new stores because they’re trying to slow down their capital spend,” continued Karabus. “Some have signed leases for centers to be built in a year or two, but some of those landlords aren’t going get financing for those new developments.

“For retailers, the focus should be to conserve cash, manage inventory extremely well, and budget and plan realistically and practically for the new economic reality-which could be minus-4 or minus-10 next year. Based on that, review every single overhead cost you have and take a long, critical look at your real estate portfolio to cull the underperformers. Consumers are going to look for value. They’re going to want more for less.”

Nathan Pund, president of Silver Steep Partners, an investment banking firm specializing in the outdoor industry: “The most profound effect of the credit crisis, I believe, is the impact it will have on the small retailers and small brands -what I consider the bedrock of the outdoor industry. Companies that are $15 million in sales and below are going to be severely affected by the lack of credit available.
“Many companies of that size have personal assets, such as their house, pledged as collateral and their financing is being cut off. The values of the underlying collateral have deteriorated so badly that banks are forced to rework loans and that will impact their access to capital.

“What you need to do is be proactive and understand where your competitive position is and what path is the right one for you. For some firms that have a strong business and accumulated cash, like Columbia and VF, this may be the buying opportunity of the century. For companies not in that position, it is all about survival. It is all about minimizing your spend and making sure you can make do and get your business through this crisis. It’s just about staying afloat.”