On Sunday, September 29, one-time apparel retail disruptor Forever 21 filed for chapter 11 bankruptcy and will now seek to beat the odds by restructuring its liabilities, right-sizing operations and emerging as a going-concern post-restructuring. The company, founded by South Korean immigrants Do Won and Jin Sook Chang in Los Angeles in 1984, fueled its growth by pushing a relentless stream of low-cost but novel merchandise into its stores, effectively turning speed into a competitive advantage while exposing the operational weaknesses of many of its competitors. In the aftermath of the Great Recession, the combination of a business model in synch with the times (high novelty, low-cost) and eager landlords seeking expansion-minded tenants led to explosive growth.
Though Forever 21 does not report financial results, industry sources in recent years suggested that growth had slowed, revenue targets were missed, and the company was experiencing cash flow challenges. The bankruptcy filing stands as confirmation that the combination of increased fixed costs due to expansion, shifting consumer tastes, and the migration of an ever-larger share of apparel spending to ecommerce successfully halted the momentum of what had until recently been a winning model.
Too Big to Fail
No one likes to see a good customer fail, but the specter of Forever 21 failing could be particularly chilling to Simon Property Group, which counts Forever 21 as its sixth-largest tenant, occupying 1.5 million square feet of retail space spread over 99 locations.
With 800 total locations, a major question for Forever 21’s landlords will be what the post-restructuring footprint of the company will look like. History suggests the pullback could be severe: a report by AlixPartners indicates that of 44 store-based retailers that emerged from bankruptcy in recent years, 24 reduced their store count by 25% or more.
Landlords are not without options, however. When Aeropostale exited bankruptcy, it did so with the support of a consortium that included landlords Simon Property Group and General Growth Properties. Leadership at Simon Property Group has signaled that the Aeropostale investment may not be a one-off, and could represent a model that the company would utilize again.
With 800 total locations, a major question for Forever 21’s landlords will be what the post-restructuring footprint of the company will look like.
The Advantages of Bankruptcy
The U.S. bankruptcy code is designed to give companies the opportunity to reorganize. Company management and advisors take advantage of the automatic stay to gain some breathing room in order to execute their plans. Reluctant lenders can take comfort in the additional protections afforded to Debtor-in-Possession (DIP) loans; for troubled companies it is often easier to borrow money in bankruptcy. These advantages provide only temporary respite from market forces, however. Retail companies seeking to reorganize since 2005 (when the U.S. bankruptcy code was last amended) have an uninspiring track record. The challenge now is for Forever 21 and its advisors to navigate a path to a true going-concern reorganization, avoiding the ignominious fate of liquidation that has befallen many troubled retailers in recent years.
An Industry in Turmoil
Traditional bricks-and-mortar retail is a high fixed cost business, and the explosive growth of ecommerce has had a devastating effect on many retailers, forcing the restructuring of many one-time industry darlings, and more than a few liquidations. Perhaps more frightening, with some experts estimating that U.S. retailers are “over stored” by as much as 30%, the current spate of retail restructuring is not yet at an end.
Forever 21 is now in a moment of crisis, but with the right mindset, a crisis can lend an invaluable level of clarity. The company successfully grew from a single store in 1984 to 800 today, leveraging “fast and cheap” into an industry-shaking competitive advantage. A reasonable guess would be that the next phase of the company’s story will involve a lower store count, and perhaps a non-traditional ownership structure. The creativity and out-of-the-box thinking of the company’s leadership, combined with subject matter expertise on the intricacies of a successful restructuring in bankruptcy on the part of its advisory team, may enable the company to reset and set the stage for further triumphs in the years ahead.
About the Author:
David Johnson (@TurnaroundDavid) is Founder and Managing Partner of Abraxas Group, a boutique advisory firm focused on providing transformational leadership to middle market companies in transition. Over the course of his career, David has served as financial advisor and interim executive to dozens of middle market companies. David can be contacted at: firstname.lastname@example.org.