Private equity’s long hangover

As we digest news of Colorado Group’s collapse, let’s go back in time to 2006.

It was a gentler time. The economy was booming, the banks were lending like there was no tomorrow and consumers were spending like their credit cards had no limits.

In the business world, big deals were the order of the day. And no one was doing bigger deals than the new takeover kings – the private equity players.

Their model was simple. Buy up well established companies using large amounts of debt, get in and slash costs and then offload the thing within three to five years. What could be easier?

Back then, the price private equity paid for a business was always justifiable. And so it was when Hong Kong’s Affinity Equity Partners made a play for Colorado Group.

Usually, private equity deals were done in backrooms, away from the prying eyes of the public markets.

But after failing to get a deal after three months of negotiations, Affinity launched a hostile takeover, the first ever from a private equity firm.

It would eventually pay $430 million for this business and end up with an estimated $440 million in debt.

The timing really couldn’t have been worse. Within two years, the world was plunged into the GFC and while the Australian economy came through in good shape, Australian consumers were shaken to the core.

After propping up retailers in 2009 by spending Kevin Rudd’s cash handouts, households began pulling back, shopping only when they absolutely had to – and then only when they could secure big discounts.

Many of the private equity firms that borrowed large amounts to buy retail chains were probably hoping they could have sold out now, but find that they are still stuck with these investments.

Bras N Things, Witchery, Mimco, Godfreys and Collins Foods are just some of the businesses being shopped around by private equity at present.

There have already been reports that the private equity firms will receive far less than they hope for and today’s collapse of Colorado – which comes so quickly after the collapse of the private equity-owned book seller RedGroup Retail – is unlikely to inspire anyone other than bargain hunters.

Investors will also be keeping the performance of Myer since it was floated by private equity firm TPG in 2009 in the back of their minds – the company has never traded above its $4.10 issue price and is trading today at $3.16.

The question remains: Do episodes like Colorado and RedGroup suggest private equity firms are bad at running retailers, or were they victims of circumstances?

I’d suggest that the private equity players are suffering from a horrible post-GFC hangover, brought on by over-exuberance (they simply paid too much for many of these assets at the height of a bull market), a lack of foresight (how these brilliant types didn’t see the retail sector transforming is hard to understand) and an over-reliance on debt.

The problem is, this hangover can’t be solved with some take-away food and a good night’s sleep.

The rapid rate at which retail is being transformed – particularly by the new mindset of consumers and the internet – means the pain will continue for some time for many of these private equity investors.