Shrink Contributed to 99 Cents’ Demise, And So Did An LBO

Vicki M. Young
·7 min read
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Shrink and inflation are among multiple reasons 99 Cents Only Stores had to call it quits.

Increases in operating costs, such as rising minimum wage in some states, also contributed to the extreme value retailer’s demise. But the biggest impact that triggered the entire chain of events was a leverage buyout that occurred in 2012, an event that stacked the deck against the retailer’s fate.

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Private equity firms had been circling around the retailer. The company in March 2011 received a $1.3 billion offer in a management-led buyout from Leonard Green & Partners and the Schiffer-Gold family, which founded the retail operation. Family member Eric Schiffer was CEO at the time. But in October of that same year, the Schiffer-Gold family switched buyout partner and agreed to be acquired for $1.6 billion, this time moving its allegiance to private equity firm Ares Management and the Canada Pension Plan Investment Board (CPP).

The deal closed in January 2012, but the leveraged buyout also left a huge debt load on the company’s books. That was evident in a declaratory statement filed by Christopher J. Wells in a Delaware bankruptcy court. Wells, chief restructuring officer for 99 Cents’ parent Number Holdings Inc., made the filing on Sunday as part of Number’s Chapter 11 bankruptcy case.

Wells said the company in December 2017 completed a deleveraging exchange offer of its high-yield notes to extend their maturity. Ares and CPP agreed to exchange the notes for new preferred equity in the firm that carried a dividend payable in-kind (PIK). That gave the retailer short-term breathing room because it didn’t have to pay a cash dividend, but it added to the ballooning debt load because it pushed off the payment to a later date. The retailer also completed an out-of-court restructuring in July 2019, which included an additional exchange of certain loans for common and preferred shares. The court document noted that PIK dividends carried a rate ranging from 2.5 percent to 12.5 percent.

PIKs on a balance sheet can haunt a retailer, leaving it in a position where it’s always hoping that sales turn for the better so improved cash flow can be used to pay down some of the debt.

The luxury retailer Neiman Marcus had a debt structure that included the risky PIK when it was acquired for $5.1 billion in October 2005 by private equity firms TPG and Warburg Pincus. In 2013, the two sold Neiman for $6 billion to Ares Management and CPP, the same firms who invested in 99 Cents a year earlier. The PIK toggle notes due October 2021 were still on Neiman’s balance sheet in 2018, adding $658.4 million to its debt load. And while it gave the luxury retailer the ability to defer interest payments, it could only do so if it agreed to pay a higher interest rate on the debt in the future. Following the pandemic, Neiman ended up in bankruptcy court in a pre-packaged filing that had the agreement of the bulk of its creditors. The retailer filed in May 2020 and exited bankruptcy proceedings four months later.

In the case of 99 Cents, the 2012 LBO highly leveraged the retailer’s capital structure. Operating losses of $30.8 million in 2022 and nearly $60 million in the first three quarters of 2023 compounded the retailer’s financial distress.

Wells said the company tried new strategies to increase customer satisfaction and drive sales growth. But post-COVID inflationary pressures also meant higher operating costs for merchandise, distribution and employee wages.

“At the same time, the company experienced ever-increasing inventory shrinkage, due primarily to elevated levels of theft and crime in the areas in which it operates,” Wells said. “The company had no choice but to pass on to its customers some of the resulting costs, in the form of higher prices, which was met by significant customer resistance and reduced customer traffic.” The significant increases in inventory shrinkage occurred in 2022, and to an even greater extent in 2023, Wells noted.

He said the percentage of items priced at 99 cents or less fell from 65 percent in 2020 to below 50 percent in 2023. A “transformation plan” also failed to create the cash flow needed to sustain operations, and the retailer last September hired Jefferies as its investment banker to address the company’s “highly leveraged balance sheet.” Options under review included new financing, strategic combinations, and selling a portion of its assets, among other ideas. Wells said Jefferies reached out to 32 prospective buyers, including 20 potential strategic acquirers. While none of those talks resulted in a deal before Number Holdings’ Chapter 11 filing, Anaheim, Calif.-based Pic ‘N’ Save Bargains is reportedly putting together a team of investors to buy and save the 143 99 Cents doors that operate in Southern California.

How bad did it get? Creditsafe data indicated that the number of late payments jumped from 20.1 percent in December 2023 to 42.4 percent in January 2024 and rose again to 46.5 percent one month later, according to Ragini Bhalla, the credit data monitoring firm’s head of brand and spokesperson.

Wells said in his court document that by March 2024, the retailer’s liquidity continued to rapidly deteriorate and an “increasing number of the company’s vendors had tightened trade terms and shifted to cash-on-demand.” Once vendors shift to demanding cash payments, that’s usually the end of the line for retailers. Wells also said several landlords also sent “pay or quit” default notices.

The retailer said on April 4 that it would close all 371 locations and wind-down operations. Parent firm Number Holdings filed its Chapter 11 petition three days later.

Jefferies retail analyst Corey Tarlowe wrote in a research note that Dollar Tree could be a beneficiary of the 99 Cents store closures due to some overlap of customers and store banner proximities. Other dollar channel competitors that could benefit include Dollar General and Family Dollar, owned by Dollar Tree. He noted that the 99 Cents’ customer profile is most comparable to Family Dollar, as both have their largest bucket of customers making $40,000 or less in annual household income. Jefferies Research operates independently from the Jefferies investment banking arm.

As for the shrink problem, 99 Cents hasn’t been the only retailer dealing with the issue. Its competitor Dollar General said in its earnings call last month that shrink was a big headache in the fourth quarter. CEO Todd Vasos said elevated shrink weighed down the retailer’s profitability. That necessitated a change to convert most self-checkout registers to assisted-operated options, as well as limit transactions to five items or less in stores that retain self-checkout. Vasos said Dollar General will “completely remove self-checkout from more than 300 of our highest shrink stores,” as well as change the merchandise mix by “removing certain high-shrink items from high-shrink stores.”

Shrink, the retail industry’s term for shoplifting, has been a hot-button issue for retailers, and it’s impacting more than just those banners operating in the dollar space. Last September at Goldman Sachs’ retail conference in Manhattan, Tractor Supply Co. CEO Hal Lawton said shrink is worse than anything the former Macy’s president has seen in nearly 30 years in retail.

Last year, executives at Ross Stores said in its first-quarter earnings report that shrink was a bit higher than in 2022. But in 2022, retailers such as Target said it was a tough year keeping crime at bay. And that criminal element has expanded to more than just individual shoplifters. The mass discounter in its third-quarter report in November 2022 blamed “criminal networks” for much of the $400 million gross-margin impact from shrink for the first three quarters of 2022.

Fast forward to 2024 and retail crime hasn’t gotten any better. With retail theft and organized retail crime escalating across many of the nation’s largest cities, tech firms are working on solutions that can share data with law enforcement to identify and help prosecute repeat offenders. Earlier this month, some New York lawmakers at a press conference seemed keen on taking a tougher stance on organized criminal enterprises. And on Wednesday, Florida governor Ron DeSantis signed new laws that takes aim at both retail criminals and porch pirates.