How Is Staples Owned By Sycamore Partners?
Today, we’re going to talk about how and why Sycamore Partners (a private equity firm) will go out and buy companies like Staples.
Sycamore Partners owns Areopostle, Nine West, Hot Topic and a handful of other businesses. They acquired Staples back in 2017 – but I want to take you through the different avenues that they could have taken.
So- let’s get into Sycamore Partners acquisition of Staples for $6.9 billion. Not million, but to quote our enthusiastic president… “billions and billions and billions”.
So if you haven’t seen in our other content, we talk about the fund structure and private equity funds… and Sycamore partners are no different. I’ll give you a quick recap:
They have a general partner and a limited partnership. Investors will put money into the limited partnership and the general partner will manage the limited partnership….
…. and then they can go out and make acquisitions- they actually recently were going to buy Victoria’s Secret, but they canceled that last minute.
Now- something different in these types of buyouts is they aren’t using just straight equity(cash). What I mean by that is Sycamore Partners isn’t going out and saying,
“Hey, staples is selling for $6.9 billion. Let’s go raise $6.9 billion in our fund, write a check and buy it.”
Nope- they do something instead called a leveraged buyout or ‘LBO‘. I want to talk about why and how they do it.
But first, want to know something wild about the fund model? Sycamore partners only has about 20 people that work there- and they manage all these big businesses. 20 people, people! That’s insane!
That’s why I love the fund model; so few people can control so much money and it makes for very happy and wealthy fund managers.
So let’s break it down the $6.9 billion. I don’t know the exact numbers, but we’re going to use some educated estimates on a couple ways they structured this deal.
Let’s assume for example, that they used $2 billion of equity from investors.
They went out and raised $4.9 billion from a bank in loans and, similar to a mortgage, they put in a down payment of $2 billion. So they go get a ‘mortgage’ or a loan from a bank and they get to leverage their buyout from a bank.
Total borrowed: $4.9 billion – let’s assume at 6%. It’s probably cheaper than that, but let’s be conservative with this estimate.
So 6% of a $6.9 billion LBO is $294 million. That means that they pay out $294 million every single year in interest to the bank to supply this leverage.
Now remember, this is just a single example. There are several different ways they could have stacked capital here: a whole mix of mezzanine financing, with different lien positions on different assets, which is why they are more common in large conglomerates.
Short said, there is a lot that goes into this.
So why would Sycamore partners ever want to take out a $4.9 billion loan, especially when they have to pay out so much in interest every year?
Well, what the alternative look like? They do not use this leverage of $294 million and just use cash.
Staples does ~$18 billion gross revenue every year. Let’s say they take home, net $1 billion, just for round numbers sake. If they used all cash for this deal and bought staples for $6.9 billion then they would only net $1 billion.
That would be 14.4% return. Not bad – but it could be better! They can split profits with their investors at an 80/20 split.
So minus the $294 from the $ 1 billion would give them $706 million on their $2 billion investment, and not the $6.9 billion investment- which would decrease their IRR.
But if you take that same $706 million on a $2 billion dollar investment, their returns jump up from 14.4%, all the way to a 35.3%. Not bad for the exact same deal.
Takeaway- When you do a leverage buyout, you essentially just leverage up your return. It is a bit riskier- like what if the company doesn’t do well?
What if Staples didn’t actually make a profit? What happens when they post losses (which they have been) you are still stuck with a bill of $294 million. This debt obligation has to come out of your fund to pay back the bank.
That is where the risk comes in. You see this same pattern all of the time in real estate. If you get a mortgage on a house, even when you could pay cash, you get a mortgage. And with the leverage you make more money.
However, if you get in a bind, and can’t make your payments…they’re going to come take the house or the company away from you, depending on your terms.
Now, what do these private equity funds do with these businesses when they buy them? There are hundreds of different approaches, depending on the firm.
But the goal is to force appreciation- like you would see in a house flip in real estate. They might come in and replace the entire management team, bringing the company under one roof, or expand sales, cut costs, or many other approaches.
Sycamore partners, as I mentioned, own more clothing brands. PE funds will often go after the same type of businesses in their niche.
So, why would Sycamore Partners acquire Staples, who is outside of their wheelhouse?
They come in and say,
“Hey, staples, we both know your business is going down. Let’s separate each part of your business and sell them separately. It’s going to be a win-win.
We can sell all the real estate pieces separately. Your printer division is going to be a separate sale and your inside sales team is going to be a whole separate division sold as well.”
This is a difficult approach- but if you have the right connections and partners, then it can be extremely lucrative.
Remember, they bought it for $6.9 billion. They believe individual pieces will be worth more. They think they can sell the pieces individually for maybe $7.8 billion, right? And then they make their money on that spread.
This approach is more of the corporate raider type of private equity firm. Sometimes the PE fund will take their acquisition through bankruptcy restructuring. You’ll see on the news sometimes politicians get up and say that private equity funds are the scum of the earth and they’re destroying businesses and companies.
Unfortunately, sometimes they are right. Some funds will do whatever it takes to a make money… Whether that means tearing apart a company, firing all the staff, and hiring new management team.
Private Equity Funds also save businesses. They come in a help companies- they bolster their profits, give them advice, or make pivots that enable them to save alive.
There is also the passive Private Equity approach- like Berkshire Hathaway. They will come in and they buy a company like Heights, Catchup, or Coca Cola and they just want to be a passive member.
They say something like,
‘Hey, you guys are already doing a great thing. Just keep growing. We don’t want to step in and replace or change anything- we’re going to be a passive member, but we’ve got the money that can help you grow.‘
This is a great approach! I mean look how good it worked out for Warren!
Now- alternatively there is also the active management approach. They step in and say,
“Alright, I don’t like how it’s going here. We need to change some things up- You’re all fired.”
That’s where the negative reputation comes in. It’s a cutthroat industry- but they seriously contribute a lot of good to our economy and world. I personally am a huge advocate of the fund model.
Hopefully that gives you a little overview of of how things work. If you want to learn more, I actually give a free 1-hour webinar on How to Start your own fund- if you are interested- go sign up at “Investment Fund Secrets”