Loans to Small Businesses Hit Four-Year Low in 2010

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Loans outstanding to small businesses hit a four year low of $652 billion in 2010, down 6.2% from the $695 billion outstanding at the end of 2009, according to a Small Business Administration study published in February, 2011 titled “Small Business Lending in the United States 2009-2010.”  For purposes of the study, the SBA defines small business loans as business loans under $1 million.

Of the $43 billion decline in loans outstanding to small businesses, so called “mega-lenders” (i.e., institutions with assets exceeding $50 billion) accounted for an aggregate reduction of $18 billion, or 6.7%, as their collective small business lending dropped from $270 to $252 billion.  By way of comparison, lenders with assets in the $100 to $500 million range saw their loans outstanding to small businesses drop by only 3.7% in 2010, from $130 to $125 billion.

A variety of reasons were given for the overall drop in small business lending, ranging from tightened credit standards, weakened lending institutions, and also weaker loan demand from healthy, established institutions concerned about the strength of the economic recovery.

The SBA report states that the recession has not pitted large borrowers vs. small borrowers, and that loans outstanding to large borrowers dropped by an even larger percentage, declining by 8.9% from the end of 2009 to the end of 2010.

 

Sbarro Files for Chapter 11 Bankruptcy to Lighten Debt Load

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Sbarro Inc. filed for chapter 11 bankruptcy protection on Monday, April 4th, joining a growing number of restaurant chains that have done the same, such as Uno Holdings, Claim Jumper Restaurants and the parent company of Charlie Brown’s Steakhouse., the “Nation’s Restaurant News” reported.  If approved by the bankruptcy court, the company would be able to cut its $486.6 million in debt by $195 million.  (By way of comparison, competitor Papa John’s, which has grown to three times the size of Sbarro, and is not in financial difficulty,  is carrying only $95 million of long term debt on its balance sheet)

Since the founding Sbarro family immigrated from Naples and opened their first Salumeria in Brooklyn in 1956, Sbarro has alternated between public and private ownership, going public in 1985, and then being taken private again by the Sbarro family in 1999, perhaps due to their dissatisfaction with the company’s sluggish stock price.

The “Wall Street Journal” reporteed that “much of the pizza chain’s troubles go back to debt taken on in 2007 to back a buyout by private -equity firm MidOcean Partners” while in fact, the Italian quick-service operator had been under-capitalized and over-leveraged ever since 1999.   As reported in Sbarro’s 10-k reports, the company’s ratio of earnings to fixed charges dropped from 4.1x in 1997, two years before the 1999 buyout, to 0.7x in 2001, two years after.

After its acquisition by MidOcean Partners in 2007, the company was walloped by the recent recession, as foot traffic at malls dropped off, while flour and cheese prices climbed.   Sbarro is the only restaurant company in MidOcean Partners’ portfolio, which includes Freshpet, LA Fitness, Bushnell (fans) and Isotoner.    Sbarro had indicated in an SEC filing in late 2010 that there was substantial doubt it would be able to continue as a “going concern.”

The Sbarro company website says, “there will be no impact on our ability to deliver the great food and excellent service our customer’s have come to expect.”  Since I had never eaten at a Sbarro, I stopped in to their location at 46th and 5th Avenue, to sample a slice of their tomato and onion pizza, and can truthfully report that it looks great, with lighting that would make Julie Taymor proud, but tastes just average, with an unexceptional bread-like crust, and uninteresting sauce and cheese.

 

 

Harry & David Files for Chapter 11 Protection

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Harry & David Holdings Inc. filed for a pre-arranged  chapter 11 bankruptcy on March 28th, 2011 after having skipped a $7 million interest payment to bondholders on March 1st.  Harry & David’s sales had declined in recent years, as recession-strapped consumers and corporations cut back on discretionary gift purchases, and new competitors such as Amazon and Edible Arrangements entered the fruit basket business, competing with free/discounted shipping and innovative new fruit basket arrangements respectively.

Harry & David arguably would have been able to ride out the recession without the need for a bankruptcy if its balance sheet had not been weakened earlier in the decade.  Specifically, the acquisition of Harry & David by investment bank Wasserstein in 2004 for $254 million weighed down the company with $250 million of debt, as Wasserstein hastened to pay itself back for the capital it had used to make the acquisition, recouping 1.25x its original investment. The founding Holmes family had sold Harry & David to RJR Nabisco in 1986, a previous peak period for leveraged buyouts, and ownership of the company had changed hands additional times before Wasserstein’s acquisition in 2004.

The company’s bondholders, including Wells Fargo, will become the new owners, as they convert their debt into equity, the “Los Angeles Times” reported.     The company is continuing normal operations on the internet and its 70 remaining retail stores, under the leadership of Kay Hong, chief restructuring officer and interim CEO.  Harry & David’s previous CEO,  Steve Heyer, former CEO of Starwood Hotels, was appointed Chairman and CEO of Harry & David in March, 2010 by Wasserstein, and never moved to Oregon, choosing instead to run the Oregon-based company from his office in Atlanta, Georgia.   In February 2011, Heyer was replaced by Hong, the former CEO of turnaround firm Alvarez and Marsal, when it became clear, after a disappointing Christmas selling season for Harry & David, that some sort of financial restructuring was unavoidable for the century-old firm.

Crumbs Investor Presentation Looks Good Enough to Eat

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Crumbs Bake Shop, which was founded in 2003 by wife-and-husband team Mia and Jason Bauer, hopes to see their company stock soon listed on the NASDAQ exchange – quite an achievement coming at the tail end of the recent recession.

The 2/8/11 Crumbs investor presentation is as nicely laid out as the Crumbs store I visited earlier this week, and a must-see document for any would-be restaurant owner who is thinking about writing a business plan.  At first glance, I was amazed by the degree of disclosure of their business strategy, and key metrics.

Crumbs’ business model may wind up being  just as delicious for investors as their cupcakes are for consumers.   By baking their cupcakes off-premises, the average build-out cost of a Crumbs location is held to $300,000, while their average ticket (i.e., sales per transaction)  of $18-20 translates to average sales per location of $1.1 million, for an average 16-month cash payback on each new location.   And with an average EBITDA per store of $231,000, their cash-on-cash return on that $300,000 build-out cost is a tasty 77%.

The vehicle for taking Crumbs public is 57th Street Acquisition Corp, which already trades over-the-counter, and in January announced plans to acquire Crumbs as soon as this month, which would be the final step of a reverse merger.  The Crumbs investor document projects that at closing, 55% of Crumbs stock will be owned by the public, 40% by current Crumbs management, and 5% by 57th  Street sponsors.  The deal structure is less easy to understand than the store economics, and I noticed from the investor document that a considerable number of contingent shares are being created which would be issued once the stock price reaches certain future targets, which could serve to dilute public investors’ returns. And at $31 million of (unaudited) 2010 revenue, Crumbs is on the small size to be a publicly traded company, although it projects it will be at $85-90 million of revenue by 2012, and be at 200 units by 2014.

So with cupcakes coming in three different sizes: “taste”, “classic” and “signature”, hopefully there will be enough Crumbs to go around on a post-IPO basis to make everybody satisfied.

Borders’ Bankruptcy Result of Bad Timing and Decisions

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Borders’ February 16th, 2011 bankruptcy filing was the result of bad timing and bad decisions, as reported by the “Wall Street Journal” and others.  The recession that started in 2008 cut a swath through the ranks of bricks and mortar retailers, as consumers cut out discretionary purchases, taking out such big names as Linens ‘N Things, Circuit City, Mervyn’s,  The Sharper Image and Wickes Furniture.  And Borders was slow to diversify to on-line sales, having turned over its internet operations to Amazon in 2001, and only taking back its Borders.com website in 2008.

One truly poor bad decision that has been just a minor mention in most press coverage of its recent bankruptcy filing was Borders’ heavy stock repurchases: nearly $600 million dollars worth over for the three fiscal year period ending 2/3/2007.  For perspective, the share repurchases over these three fiscal years is nearly three times the amount it owed in aggregate to its top ten unsecured creditors at the time of its recent bankruptcy filing.

Companies typically choose to repurchase their stock to accentuate the growth of their earnings per share, anticipating that they can reduce the number of shares more than the added interest expense reduces their net income. And if that happens, the reasoning goes, then stock holders will be rewarded with a higher stock price, and in a very tax efficient way.

This sometimes works beautifully, and an example that I have used in my Introductory Finance class is Coca-Cola’s share repurchases for the ten year period from 1987 to 1997.  Over that stretch Coca-Cola’s net income increased an average of 16.3%, and due to an ongoing program of share repurchases, its earnings per share increased an average of 18.7%.  Better yet, Coca-Cola’s stock price had average annual gains of 30.2% over those ten years, as institutional and individual shareholders clamored for a decreasing supply of Coca-Cola shares.  (For more about the Coca-Cola share repurchase, go to https://www.rudofskyassociates.com/finance.html and press on the widget to hear a 4:30 voice recording)

The difference between Coca-Cola and Borders is that Coca-Cola was consistently profitable over that stretch, and it also had a well-defined and winning strategy in place, which meant no surprise alternative uses for all that cash.  The share repurchase algebra fell apart for Borders because it ran a $151 million loss in fiscal 2007, and reducing the number of shares can’t accelerate your earnings per share growth, if your earnings per share isn’t positive to begin with.

In conclusion, if all the cash that was used to repurchase shares in the middle of this past decade had instead been used to somehow strengthen or restructure the company on a more proactive basis – perhaps by either launching a more competitive eBook reader  or by closing some of their many unprofitable stores earlier – Borders’ creditors, employees and shareholders all probably would have been better served.