Why Businesses Go Bankrupt: Mervyn’s

Private Equity firms Cerberus Capital Management and Sun Capital Partners, along with real estate investors Lubert-Adler and Klaff Partners led a 2004 buyout of Mervyn’s discount retail chain for $1.26 billion in 2004.   Upon closing, the new owners split Mervyn’s into two companies, one owning the real estate, and the other operating the stores.   The real estate company borrowed $800 million to fund the LBO, and then dramatically raised store rents to the operating company.  In October 2008, Mervyn’s went into bankruptcy, with its remaining 149 stores liquidated, and more than 18,000 employees thrown out of work.

Lesson learned: Financial engineering often increases the risk of failure.  After the split of Mervyn’s into two companies, the retail stores were left with $674 million of assets and $664 million of liabilities and worse yet, negative working capital. According to a 11/26/08 “Business Week” article, the moves left Mervyn’s “so weak it couldn’t survive.”