By the time Sears Holdings filed for bankruptcy in 2018, it had surely reached some sort of financial engineering singularity, if such a thing is possible. 

Under Eddie Lampert's majority ownership and executive stewardship as CEO, a headache-inducing web of interrelated financial relationships had been created around and through the retailer. When all the asset sales, spinoffs and loans were finalized over the course of more than a decade, Lampert and his hedge fund were Sears' largest shareholder and lender, as well as a major landlord and supplier. 

Through the 2000s and into the next decade, Sears also spent billions of dollars buying its own stock, which profited shareholders like Lampert. Some have pointed to Sears' massive buybacks as contributors to the company's ultimate downfall. 

As the one-time retail giant went into terminal decline, Lampert earned the scorn of many industry observers. But Sears is only an extreme case of the financialization of retail. Had Lampert taken a somewhat more moderate approach, Sears would have found itself in good company. 

Over the past decade, dozens of retail companies have been acquired by private equity firms, which finance those buyouts, and dividends for themselves and their investors, with debt left on the retailer's books. Publicly traded companies over the same period have spent many billions of dollars buying their own stock, a practice that benefits investors by reducing the total number of shares on the market and boosting earnings per share. That, too, is often financed with debt.

"Shareholders love repurchases. They love dividends," said Dennis Cantalupo, CEO of Pulse Ratings, a credit analysis firm focusing on the retail industry. "But from my perspective, it'd be very difficult to argue that any retailer in my world wouldn't be better served if, rather than pay dividends or buy back shares, they reinvested that money back into the business."

An exodus of dollars

Many of these practices would look different were retail living in an age of plenty, of stability. But it's not and hasn't been for some time. Technology is changing. Consumers are changing. Competition is changing. 

Whether you call it "evolution" or "apocalypse," much of the industry has been struggling for years to grow sales, stabilize their customer base and stay out of bankruptcy court. And the number of those that have lost that fight and filed for bankruptcy has surged since 2016. 

And this was all before a pandemic ruptured the industry, accelerating changes and deepening the financial troubles for many as stores were forced to close and consumers avoided physical shopping.

It's telling that many if not most publicly traded retailers halted their dividends and share buyback programs as they shut down their stores. 

To let precious cash out the door during a major crisis and revenue collapse, with stores shut, would be unwise at best. But what about those same activities during a slow-burning crisis like the one apparel, department stores and much of mall-based retail have experienced over the past half-decade? 

Macy's, which has continually stalled in its efforts to reinvent itself, paid investors nearly half a billion dollars per year in dividends every year between 2015 and 2019. 

Nordstrom, which has been among the hardest hit financially by the COVID-19 crisis, paid out even more to shareholders through a combination of dividends and share buybacks in that period — $4.8 billion all told.  

Over the past half decade, Tailored Brands, Stage Stores, Stein Mart and Pier 1, which all filed for Chapter 11 this year, made a regular practice of paying out millions of dollars a year in buybacks and/or dividends, even in years when sales were falling. 

When Tailored Brands filed for bankruptcy in August, a restructuring officer for the men's apparel retailer bemoaned "the continuing decline in the brick-and-mortar retail industry" and the COVID-19 pandemic — both familiar refrains in retail bankruptcy filings this year. 

Last year alone, this same company — whose sales fell 5.6% over the past two years — paid shareholders $28.1 million in dividends and bought $10 million of its own stock. In 2018, Tailored Brands paid another nearly $37 million in dividends. 

Others that have fallen into distress just this year, or at least find themselves on more unsteady financial footing than in past years, have paid out far more. 

It should be said that there are plenty of retailers that have been in distress for some time that paid nothing in dividends or buybacks. One simple reason for that is that in many cases, retailers' loan contracts won't let them issue dividends or buy their own stock — for all of the obvious financial and repayment risks involved when a company already has liquidity issues.

A brief history of buybacks

The practice of buybacks wasn't always legal at the level they are allowed at today. In 1982, the SEC changed its rules so that companies would not be charged with market manipulation as long as their repurchases of shares were no more than 25% of the company stock's overall daily trading volume in the preceding four weeks. 

William Lazonick, president of the Academic-Industry Research Network and a professor emeritus of economics at the University of Massachusetts, who has devoted much of his research to the topic of buybacks, has written that the rule change "in effect gave corporations license to use open-market repurchases to manipulate the market." 

Lazonick has attacked the common wisdom that executives use buybacks to signal confidence in the company at times of low share prices. Companies "never sell the shares at higher prices so that the corporation can cash in on these investments," Lazonick wrote in 2014, based on his and his colleagues' research. "To do so would be to signal to the market that the company's stock price had peaked, which no CFO would want to do."

Data from the Federal Reserve shows that equity issues by non-financial companies have been net negative, often by very large margins, for most years since the SEC changed its rules. Moreover, Lazonick also cites data that repurchases have increased at times of a rising stock market. Repurchases, by reducing the shares on the market and boosting earnings per share, can bump up a company's share price — frequently making profit for executives in charge of the companies who are paid largely in stock.

In an interview, Lazonick told Retail Dive, "These distributions to shareholders, particularly buybacks on top of dividends, are at the expense of keeping people employed, rewarding them for the work they've done, and investing in new products and processes." 

Of particular concern are buybacks financed by borrowing. In January, Lazonick and other researchers argued in the Harvard Business Review that debt-financed buybacks were a threat to the U.S. economy by leaving more leverage on corporate balance sheets that, rather than going to revenue-increasing investments, went to shareholders.

"The vulnerability was exposed by COVID-19," Lazonick told Retail Dive. "The problem is that the whole business system was structured on just making as much profit as you can and getting your stock price up." 

Lazonick draws a distinction between share buybacks and dividends. Dividends, he said, "are paid to people who have to hold the shares, so they care about what happens. They care about whether the company is reinvesting." Buybacks, on the other hand, favor the sellers of stock. 

Others argue that, in terms of cash leaving a company and going to shareholders, dividends are essentially equivalent to buybacks. 

To the extent buybacks can make a company vulnerable to a crisis, the financial health of the company, obviously, matters a lot. "The company that is able to generate the same amount of top-line [revenue] and the same amount of profitability with a smaller share count is more efficient," said RapidRatings Chairman and CEO James Gellert. "A company with significant overabundance of cash performing a share buyback in general is totally fine."

However, Gellert added, "The problem comes when a company is borrowing to do a share buyback, and therefore they're increasing their leverage."

Intentionality and consistency also matter. "It's really important to us that they're very clear with us what their policy is, so that we can have a reading that reflects that, and no one is caught off guard," said Sarah Wyeth, sector lead for S&P Global's retail and restaurant coverage. 

For those retailers on the edge, or edging toward the edge, a crisis like that brought by COVID-19 puts the practice in a different light. "The companies that are engaged in share buybacks, and then hit troubled times, undoubtedly, look back and go, 'Well, our shareholders were happy, but we sure wish we had that cash,'" Wyeth said. 

'In the face of operational deterioration'

Retail is by no means alone in its thirst for stock repurchases, but it is an industry that has faced more distress and disruption than others in recent years. And the pressure on companies to invest in technology, stores and staff has been immense. 

To take one case, GameStop in 2016 issued nearly half a billion dollars in new bonds, around two years after issuing $250 million. In both cases, the retailer said it would use the cash for "general corporate purposes," including paying for dividends and stock buybacks. Over the five years between 2015 and 2019, GameStop spent $662.7 million on dividends and $456.1 million on share buybacks, according to Retail Dive research. That's more than $1 billion that left the company in the form of shareholder returns. 

Which is great for shareholders. But over that time, GameStop's comparable sales have been negative three out of five years. In 2019, comps were down more than 19%, while during the same year it paid out $40.5 million in dividends and bought back nearly $200 million in shares. 

The sales declines are in large part due to the hardware cycle, but they also go back to competitive issues and the digitization and online sales of GameStop's core product. The retailer still does not fully have an answer for that existential issue, which has been gaining in importance for years.

The pandemic brought more financial stress to GameStop with the pandemic hammering sales. The retailer is probably still far away from a potential bankruptcy, but it's worth considering what its situation would look like today if it had been using the funds spirited out of the business to reinvent itself for the next era of gaming. 

"In the face of pretty significant operational deterioration, they're still somewhat active in share repurchases and dividends," Cantalupo said of GameStop, noting that the retailer had to exchange some debt to relieve pressure with maturities looming. "There are some short-term credit concerns. And again, it'd be hard to argue that they wouldn't be better served having that cash in the bank right now or, over the last five years, invested more heavily into the business."

Private equity: Taking cash, leaving debt

The practices of publicly traded companies haven't gotten as much attention throughout the period of retail consolidation as those of private equity-owned companies.

The destruction in retail brought by leveraged-buyout debt has been well documented. But its impact on retail is deep. Any story of the past decade that didn't mention private equity's forays into retail would be incomplete. 

There's a straightforward reason for this: Through much of the retail apocalypse, the majority of major retail bankruptcies were private-equity owned or had been in the past. 

Since 2018, Retail Dive has been collecting data on private equity's record in the industry. This has essentially been an effort to take as full a census as possible of private equity acquisitions in the industry to track the outcomes of those purchases, including bankruptcy. 

At last count, of 104 retailers that have been through a private equity acquisition at some point since 2002, 34 — about one-third of the total — have filed for Chapter 11 at least once.

And that doesn't include the many other retailers that have defaulted in other ways, such as through out-of-court debt-for-equity swaps, or are in distress today with uncertain prospects. 

Private equity has a reputation for slashing and burning and stripping. In several retail bankruptcy cases, ownership firms have been accused of fraud in their dealings. But in the era of retail consolidation, the larger theme is debt. 

The retail business — especially rattled as it is by technological, demographic, and consumer behavioral changes — just can't sustain the debt piled on by leveraged buyouts in many cases. 

The vast majority of retail companies that have undergone leveraged buyouts (LBOs in finance parlance) carry speculative-grade ratings by S&P, according to Wyeth. LBO debt "always is going to make a company vulnerable to any kind of stress in the market," Wyeth added. 

Just this year, two iconic retail names, J. Crew and Neiman Marcus, filed for bankruptcy amid the disruption wrought by COVID-19. Both were private equity owned; Neiman Marcus had been through multiple buyouts. Both wrestled with their debt for years, taking half measures to buy time and kick the can down the road, before a reckoning came that they couldn't manage without court protection. 

Neiman and J. Crew's private equity acquisitions "really left them with a debt burden that did not allow them to weather this pandemic, in addition to what they've been fighting, or the headwinds they've been facing, for years now in brick-and-mortar, traditional retail," Wyeth said. 

Along with acquisitions, private equity firms have also used debt to finance dividends. Those get paid out to the private equity owners and those financial firms' investors, with leverage meanwhile staying with the retail company. 

In recent memory, Staples stands out as one of the more infamous examples. In 2019, Sycamore Partners paid itself a dividend from Staples using $1 billion-plus in debt that stayed on Staples' books. The move, according to Bloomberg, "left even seasoned leveraged-buyout experts agog." 

"That's the nature of LBOs," Wyeth said. "That's their raison d'etre, is a dividend or a dividend recap. That's their purpose, to just maximize those returns. And lenders are willing to do it, because they're looking for some return too."

For its part, the private equity industry appears to have learned the hard lessons about the retail business. Private equity acquisitions in the retail industry surged in the mid-2000s before the Great Recession, and then again starting in 2011. However, Mergermarket data shared with Retail Dive shows buyouts in retail have remained below their most recent peak in 2016.

Because they're private by nature, it's hard to know how much money private equity sponsors lose on investments that go bankrupt. It's entirely possible some still make money even if the company ultimately goes bankrupt. Private equity's investment strategy in either case provides a buffer against steep losses, raising questions about incentives.

"The private equity sponsor leveraged buyout comes in with relatively small capital investment, finances the rest of the acquisition of the company with debt, pays themselves management fees, tries to expand the business at the same time while cutting some of the overhead and in the back of the company, and then maybe even pay themselves dividends," Cantalupo said. "And then if the expansion doesn't work out, they're paid out. There's no skin in the game anymore."