ShopKo Stores, founded in 1961, was one of the first mass retailers to offer pharmacy and eye care centers. Today the Greenbay, Wisconsinbased retailer, which operates 135 outlets in the western and midwestern U.S., is recognized for an altogether different innovation: the sale leaseback, which enables companies to tap their real estate assets for capital that can be used to reduce debt or fund expansion.
In December 2005 private equity firm Sun Capital Partners took ShopKo private in a $1.3 billion deal. Six months later the new owners sold 178 properties managed by ShopKo and its Pamida brand stores -- which operate in rural midwestern markets -- to Spirit Finance Corp., a Scottsdale, Arizonabased real estate investment trust that leased them back to the retailer. The sale yielded $815.3 million for ShopKo, unlocking capital from its balance sheet to cut its debt.
The deal was also a boon for Spirit Finance, which specializes in such transactions. It acquired the properties at a competitive price and signed long-term, triple-net leases, which obligate ShopKo and Pamida to pay all operating expenses associated with the properties, including taxes, insurance and maintenance.
Sale-leaseback deals have become an increasingly prominent financing tool in retail buyouts. Last year sale leasebacks in the retail sector totaled $2.2 billion, nearly double the amount in 2005, according to Real Capital Analytics, a New Yorkbased real estate research firm. In addition to ShopKo, leading companies that were taken private in transactions with a sale-leaseback component include specialty retailer Michaels Stores, purchased in October for more than $6 billion including assumed debt by private equity firms Bain Capital and Blackstone Group; and supermarket Albertsons, which was bought in June for $15.9 billion by grocer Supervalu, drugstore chain CVS Corp. and an investor group that included private equity firm Cerberus Management and Kimco Realty, a REIT.
The economics are compelling. Thomas Lewis, CEO of Realty Income Corp., an Escondido, California, REIT specializing in retail real estate, says buyout firms can earn 8.5 to 9 percent by selling newly acquired retailers’ properties and reap 13 to 15 percent returns by reinvesting the capital in the core business.
Off-loading the real estate is also an easy way to lower the acquired retailer’s cost of capital. “Leases are not considered debt and have lower contractual payments than any other debt equivalent,” says Christopher Volk, president and CEO of Spirit Finance.
Using sale leasebacks to finance buyouts originated with activist hedge fund manager Edward Lampert, chairman of ESL Investments in Greenwich, Connecticut. In 2002, Lampert took control of Kmart Corp. by snapping up the once-bankrupt retailer’s bonds. The following year he sold 78 Kmart stores to Sears, Roebuck & Co. and Home Depot for nearly $1 billion; he later used Kmart’s soaring stock as currency to buy Sears. The model evolved in 2005, when Bain Capital and Kohlberg Kravis Roberts & Co. teamed up with Vornado Realty Trust, a REIT, to acquire struggling toy store chain Toys “R” Us for $6.6 billion. Vornado later agreed to acquire up to 44 previously closed stores from its partners; by then more than half had been leased or subleased.
In today’s frothy market properties can change hands often. On November 1, Realty Income completed its $348 billion purchase of 144 restaurant properties owned by New York investment firm Fortress Investment Group, which had acquired them in a sale-leaseback deal with Buffets, a casual-dining chain based in Eagan, Minnesota. The sale leaseback helped finance Buffets $876 million acquisition of Greer, South Carolinabased Ryan’s Restaurant Group, a transaction orchestrated by Caxton-Iseman Capital, a New York private equity firm that took Buffets private in 2000.
Expect the deal making to continue. “What you are seeing is just the tip of the iceberg,” says Spirit Finance’s Volk.
