By and and  on October 17, 2008

The economy has claimed its first major department store casualty — stoking fears more may come.

On Friday, the $2.5 billion Mervyns said it would liquidate, holding going-of-business sales at its remaining 149 locations and auctioning off its store leases. The 59-year-old moderate-price regional department store chain was once a dominant force in California and the Southwest.

The demise of Mervyns comes at a time when retailers across the price spectrum are feeling the chill of consumers’ reined-in spending. Steve & Barry’s, CompUSA and Sharper Image have filed for bankruptcy protection, while Linens-N-Things also is being liquidated. Meanwhile, chains from

J.C. Penney Co. Inc. to Family Dollar Stores Inc., The Home Depot Inc. to Lowe’s Co. Inc. are scaling back expansion.

Mervyns filed for bankruptcy protection in late July. The retailer’s board determined that holding the going- out-of-business sales during the holidays was the best way to maximize value for its creditors. Mervyns said it will retain an outside professional services firm to assist in the liquidation of inventory.

“We are disappointed with this outcome but the company’s declining liquidity position and the extremely challenging retail environment, together with the fact that we have exhausted all other possibilities, requires that we take this action,” John Goodman, chief executive officer, said. “…we are confident that the deep discounts available through going-out-of-business sales will drive significant traffic in our stores.”

The news raised fears over what impact the dumping of Mervyns’ inventory during holiday will have, especially since the forecast for Christmas already is bleak. The liquidation also is expected to place further pressure on already-beleaguered vendors, both because they are debtors and because yet another outlet for their goods is disappearing.

Mervyns’ top unsecured creditors include Levi’s, with an owed claim of $12.8 million. Others holding trade debt claims include: VF Corp., Greensboro, N.C., which owns Vans, JanSport, VF Outerwear and VF Jeanswear, $6.6 million in claims; Wicked Fashions Inc. in Fort Lee, N.J., $6.1 million; Nike USA Inc., Beaverton, Ore., $4.7 million; Vans Inc., Larkspur, Calif., $2.9 million; Fashion Resource, Los Angeles, $2.7 million; Hanes Brand-Hanes UW, Winston-Salem, N.C., $2.6 million; Lolly Togs Ltd., New York, $2.6 million.

“Mervyns was consistently a good customer of ours over the past 20 years,” said Richard Leeds, of Richard Leeds International, a licensed innerwear manufacturer in New York. “Sadly for the Mervyns team, it is widely speculated that Sun Capital raided their retail real estate assets after the purchase of Mervyns from Target Corp., forcing the retailer to pay a premium in new leases. These rising costs, together with the recessionary impact of a California economy hit hard by the housing credit crisis, helped undermine Mervyns’ balance sheet.

“Our company, along with many others were taken totally by surprise when a ‘cash poor’ CIT refused credit to fund Mervyns shipments,” he added. “Thus began a domino effect that quickly swept Mervyns into Chapter 11. Yes, we have been effected, both in lost receivables, and inventory designed and at the time, in work (or on the water) for Mervyns.”

A consortium that included Sun Capital Partners Inc., Cerberus Capital Management L.P. and Lubert-Adler/Klaff Partners LP acquired Mervyns from Target for $1.65 billion in September 2004. Afterward, the owners spun off the real estate portfolio into a series of separate companies and Mervyns began paying rent.

“The leases did go up, but they went up to market value, not ‘a premium’ over market rates,” a source close to Sun Capital said.

The source said that after Mervyns filed for bankruptcy, the leaseholders offered $55 million worth of rent reductions and other concessions, but the moves weren’t enough to save the ailing chain.

Mervyns’ going-out-of-business sale at holiday time will create a glut of low-priced products in the Heyward, Calif.-based retailer’s markets. “It will hurt everybody when the [going-out-of-business] sale begins,” said Walter Loeb of Walter Loeb Associates. “Just before Christmas, people are going to take markdowns very early and with Mervyns taking more aggressive markdowns, consumers will respond. It will hurt Target, Wal-Mart, J.C. Penney’s and Macy’s.”

Richard Jaffe, a retail analyst at Stifel Nicolaus, said the going-out-of-business sale will be “disruptive to the marketplace, but not as disruptive to Kohl’s [Corp.] because it doesn’t have a big presence in the marketplace. It will be more disruptive to Penney’s. Liz Claiborne is a brand [at Mervyns] and American Living [at Penney’s] is not a brand, it’s a private label. It will be disruptive for a short period of time.”

Retail experts were not surprised by the latest Mervyns development, however. “The stores were irrelevant and the customer did not care to shop in them any more,” said Loeb. “It’s not surprising that the demise of the company is taking place. Their locations weren’t good enough and their message got diluted. Because of their lack of momentum, their pricing may not have been as sharp as it should have been. When Mervyns started out, every department in the store had to come up with a sale item each week. They had a flyer every week that made it an exciting presentation.”

The fate of Mervyns’ leases in this uncertain economy remains to be seen. “If this was ordinary time, much of the real estate would have been picked up by other retailers, but in this environment it will be more difficult because retailers are careful in choosing locations and making commitments, especially since there’s no liquidity,” said Loeb. “Some of Mervyns’ real estate is excellent, but recent real estate is not that good. It’s a mixed bag.”

“Apparel retailing is a zero-sum game,” said Jaffe. “It’s a business that is growing very slowly. For any retailer to do well and grow more than 3 percent to 4 percent annually, it has to take market share from somebody else. With Mervyns leaving the marketplace in 2009, there will be significant market share opportunities. Where will Mervyns shoppers go? Mervyns is a moderate price-driven department store. Kohl’s would be well positioned to benefit, but doesn’t have that many stores in California. Mervyns real estate represents an opportunity to Kohl’s to strengthen its [store base] and pick up Mervyns’ displaced shoppers.”

There was skepticism about Forever 21 Inc., which was said to be interested in Mervyns’ locations, snapping up any leases since the teen retailer’s stores have historically been smaller than Mervyns units. Forever 21 made a bid for Mervyn stores in the past and opened a 40,000-square-foot unit in a former Saks Fifth Avenue in Pasadena, Calif., but several retail and real estate experts questioned whether the chain’s balance sheet could justify opening large stores now.

“You’ll probably see people like Target take some of Mervyns’ boxes and some sporting goods retailers,” said Leslie Mayer, executive director at Cushman & Wakefield Inc. in Century City, Calif. “You’ll see people get more creative in the use of space. A lot of landlords will actually be happy to get the real estate back. Mervyns has been in locations for a while and they’re usually pretty darn good locations. Mervyns wasn’t bringing anything to the centers. In some centers you have Mervyns, Target and Kohl’s in the same center. Kohl’s and Target have distinguished themselves as more fashion-oriented. Mervyns has never done that, it’s always relied on selling brands such as Levi’s. They lost younger consumers that didn’t want traditional labels.”

Lenders and credit analysts first became jittery about the future of Mervyns when credit sources said the factoring arm of GMAC Commercial Finance had stopped approving orders of goods to the chain. In May, the factoring division of CIT stopped its approval of orders for Mervyns. The retailer tried to calm fears in May when it pointed out that 17 new Mervyns stores had opened since its acquisition. Mervyns said the new units reflected “its commitment to maintaining a dominant real estate position in California and the Southwest.”

But that geographic region appears to be one of the main reasons behind Mervyns’ ills. Mervyns hired DJM Realty LLC in May to sell five to 10 store sites in upscale neighborhoods, estimating the transactions would generate $25 million to $50 million in cash to fund operations and new growth initiatives. The stores were in areas that were becoming more affluent than Mervyns’ target customer.

Retail analysts said there was more to Mervyns’ demise than the California economy. “Mervyns had a leveraged buyout,” said one analyst. “LBO guys take a lot of money off the table, which they did do. They weren’t as concerned with what was left.”

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