Hot Topic’s plus-size affiliate Torrid is at the heart of a burgeoning lawsuit between private equity backers and a very unhappy group of creditors.
The investors put up $335 million for Sycamore Partners Management LP’s 2013 $600 million leveraged buyout of Hot Topic, but claim that the private equity firm organized an “insider scheme” to separate the Torrid business away from other parts of Hot Topic’s operation “to net hundreds of millions of dollars in financially engineered profits.”
A spokesman for Sycamore said the firm and Hot Topic believe the allegations “are without merit.”
“In May 2015, Hot Topic sold its Torrid brand to Sycamore Partners in full compliance with the requirements of Hot Topic’s bond indenture,” the spokesman said. “Hot Topic, Sycamore Partners and their affiliates intend to vigorously defend themselves in this matter.”
While the creditors’ $335 million investment is backed by a lien on substantially all of Hot Topic’s assets, the creditors said the Torrid business was seen as the only portion of the company with growth potential and had “consistently outpaced its sister chain in sales growth,” according to the complaint filed in New York state court late last week.
“With only 200 stores at the time of Sycamore’s acquisition and a focus on the women’s plus-size market — among the fastest-growing retail markets in the country — Torrid was widely regarded as Hot Topic’s growth vehicle and crown jewel. Torrid’s future prospects were anything but limited,” the creditors wrote.
“Like most private equity firms, Sycamore seeks high-growth opportunities,” the creditors added. “And when it came to Hot Topic, what caught Sycamore’s eye was undeniably Torrid and its explosive growth potential.”
Sycamore in July filed an initial public offering for Torrid, aiming to raise $100 million while still maintaining a 50 percent stake.
But in 2015, Sycamore’s cofounders Stefan Kaluzny and Peter Morrow allegedly worked with “accomplices” to form a new entity to take control of the Torrid business, which was valued at the “absurdly low sum” of $55 million, the creditors claim.
“When Hot Topic’s creditors raised questions about the terms of the transaction, Sycamore and the company refused to explain how the $55 million purchase price was determined or provide any supporting material.”
The alleged move by Sycamore bears similarities to one made late last year by J. Crew, which separated its intellectual property assets into a new holding company that its creditors had no rights to. J. Crew eventually cut a deal with its investors and moved on with an internal restructuring.
The sale of Torrid left the business split between a Hot Topic half “saddled with $335 million of debt” related to Sycamore’s leveraged buyout, and a Torrid half of “mushrooming sales and earnings projections and no appreciable debt, poised for a monetization event that would yield its beneficial owners hundreds of millions of dollars in profit.”
“Under the circumstances, it should come as no surprise that all of Hot Topic’s senior executives would eventually leave Hot Topic for the more fertile pastures of Torrid,” the creditors wrote. “That, apparently, was the plan all along. Consistent with everyone’s expectations, Torrid’s business has continued to skyrocket since its separation from Hot Topic.”
When Sycamore filed Torrid’s IPO, it said 2016 sales for the brand exceeded $640 million. Although the firm intends to maintain a majority of the company after it goes public, the creditors said even a sale of a minority stake will see Sycamore net a lofty sum.
Creditors claim the Torrid sale was made “in secret” without the requisite approvals and checks and announced only after it had been completed. The creditors said the sale “bears all the badges” of a fraudulent transfer, leaving the court free to cancel it outright. The creditors are also seeking unspecified damages.
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