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  4. J. Crew struggles with its ‘great man’ dilemma

J. Crew struggles with its ‘great man’ dilemma

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Steven Davidoff Solomon writes for The New York Times, June 10, 2015

J. Crew, Michelle Obama’s sometime clothing retailer, is yet another struggling private equity buyout. J. Crew’s owners, TPG Capital and Leonard Green & Partners, are stuck, tied to the bargain they struck with the company’s chief executive, Millard S. Drexler. Call it the “great man” problem.

J. Crew went private in 2011 in a $3 billion deal that was controversial because of Mr. Drexler’s actions. He began discussing a buyout with the two private equity groups and waited seven weeks before informing the company’s board. Mr. Drexler then refused to consider a buyout with another party. To cap it off, the two private equity firms lowered the price they were willing to pay at the last minute, a move supported by Mr. Drexler.

Mr. Drexler’s actions led to a bit of an outcry that he was abusing his position to engineer an acquisition of the company and force J. Crew’s shareholders into a deal with him alone. Not only that, but Mr. Drexler was teaming up with TPG, which had previously taken the company private and had recruited Mr. Drexler as chief executive.

It was also a testament to the “great man” theory of business. Mr. Drexler is a retail legend — the man who made the Gap into the Gap and, after being fired, the one who turned the same trick of creating a well-known fashion brand out of J. Crew. Because Mr. Drexler built J. Crew, the theory goes, he was the only one who could run it, leaving the board with no choice but to sell despite Mr. Drexler’s machinations.

The buyers trotted out the tired argument that J. Crew’s business was in flux and Mr. Drexler needed the freedom of the private markets to engineer a turnaround, an argument that would be recycled a few years later in the Dell buyout, in which the company’s founder, Michael S. Dell, took the company private.

Shareholders did sue J. Crew in connection with Mr. Drexler’s actions. The company settled by paying the relatively small amount of $10 million and agreeing to reshop the company. When no one else bid — Mr. Drexler was seen as J. Crew’s secret weapon and he was unwilling to work with anyone but TPG — the deal went through. The company borrowed $500 million.

The private equity owners have come out O.K. Since the acquisition, it has paid them $685 million in dividends. Mr. Drexler received $55 million for his 8 percent stake. And every quarter, J. Crew pays the owners at least $2 million in consulting and management advisory fees, as well as expenses.

Four years later, the question of whether shareholders received a raw deal has become a much more complicated matter.

J. Crew is struggling in ways it never did as a public company. In the last quarter, revenue declined 2 percent, to $582 million, compared with total revenue in the previous quarter. However, companies owned by private equity firms often use earnings before interest, taxes, depreciation and amortization to measure performance. In the last quarter, J. Crew had $44.8 million of Ebitda, down 31 percent the period a year earlier. And same-store sales dropped 8 percent from the period a year earlier. In the wake of this decline, J. Crew wrote down $341 million in its own value.

In terms of merchandise, inventory has been building steadily, climbing 4 percent in the first quarter compared with figures in the period a year earlier. And J. Crew has an international expansion plan, but that has been a capital quagmire for many United States retailers and it has opened 20 additional J. Crew stores across the globe. Expanding with a declining brand does not seem like the best option.

And Mr. Drexler appears to be caught a bit flat-footed. On J. Crew’s recent earnings call, he attributed the decline in earnings in part to stocking too much of the Tilly cardigan but not enough of the Tippi. That sounds like someone who is too caught up in the details. Absent from the call was any grand vision of what J. Crew should be and where it should go other than a return to classic styles and basics.

This is a turn from what the company’s creative director, Jenna Lyons, has pushed — trying to sell more fashionable and expensive goods to compete with the fashion crowd. The schizophrenic tension between being a runway sensation and meeting everyday needs was illustrated last week when J. Crew served doughnuts in honor of National Doughnut Day along with a 40 percent off sale. Fashion mavens do not eat doughnuts.

The company almost made it to the promised land a few years ago when the owner of Uniqlo was reportedly in negotiations to buy J. Crew for $5 billion. Then there was a planned initial public offering that faltered. J. Crew is still a brand with wide appeal, and the company’s Madewell denim stores are expanding nicely.

But Mr. Drexler has not been able to execute despite the notorious rigor private equity brings to its companies. J. Crew, though, may be an exception under Mr. Drexler’s tenure. Last year, the company paid $1.3 million for his air travel.

Here we have the “great man” problem. The narrative arc of J. Crew has become one about Mr. Drexler. He was the one who built it after becoming chief executive. He is the one with whom TPG and Leonard Green have lashed themselves to the mast and why they were able to take this company private, despite accusations of irregularities.

TPG is continuing to express confidence in Mr. Drexler. “J. Crew has experienced enormous growth and success under Mickey Drexler,” James Coulter, a co-founder of TPG, said in a statement. “Fashion retail is cyclical, and we have been through down periods at J. Crew before. The companies that rebound fastest are those that have a dedicated, experienced management team that recognizes what changes are necessary. We are confident that Mickey has made, and is continuing to make, the long-term strategic decisions that will keep J. Crew as the retail powerhouse it has been under his leadership.”

Now that the company is struggling, the question is whether any company should be so tied to one person. Mr. Drexler and his private equity partners were able to take J. Crew private because he was viewed as the only one who could run it. We’ve seen this narrative time and again with retailers and sophisticated investors, including J. C. Penney and Sears. The idea that one person can succeed where others have failed seems to wager a lot of money on one person.

But now that Mr. Drexler seems to be floundering, despite making hundreds of millions, what’s a private equity firm to do when the magic runs out and the retail nightmare begins?

Steven Davidoff Solomon is a professor of law at the University of California, Berkeley. His columns can be found at nytimes.com/dealbook. Follow @stevendavidoff on Twitter.

Steven Davidoff Solomon is a professor of law at the University of California, Berkeley. His columns can be found at nytimes.com/dealbook. Follow @stevendavidoff on Twitter.

06/10/2015

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