Mervyn's: A Eulogy

I’ve been trying to write about Mervyn’s (1949-2008) since October: this is my fourth attempt, and the net result is the most time-consuming research and posting of any in my two years of blogging. The story of Mervyn’s failure is complex, as are my feelings about it. It’s more than just about a failed business: it’s like delivering a eulogy for a friend, in which the story is not just the friend, but our memories of that friend.

Capsule Biography

For most of its life, Mervyn’s was California’s leading discount clothing retailer. Certainly its first four decades were an entrepreneurial success story. It began on July 29, 1949 with its first store in San Lorenzo, a working class community about 20 miles south of Oakland. Its initial growth was concentrated in the Bay Area, growing to two stores in 1964 and four in 1966. Gradually, it spread across the West Coast and eventually elsewhere, with 42 stores by 1977 and 100 stores by 1983.

Mervyn’s celebrated its IPO in 1971, and with its growth attracted attention from both competitors and suitors. In January 1978, Dayton Hudson Corp. (parent of Target) announced a $291 million, all-stock acquisition of Mervyn’s. Apparently the West Coast retailer was worth a premium, because the NYT figures indicated that Mervyn’s provided 15% of the revenues of the combined company but its shareholders won 33% of the equity.

Despite this initial optimism, Mervyn’s grew more slowly than its sister Target stores, such that by 2003 it accounted for only 7.5% of Target Corp. In July 2004, Target announced sale of Mervyn’s to a group of private equity firms, and sale of the Mervyn’s credit card to GE Consumer Finance.

On Mervyn’s 59th birthday last July, the new owners pre-emptively filed for bankruptcy. After finalizing debtor-in-possession (DIP) financing in August, there was hope that the stores would eventually emerge from Chapter 11. Instead, on Oct. 17 the owners announced plans to liquidate all remaining inventory and close its 149 remaining stores.

From what I could see visiting three stores, Mervyn’s sold its last clothing on Dec. 28, with the liquidation of fittings, fixtures and supplies continuing until the doors closed for good on Dec. 31.

Entrepreneurial Risks and Rewards

Mervyn’s is neither the first California retail chain to be born, nor the first to die.

The story of California business is an entrepreneurial one: we have attracted risk-takers from the rest of the country since 1848. The main reason the rest of the world looks to us is that some of these risk takers launched and grew new businesses, whether during the gold rush in the Sierra Foothills, the arrival of the aviation and movie industries to Southern California, or the semiconductor, PC and dot-com boom eras in Silicon Valley.

However, a high rate of firm formation also entails a high rate of firm death. The death of Mervyn’s parallels the disappearance of other California department stores, such as Robinson’s (d. 1986), Buffum’s (1904-1991), Broadway (1896-1996) and May Company (1923-2005).

Among bankrupt California retail chains, Mervyn’s never achieved the cultural status of a Tower Records (1960-2006), whose Hollywood store for years provided litmus test for the careers of hundreds of aspiring musicians — and whose liquidation two years ago paralleled Mervyns’.

Mervyn’s and Me

For me, Mervyn’s had a much stronger emotional connection than any of the various other retailers who disappeared over the past 25 years. In effect, it became part of my daily life. Nearly all of my casual clothes for the past 20 years have come from two of the chain. This includes the various jeans I’ve been wearing since school finished on Dec. 19: 8 of my 10 pairs of jean are the High Sierra house brand, as are many other elements of my casual wardrobe.

Compared to the clothing retailers who died in the 1980s and 1990s, Mervyn’s was much more of a discount chain. Both from visiting the stores and reading various business obituaries over the past five months, it’s clear I was at the high end of the Mervyn’s demographic, as this October LA Times profile makes clear:

First opened in 1949 in San Lorenzo, Calif., by Mervin Morris, the chain was geared toward average, working- to middle-class shoppers.

"We were targeting Joe the Plumber," Morris, 88, said Friday. "We said every customer who came to JCPenney, Sears or Montgomery Ward could be a Mervyns customer."

It appears people either loved Mervyn’s or hated it. My daughter and mother in law were very sad at the news, but my wife was largely indifferent. (She and my sister would be crushed, however, if Target ever decided to retreat back to Minnesota).

For me, Mervyn’s offered the optimal mix of convenience, price and value. Mervyn’s was the closest clothing retailer to three of the four places I’ve lived in the past 20 years. As a large clothing-only retailer, it offered a wider selection than general department stores (like Target or Sears) or small specialty stores like Gap or Old Navy. I found the Mervyn’s advantage in selection particularly noticeable for purchasing mundane items like socks or a belt.

One thing I never noticed over the decades was the employees: this was no Nordstrom’s — more like Home Depot, Target or any other big box retailer. However, in its death throes, I took more notice of those who remained — talking to a 9 year employee in San Diego and a 33 year employee in San Jose — who retained their professionalism with a stoic sense of determination.

Apparently there were many customers who had an even stronger tie to Mervyn’s. Some were quoted by Clint Reilly, the populist businessman (that ran for San Francisco mayor), who devoted his Dec. 2 and Dec. 9 columns to the subject. The latter included stories far more emotional than my own:

I received dozens of thoughtful messages from folks who came from families like my own and who wished to share their own fond memories of Mervyn’s.

The unnecessary demise of this Bay Area retailing icon evoked deep emotions. It was more like the death of a person than the passing of a department store chain.

“I remember many times when my children gathered their allowance to purchase Hot Wheels or a Barbie outfit,” wrote one parent.

Another reader recalled a time when “credit” was more personal: “When I was about eight years old, my mother would give me a note saying it was OK to charge a new shirt or a pair of shoes at Mervyn’s.

“Mr. Mervin Morris would check our account on a 3×5 card and I would soon be on my way with my purchase.”

(Both columns also include dozens of even more stirring testimonials in the reader comments appended at the end.)

Seeds of its Decline

Things were not always so sad for Mervyn’s. During the 1960s and 1970s, it was considered innovative and a trend-setter in merchandizing in what is now called the "mid-priced" (or "mid-tier") clothing segment. It grew rapidly after its acquisition by Dayton Hudson, and 20 years ago, a NYT article reported its strategic importance to its parent firm:

When the Minneapolis-based Dayton Hudson Corporation acquired Mervyn's, the California apparel chain, a decade ago, it got a powerhouse — an innovative and much emulated retailer that could contribute mightily to the parent corporation's earnings. But, as Dayton Hudson learned after Mervyn's drifted into serious problems, benign neglect is no substitute for hands-on management.

The low-priced retailer seemed to lose its competitive sting. Its market share slipped. And the chain's earnings declined.

Now, under a new management team, the chain, with 217 stores in 15 states, is turning around. Mervyn's operating profits rebounded to a record $255.7 million in fiscal 1988, which ended Jan. 28, 1989, or 33 percent of Dayton Hudson's total, from $150.4 million, and a 24 percent share, in 1987. The previous high was $245 million in 1985, when Mervyn's contributed 37 percent of the total.

Apparently the success was short-lived, because by 1996, analysts were already speculating that Target hoped to unload Mervyn’s:

"In our opinion, the strategic decision has already been made to shed Mervyn's," said Saul Yaari, an analyst with Piper Jaffray Inc. "Dayton Hudson is buying time to dress up the division for a sale or spinoff."

Similar speculation continued until the eventual 2004 deal to sell the company. Various accounts suggest that Mervyn’s after its acquisition, Mervyn’s never got a lot of executive mindshare in Minneapolis, leading Mervyn’s fans to accuse Dayton Hudson (later Target Corp.) of benign neglect.

Once acquired, Mervyn’s new owners hired a series of credible CEO with directly relevant experience. As a San Diego paper wrote in 2005:

[Some] analysts said Mervyn's has been changing for the better lately under the guidance of new chief executive officer Vanessa Castagna, who was instrumental in the recent turnaround at J.C. Penney as CEO of its stores, catalog and Internet division.

"She is pretty savvy," said George Whalin, president of Retail Management Consultants in San Marcos. "The merchandise (the chain is) selecting is a little more refined now."

But Castagna was unable to turn things around and left Mervyn’s two years ago, when she was replaced by Rick Leto, formerly of Macy’s and Kohl’s. Leto was replaced last year by John Goodman, onetime manager of the Dockers brand for Levi Strauss. As CEO, Goodman announced Mervyn’s death sentence in October.

The trend in stores has also been in only one direction. Reilly estimates that at its peak Mervyn’s had 300 stores across 16 states. When acquired in 2004, it had 257 stores in 12 states, but a year later the new owners closed 62 stores. It was down to 177 stores at the time of the bankruptcy filing in July and 149 stores that were liquidated in the past three months. Mervyn’s had shrunk back to its roots, keeping about 125 stores in California (in fact, opening a few new stores) from 2004 until the start of its liquidation sale.

If Mervyn’s offered value to the lower middle class, the biggest change in the competitive environment during the past five years came with the arrival of a new midpriced store from Wisconsin. Analysts predicted trouble for Mervyn’s with the 2003 entry of Kohl’s into the California market.

"If I was going to rate Kohl's on a one to 10 scale, they would be an 11.5," said Bruce Berton, director of accounting and consulting firm Stonefield Josephson. "They are going to give the retailers here a swift kick in their lethargic ways of doing business."

"There's no question this will have an impact on Robinsons-May, Mervyn's and most of the department stores and mass merchants in the market," said Linda Kristianses, an analyst with UBS Warburg. "Typically, the impact is several hundred basis points. Each company within the competitive circle usually loses 2 to 4 percent" on sales.

I never personally understood the threat. After Kohl’s arrived in San Jose, I found it too down-market for my taste, a K-Mart with cleaner stores. However, Mervyn’s was also considered down-market by many, and there’s no question Kohl’s was a direct replacement for many shoppers. In fact, a story Wednesday in the Merc even credited Kohl’s as benefitting from Mervyn’s imminent failure:

...the picture in the Bay Area for the department store is better than most, [said Kohl’s district manager Jason] Bittner, because Kohl's drew the former customers of Mervyns, which filed for bankruptcy over the summer.

In the past two years, analysts also speculated that Mervyn’s was suffering from layoffs in California’s construction industry. The industry has a large proportion of Hispanic workers, who were one of Mervyn’s largest customer demographic groups.

Saying Goodbye

As with other professional liquidations, the two months of the going out of business sale has been orchestrated with precision. The sale started by raising prices back up to 80% of list prices: regular shoppers knew (as at Sears) to wait for a sale. However, this succeeded in clearing out the most oft-purchased items: after the first month, most of the normal merchandise mix was gone.

I made 5 visits to 3 stores in the last half of December, buying my last clothes on Dec. 31 at 30% of list, buying a gift on Dec. 26 at 20% of list, and finding no clothes remaining at 10% during our final visit on Dec. 28. (By Monday, even the GOOB sign was being taken down).

My daughter joined me on the last three of these four visits, also wanting to see how it ended. In contrast, my mother-in-law was so heartbroken that she never set foot in a store again after the liquidation was announced — much as someone might avoid a dying friend or family member, wanting to remember the happy times.

Post-Mortem

The real cause of Mervyn’s death may (as with so much in the US) be determined by litigation. On Sept. 2 — after filing Chapter 11 but before converting to liquidation — Mervyn’s sued all parties to its 2004 leveraged buyout, alleging that they colluded on asset stripping in violation of their fiduciary duties. As Dow Jones reported:

Department store operator Mervyn's has sued three private equity firms and Target Corp., alleging that the leveraged buyout of the chain from Target was a fraudulent deal that stripped Mervyn's of valuable real estate and doomed it to bankruptcy.

The retailer said the private investors financed the 2004 takeover with $800 million borrowed against Mervyn's real estate, then leased the properties back to Mervyn's at "substantially increased rates."

Cerberus Capital Management, Sun Capital Management and Lubert-Adler have taken $400 million out of the company since acquiring it in 2004, leaving it struggling to pay creditors, Mervyn's said in papers filed Tuesday with the U.S. Bankruptcy Court in Wilmington, Del.

The result "ultimately led Mervyn's to bankruptcy and is a fraudulent transfer that cannot withstand scrutiny," attorneys for the company said.

Cerberus is today best known for winning (highly dilutive) government bailouts of two other ill-advised acquisitions, Chrysler motors and its 51% share of GMAC. Cerberus is the symbol of the private equity greed in the death of Mervyn’s, even though WSJ reported that Cerberus sold its stake to its partners in 2007 to concentrate of its other holdings

Today, in the wake of the 30-40% stock market collapse last year, Cerberus and its kin are demonized beyond Big Tobacco (inexplicably, even beyond Fannie and Freddie). As such, many have already pronounced the private equity firms guilty in Mervyn’s demise. Although I’m saddened by Mervyn’s death, I won’t join the lynch mob, but instead will let the legal process run its course.

Mervin Morris has been particularly passionate in his denunciations. But he sold the company to Dayton Hudson thirty years ago, and with it, the right to make the final decisions about the company. Morris might have done a better job of running the company if he’d kept it independent, but he didn’t, so we’ll never know.

The irony is that the prized real estate held by the buyout firms may not be so prized. There will be a lot of vacant retail space in California for several years, and thus — beyond the 31 stores leased by former rival Kohl’s — not a lot of prospective tenants for the vacant Mervyn’s locations.

The lawsuit won’t bring Mervyn’s back to life. But it — and the bankruptcy proceedings — will determine whether creditors will be made whole, including those employees (among the 18,000 laid off) who have yet to be paid for vacation pay. (One key determinant is how much money the GOOB sale raised). My guess is that if assets and liabilities were disproportionately allocated between Mervyn’s LLC and a property firm controlled by the same owners, then a court could attach those assets to pay off Mervyns’ creditors.

Would Mervyn’s have survived without such asset stripping? Retail is a highly competitive industry today: demand is cyclical, net margins are thin, and thus profit depends on a combination of operational efficiency, savvy buying power and clever merchandising. Internet-enabled price comparison (let alone online buying) has further commoditized the distribution function once served by chains of well-situated brick-and-mortar stores.

A half-dozen other major retail chains also died in 2008. Mervyn’s was particularly vulnerable given that almost all its bets were on California, where the recession came earlier and promises to be deeper.

My guess it that once cut free of Target, Mervyn’s could not have survived the triple threat of its declining uniqueness, competition from Kohl’s (and Target), and the impact of the current economic downturn upon California working class customers. But again, there’s no way we’ll never know for sure.

Photo credits: Kohl’s by City of Fontana Economic Development Corp.; going out of business sale at Hollywood Tower Records by Nancy aka ZonaGirl via Flickr (some rights reserved). All other photos taken December 2008 by © Joel West (some rights reserved).