July 21, 2008

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Mervyn’s Fights to Keep
Its Store Doors Open

(See Corrections and Amplifications item below.)

Mervyn’s LLC, the long-struggling California department-store chain, is fighting for survival as some of its vendors have halted shipments to the company and key lenders have pulled financing, according to people familiar with the situation.

Associated Press

The private-equity owners of Mervyn’s have shut many stores since 2004.

In recent days, Mervyn’s executives have been trying to persuade vendors to ship merchandise to the retailer for the crucial back-to-school season. If that effort fails, the company could be forced to file for bankruptcy protection as soon as this month and shut down, according to these people. Mervyn’s operates 177 stores in seven states, mostly in California.

A Mervyn’s spokesman couldn’t be reached to comment.

A Mervyn’s liquidation would deliver another blow to the nation’s mall owners, which are suffering through a torrent of store closings. Linens ‘n Things, Goody’s Discount Clothing and Sharper Image are just some of the chains that are closing stores or shutting down for good this year.

It would also be an embarrassment to Mervyn’s owners. Private-equity firms Cerberus Capital Management and Sun Capital Partners, along with three other partners — including real-estate investor Lubert-Adler — acquired the chain from Target Corp. in 2004 for $1.2 billion. The group put up about $400 million in equity and financed the rest.

But while thousands of employees would lose their jobs and their vendors would get hurt in a Mervyn’s liquidation, the private-equity buyers wouldn’t stand to take much of a financial hit. That is because when they bought the company they structured the $1.2 billion deal as two separate transactions — one for the retailer and a second one for the retailer’s real estate.

The real-estate arm has been a lucrative investment, according to people familiar with the deal. It leased many of the stores to Mervyn’s and has sold and leased certain properties to other retailers. And through sale-leaseback transactions and the appreciation of real-estate values over the past several years, the buyers have more than doubled their money on the real-estate investment. Those profits have far exceeded losses on the retailer, according to these people. In a bankruptcy of the store operations, the real-estate arm would become a creditor.

Mervyn’s store business had long struggled, but Cerberus and Sun — both turnaround specialists — sought to reverse its fortunes. Two retail experts familiar with the bankruptcy planning at Mervyn’s said the retailer’s sales began to tumble quickly as the real-estate slide began in California and Arizona. Mervyn’s tried to cater to Hispanic consumers, many of whom have been hurt by the downturn and job losses in the mortgage and home-building industries.

In the spring Mervyn’s lender CIT Group Inc., which has severely cut back on its business loans overall, stopped providing financing to the chain, according to people familiar with the matter. This caused Mervyn’s vendors to get nervous, and many began withholding shipments to the company.

The retail bankruptcy wave has particularly burned Sun, a Boca Raton, Fla., buyout shop. Sun-owned companies Wickes Furniture and cataloguer Lillian Vernon filed for bankruptcy protection earlier this year. It was also the largest shareholder of Sharper Image, which is now in liquidation. Other retailers in Sun’s portfolio, including discount chain Shopko and Anchor Blue, are performing well, according to people familiar with the firm.

Among Mervyn’s largest landlords is Macerich Co., a Santa Monica, Calif.-based real-estate investment trust that owns 72 U.S. malls. In December, Macerich agreed to buy 43 Mervyn’s stores for $430 million. The move allows Macerich to gain control of 13 Mervyn’s stores in its own malls that might have languished in any bankruptcy proceedings and to sell the 30 stores in other malls to those landlords, said Jim Sullivan, an analyst with Green Street Advisors.

Write to Peter Lattman at peter.lattman@wsj.com¹

Corrections & Amplifications

Macerich Co. is based in Santa Monica, Calif. A previous version of this Marketplace article Monday about Mervyn’s LLC incorrectly said Macerich is based in Santa Clara, Calif.