Price the lease before you approve the dividend

I think boards of sponsor-owned retailers should treat store real estate, and the length of their store leases, as part of the capital structure rather than as an operating detail. A sale-leaseback that funds a dividend does more than add a long-term obligation. It removes a chain's ability to leave a declining location, or to move across town, without negotiating with a landlord whose interest is to keep the rent flowing. For a retailer whose customers live in towns that may lose population, that freedom has a value, and a recapitalisation paper should put a number on it before the board votes.

I write as the chief executive of a company owned mainly by a private equity firm, and as someone who has benefited from that ownership. Stonebeck Capital Partners bought 71% of Marrick Variety Stores from the founding family in 2019. Its capital paid for a warehouse system, scanned receiving in every store and the first remodel pilots, and its partners asked harder questions about returns on store investment than the family board had. Nothing in this essay is an argument against sponsor ownership. It is an argument about one financing choice that sponsors and management teams are often tempted to make late in a holding period.

A lease is debt that also decides where you trade

Marrick operates 1,140 stores, mostly in towns of fewer than 10,000 people. We own 186 of them. Most of the rest are leased for five years at a time, with options to renew. That pattern was not designed as strategy; it grew from the founders' habit of renting cheaply in towns they were unsure about. It has turned out to be one of the company's most useful features. When a town's main employer closes or a new road takes the traffic elsewhere, we can close or relocate within a few years at low cost. Over the last decade we have relocated 96 stores within their own towns, usually to a better site, and closed 41.

A sale-leaseback of owned stores typically creates leases of fifteen to twenty years with fixed rent increases, often under a master lease covering many stores at once. Current accounting standards bring most leases onto the balance sheet, and lenders and analysts adjust for them, so the obligation itself is visible. What remains less visible is the loss of choice. A master lease can turn the closure of one weak store into a negotiation about the whole portfolio. A twenty-year term in a town whose population is falling is a bet on that town, made by the people least able to influence it.

What the recapitalisation paper left out

In March 2024 Stonebeck proposed a recapitalisation: a dividend of US$280 million, funded by a US$160 million incremental term loan and a sale-leaseback of our 186 owned stores. Our net debt was then 3.1 times EBITDA, and lenders were willing. The paper was competent. It showed debt service coverage, interest-rate scenarios and the effect on the fund's returns. It did not show what the company would give up in its ability to reshape its store network over the next twenty years. Nobody had hidden that cost. It was simply not anyone's task to measure it, because lenders price the debt and sponsors price the return.

So we built that analysis. Using our own history of relocations and closures, and population projections for each town, we estimated how many of the 186 owned stores we would want to close or move during a twenty-year lease. The central case was between thirty and forty-five. We then estimated the cost of carrying those leases empty or buying our way out of them. The figure was large enough to change the comparison between selling the stores and borrowing against the company's earnings.

I should state my own position, because I had an interest. As a holder of management equity, I would have received about US$4.4 million from the larger dividend and about US$1.9 million from a smaller one. I put both figures in writing to the board, asked that our non-management directors retain their own financial adviser and abstained from the vote. The board approved a US$120 million dividend funded by the term loan alone, declined the store sale-leaseback and approved a sale-leaseback of our Salina, Kansas, distribution centre, whose US$58 million of proceeds were committed to store remodels. I had argued against the distribution centre transaction as well and lost. On reflection, the board was right that a distribution centre carries little of the town-level risk I was worried about.

Questions for a sponsor-owned retail board

I would ask any such board to require four things before approving a dividend funded by real estate. First, an estimate of how many affected stores the company is likely to want to close or move during the lease term, based on its own history and on the prospects of the towns concerned. Second, the cost of exiting those leases or of carrying them empty. Third, whether the leases are individual or a master lease, and what that means for closing a single store. Fourth, a comparison with borrowing the same amount, on the assumption that the company will need to change its network.

There are objections. Sponsors argue, fairly, that owning real estate is not a retailer's business and that capital tied up in buildings earns less than capital in stores. For a chain in growing suburbs with long-lived locations, I would agree. Others say that a good landlord relationship makes master leases flexible in practice. Sometimes it does. But flexibility that depends on a landlord's goodwill is not the same as flexibility the company owns, and a board should not price the two alike.

The question underneath all of this is who carries the risk of a town's decline. A sale-leaseback moves that risk from the people who financed the purchase to the people who will run the company after they leave. A board represents the second group as much as the first, and it should see the price of the freedom being sold before it agrees to sell it.