It's How We Play the Game

by Ed Stack

  Although our earnings were up, sales were an important measure for Wall Street. In particular, it’s comp sales that the Street looks at closely when assessing a retailer—that is, sales at stores that have been open for more than a year. Inflated sales driven by new stores are removed from consideration, and you get a more accurate picture of how business is going. It signals whether you’re gaining or losing market share in the places you do business.

  When we met with our investment bankers, they wanted to know how our comps were going to be for the coming year, by quarter. We told them they’d be flat to plus 1 percent, though we anticipated that number might be higher. “You can’t go public,” they replied. “The Street wants to see strong comp gains.” We didn’t make the grade, in particular because Wall Street wasn’t much interested in bricks-and-mortar retailers—like our own venture capital partners, the financial community was crazy for dot-com investment.

  At the next board meeting I broke the bad news: “Our bankers have told us we can’t take the company public.”

  Jerry Gallagher was sitting across the table. He was a smart guy. He knew we couldn’t take the company public. But he sneered at me. “I think you’re not going public because you don’t want to go public. I think you could, if you wanted to.”

  “Jerry, actually, that’s not the case,” I said. “We were ready to go.”

  Our agreement with the venture groups included something called a mandatory redemption provision. It says, in effect, that a shareholder can declare, “I own this much stock. I’m hereby cashing it in. I want you to buy me out.” It’s included in such documents as a mechanism for investors to pull their stake. Thing is, the arrangement doesn’t work if the party obligated to buy the stake doesn’t have money.

  Even so, Gallagher announced he was invoking the mandatory redemption provision. Because he knew we didn’t have enough money to buy out our venture partners, he said, “I’ll move the mandatory redemption provision out a couple of years. But I’m going to make it hurt.” Meaning, in lieu of payment, he wanted a bigger share of the company—and he’d take it from my family’s piece.

  I looked across the table at him and thought: It’s time for you to go. You’re no longer acting like a partner. It was a ballsy thought, admittedly, because I did not control the company. But to my mind, he’d gone from venture capitalist to vulture capitalist. He knew we couldn’t go public. He knew we couldn’t meet the conditions of the mandatory redemption provision. It was a setup to give him and the group a bigger piece of the pie.

  And true to his word, he made it hurt. Our venture partners took another 3 percent of the company.

  * * *

  I didn’t dwell on the situation for long. The solution to this dilemma, it seemed to me, was to buy out the venture capital folks by any means necessary, even if it meant taking on debt. I knew we couldn’t, as a company, afford to buy all of their stakes—that would have cost $100 million, and the idea of borrowing that much struck me as far too risky. But I was confident that we could live with a $60 million loan, and if we were to buy 60 percent of their shares back, we could reduce their voice in the company’s affairs by the same percentage. I could regain control of the company, and eventually get them out all the way.

  Which is what took me back to our friends at GE Capital, who, I want to stress, had proved to be real friends since our near-death experience a few years before. I explained that I wanted to buy out a majority of the venture capital investment in the company, and they were wonderful in putting together a deal that enabled that to happen.

  When I broached the idea with Gallagher and the others, they were thrilled. They so desperately wanted to take chips off the table. There were a lot of players involved: after the initial buy-ins, several other investors had put money into Dick’s. They appointed Gallagher to negotiate the deal on behalf of the group.

  We talked. He squeezed me quite a bit on share price and conditions, but we finally got to the point where both of us were able to say, “We’re good.” Ah, but then Barach called to say, “You know, I think the deal’s fine, except for this part and this part.” He squeezed a little more, and I adjusted until I thought we’d finalized the thing. And then another player called, trying to squeeze more dollars out of us.

  This went on until Mike Hines walked into my office. Remember, you always need someone on your team who’s unafraid to tell you that you’re screwing up. “You know what?” he said. “You need to realize that they’re not going to say yes until you say no.” Which was great advice. Gallagher was so wrong about Mike. Because the next day, when another in our roster of venture capitalists called to get his piece, I told him: “We’re done. You either want the deal, or you don’t.”

  Lo and behold, they said yes.

  So we had a deal. It was done. Or so it seemed. We distributed paperwork laying out how much we’d pay per share, how many shares we were buying back, all the details. A few days later, a Friday afternoon, I was playing golf with some vendors when my assistant called. “You need to get back here right now,” she said. “We have a problem.” I asked what was going on. “We got a fax,” she said.

  “Okay. Read it to me.”

  “I don’t want to do that,” she said. Her voice quavered.

  “Please, just tell me what it says.”

  It was a letter from Leonard Green & Partners, a large private-equity investment firm out of Los Angeles that owned pieces of Rite-Aid drugstores and Petco, among other retail outfits. The letter offered to buy the shares of our stockholders at a higher price than we were offering—and to buy all of them, not just 60 percent. We evidently had a mole. To this day, I cannot say for sure who it was, but someone who was privy to the paperwork that was passing back and forth between board members leaked it, and Leonard Green had recognized that we were in play—and ripe for a hostile takeover.

  I wasn’t the only person at Dick’s to get this letter. Leonard Green sent it to everyone on the board. I knew we didn’t have the money to match their offer, and I knew that Gallagher and Barach were prepared to sell; this represented a huge windfall for guys who’d been looking to put their money elsewhere anyway. It seemed that I was outmatched. If Leonard Green’s takeover succeeded, I’d be fired immediately. I stood to make some money—the new owners would buy my shares, along with everyone else’s—but neither I nor any other Stack would be part of the family business. It was a deadly situation.

  My one ray of hope was that the three biggest shareholders were me, Denis Defforey, and Paul Allen’s Vulcan Northwest. I knew that Denis enjoyed being part of Dick’s for the same reason he’d invested in other companies—to lend a hand to entrepreneurs in building their businesses. He enjoyed seeing good ideas brought to fruition, and if he made money in the process, great; he was always willing to play the long game with his investments. I called Steve Lebow, who was still Denis’s investment banker, and Steve agreed that Denis might not be interested in the Leonard Green offer. He said he’d set up a call.

  A few days later, Denis called me from Paris. He’d received a copy of the letter, and Steve had already briefed him that other investors wanted to sell. He asked one question: “Ed, do you want to sell your company?”

  “Denis, I don’t want to sell it for this price,” I told him. “I don’t want to sell it for twice this price.”

  Without a pause, he said, “Then neither do I.”

  Not long after, Paul Allen’s group announced through Lebow that it wasn’t selling. And with that, we blocked the takeover. We rejected Leonard Green’s offer and proceeded with our buyback of the venture group’s shares. With that out of the way, we reconstituted the board of directors to reflect the venture capital group’s reduced investment in Dick’s. Of the seven board members, I’d name four, they’d name two, and we’d have one that we all agreed on.

  Even if that last board member sided with the venture capital group, I’d have a majority of the votes. I’d regained control of Dick’s.

 
; CHAPTER 14 “YOUR INVESTMENT BANKER IS NOT YOUR FRIEND”

  I’d come to like Dave Fuente a lot during his time on the Dick’s board. He’d had a storied career—he was a college marketing professor and was a division president at Sherwin-Williams before he joined Office Depot as chairman and CEO in 1987. It had ten stores at the time. He took the company public and grew it into the biggest office-supply chain in the country, with hundreds of stores and billions in sales. Dave was really smart, confident, and was a lot of fun to be around. He’d always gone out of his way to help me. He was a great mentor and friend.

  I wanted him to be one of my four board designees and told him so. “I’d really be happy to be one of your designees,” he said. “But that’s not how you want to play this.”

  “Really?” I said. “Why?”

  “You want me to be the guy you all agree on,” he said. “We both know that they’ll definitely agree to have me be that guy.” That hadn’t even occurred to me, but he was right. The venture capital folks respected Dave, with good reason. And sure enough, Dave became that guy, which effectively gave me another board member I could always trust to do the right thing for the company, long-term.

  And so I regained my place at the head of the family business, and we got to work. Dick’s opened twenty-two new stores in 2000, and another twenty in 2001. We pushed west into Wisconsin, Iowa, and Missouri, and south into South Carolina, Georgia, and Alabama. As we had from the beginning of our expansion, we favored medium-sized cities over big ones, which gave us hundreds of thousands of potential customers to ourselves—instead of fighting our way into Atlanta, for instance, we set up shop without serious competition in Macon. But on occasion we’d blitz a metro area, as we did in Kansas City: in the fall of 2000, we opened five stores there on the same Sunday. That gave us instant scale in KC, and our team made that market into a great success.

  By now we had a pretty sophisticated system for deciding where to put our new stores. We looked at the age, income, and size of an area’s population, as well as the number of kids playing team sports there. We’d study the performance of an existing store with similar characteristics. Before we committed to a location, we projected annual sales for the store, knew the capital we’d have to put into it, and had built a profit-and-loss statement for its first three years of operation.

  Our model was that we had to earn a 40 percent cash-on-cash return by the third year, which means that the store would have to generate an income equal to 40 percent of all the cash we’d invested in the deal. Let’s say to open a store we spent a net $1 million on inventory and $200,000 on fixtures, plus $100,000 on pre-opening costs, giving us $1.3 million invested. By year three, that store had to net 40 percent of that, or $520,000 per year.

  We quickly found that to be too easy a target, so we bumped it up to a 50 percent cash-on-cash return—or, using the same example, $650,000 of net earnings by year three. And as we broadened our footprint and introduced ourselves to new markets throughout the eastern United States, we found that even that target was a low bar to clear. Our typical store brought in $8 million to $10 million a year, and netted 12 to 15 percent of that before taxes, so it often turned a profit the first year out of the box.

  We were now far too big and widespread to continue supplying the stores from a single warehouse, so we opened a second distribution center in Pittsburgh. It covered 383,000 square feet, which seemed almost absurdly big to us—between it and Conklin, we figured we could service twice as many stores as we had.

  Even with that outlay, we were rapidly paying down the $60 million loan from GE Capital and used our excess cash to open new stores. It seemed we could keep doing it until we ran out of places to put them. Our model seemed a machine for profitable growth. We’d be able to stay a private company, minding our own business, for as long as we wanted.

  * * *

  One Tuesday morning in September 2001, I got up well before dawn and flew to Saginaw, Michigan, accompanied by Dan Ostrowski, our director of stores. We expected to be in Michigan for a day and a half; we were scheduled to visit our location in Saginaw, then go on to Detroit to see some other stores. It was the sort of trip I made almost every week.

  We got to the Saginaw store at about eight thirty, which tells you how early we’d left Pittsburgh. As soon as we walked in, someone told us that a plane had flown into the World Trade Center. We assumed, like so many people, that it was a private plane—that some poor guy had suffered a heart attack at the controls while over the city and crashed into one of the towers. We were walking the store with the local managers when we heard a second plane had hit. Our walk-around stopped; we all gathered at the store’s TV. The news reports carried word that a third had hit the Pentagon, and another had gone down in Shanksville, Pennsylvania—not far from home. When the first tower fell we were stunned. People in the store were crying. I got a call from Lynn Uram, our senior vice president for human resources, who told me that the home office was in a high state of anguish. She wanted to close up and send everyone home. “Absolutely,” I said.

  When we saw the second tower collapse, the three of us decided we needed to be with our families, so we drove back to the airport. The pilot reported that all flights, including private planes, were grounded. We could either hunker down in Saginaw or rent a car. So we hit the road, listening to the radio as we crossed Michigan. The country was reeling. The world felt crazy, dangerous, out of sorts, and we worried there were more attacks to come. I needed to hear Denise’s voice, so I called her at home and asked, “How are you doing?”

  “Elaine and I are going to the store,” she replied in a panicked but defiant tone, “and we’re going to buy a shotgun and bullets and then we’re going to pick up the kids at school and bring them home.”

  This was a shock. I hadn’t expected Denise, of all people, to take up arms. I was sitting beside Dan Ostrowski. He and his wife, Elaine, lived catty-corner to us, and I couldn’t picture Elaine with a gun, either. “You’re not going to buy a gun,” I told Denise.

  “Yes, we are,” she said. “We’re going to the Cranberry store to get a shotgun and some bullets, and then we’re going to the school to pick up our kids.”

  “Denise, please don’t do that,” I said. “First of all, bullets don’t go in a shotgun. Shotgun shells go in a shotgun. Bullets go in a rifle. You don’t know how to load a gun, let alone shoot one. You’re going to hurt yourself or one of the kids.” I pointed out that the North Hills of Pittsburgh weren’t a likely target for the next terrorist attack. Even so, when we hung up, Denise was still insisting that she was headed to the nearest Dick’s to buy a gun.

  I turned to Dan: “This is a problem.” If Denise and Elaine were reacting to the attacks like this, there were going to be other people showing up at our gun counters, and some would be even less qualified to buy a gun than those two. With no idea what they were doing, they’d hurt themselves, hurt their kids, hurt a stranger. Maybe worse, I worried that in this crazed atmosphere we might sell guns to people who would march down the street and use them to shoot their neighbors of Arab descent, just because they vaguely resembled the terrorists. I called the office from the car. “I want you to take every single gun off the shelves and every box of ammunition off the shelves,” I said. “In all the stores. Until further notice, we’re not selling any guns.”

  We kept the guns and ammo out of sight for four or five days, until everyone calmed down a little. It seemed the right thing to do; we didn’t announce it, we just did it. But people noticed, just the same. We were getting to be a pretty big company by now, and we got a slew of nasty calls and letters. One guy reached me on the phone. “You son of a bitch,” he roared, “if I want to buy a gun, you’re going to sell me a goddamn gun!” He sounded completely unhinged. “I’m sorry,” I told him. “We’re not going to sell you a gun. And the more you yell, the more I’m convinced we should never sell you a gun.”

  He was an extreme case, but I was surprised by the general intensity of t
he public reaction. It was a primer on just how emotional we Americans can be when it comes to our guns. I’d get a clearer picture in the years to come.

  * * *

  The September 11 attacks were a wake-up call in another way, in that they got me thinking a lot about the company and its responsibilities. As soon as the second plane hit the World Trade Center, the worldwide economy went into shock. The New York Stock Exchange shut down and remained closed for the rest of the week, but stock prices in Europe and South America plunged, and when the American market reopened, the Dow Jones Industrial Average dived more than six hundred points, at the time the biggest one-day drop in its history.

  Over the following month the market recovered and achieved a tentative stability, but a mild recession that had started earlier in 2001 deepened, and I worried about the long-term effects of the tragedy. If the country experienced a serious economic downturn, we could be in trouble. We were healthy: We were in the process of posting a billion dollars in sales for the year, the first time we’d achieved that milestone. We had, or were building, 132 stores in twenty-four states. Our profits were healthy. Still, we had considerable debt to retire. I wasn’t confident that our balance sheet could survive three or four rough years.

  I’d have preferred to stay private, financing our own growth and remaining below the radar, and I still feel that way to this day. But we employed thousands of people. They depended on us for their livelihoods. They had families, mortgages, car payments. The world suddenly seemed a scary, unpredictable place, and we didn’t know whether another September 11 was on the horizon or if the attacks might spark a war that would throw a wrench into the economy. If the company’s health were compromised simply because my personal preference was to remain private, I’d be doing a disservice to a lot of people.