What can we learn from Party City's bankruptcy?

So big news today. Party City announced it's closing 700 stores. Lots of employees laid off, tens of thousands of employees, and most got 2 weeks' notice. So really sad situation for a lot of folks, especially happening right around the holidays. But there's some learnings from this. So let's talk about what happened, how we got here, and what we can learn from the closure of Party City. So the Party City chain— I went and researched all of this because, you know, nerd. Anyway, So the Party City chain got started back in 1986, and there was basically an entrepreneur named Steve Mandell in New Jersey, and he saw two things. He saw that parties were a big deal, and he saw that none of the competitors were actually doing a good job of delivering both a wide selection and good prices to consumers. So he set out to go build kind of the first party superstore chain, and he called it Party City. And to open the first one, he scraped together $125,000 and opened his doors. The third big tailwind that, you know, he saw, whether he saw it or not, was this was really peak kind of specialty superstore time, right in the '80s into the '90s. The internet had not come yet. Like, the suburbanization of America was in full force, right? Power centers and all these malls were still being built. So it was ripe for that situation. And then lastly, the tailwind that he was riding, whether he knew it or not, was something I call the Hallmark Effect. And look, whether the Hallmark Effect has a name or that somebody's already named it, but it's basically this idea that in America, if there is a holiday, we will figure out a way to make money from it. Right? So Hallmark basically, you know, is a famous kind of gift card business, right? Well, they've turned everything into a Hallmark holiday, right? Valentine's Day, Easter, frickin' Arbor Day. And then the two granddaddies of them all, Halloween and Christmas. And if you go back and you look at pictures of like how Halloween used to be or how Christmas used to be, it wasn't this like orgasm of like buying plastic crap. Like we didn't feel so compelled to signify every holiday by going to drop a few hundred dollars in order to do it. But starting in the '80s and pushing on, like, the Hallmark effect really worked on America. And we as consumers did our duty and started buying a lot of crap. And Party City benefited hugely from that. And you can see where this goes. When you're, you know, riding a bunch of tailwinds as a business owner, life feels pretty great because everything is easy. And Party City chain rode those tailwinds to really big growth. And so from 1993 to 2005, they opened up hundreds of stores. And by the time 2005 rolled around, they had nearly $1 billion in sales. And don't quote me on this, but it was like 600 or 700 stores, like just an absurd number of stores. And look, in 2005, at the time the company sold in a take-private transaction, meaning the public shareholders sold their shares to these private equity firms. A lot of times shareholders like that, when they own a company, they are terrible at timing. In this case, they were pretty darn smart at timing. Because if you remember back in 2005, which is nearly 20 years ago, if you're old like me, it seems like yesterday. But a lot of the tailwinds that the business was experiencing were turning to the headwinds. And these tailwinds that were now turning to headwinds were multiple. So first and foremost, back in 2005, e-commerce really wasn't a thing. We were still mostly just kind of buying books here and there. And there certainly wasn't much kind of TMU or direct from China happening at the time. The second thing was the demographics of the US were starting to change, right? You were seeing declining birth rates, fewer kids, and all that kind of stuff. And lastly, big chunks of Party City's business were starting to be competed away by other players. And if you remember when the business was started, they were— part of the original thesis was that the big box chains didn't do a good job of stocking party supplies. Well, bigger and better stores from Target and Walmart, Amazon started to figure that kind of stuff out. And additionally, Party City's Halloween Express business was getting eaten by an even more specialized business and playing second fiddle to Spirit Halloween, which has turned into a juggernaut. And at least around here in San Antonio, we have Spirit Halloween's, uh, as specialty Halloween retailers and nothing else. Halloween Express hasn't been seen here for years. And of course, all the little independents, of which I was one back in the day, have been run out of business. So fast forward from 2005 to 2015. Over the next decade, in face of these headwinds, the company mostly stagnated. And it was traded back and forth amongst PE firms, go publics, go privates, all that kind of stuff. And in situations when you have trouble creating value by delivering more value to customers, a lot of times what happens is called financial engineering. And in this type of model, private equity starts to deploy capital in ways that don't directly create value for customers, but create value for shareholders. And so one of the things Party City did was go and start to buy a lot of their franchisees. So early on, they had done both company-owned stores and franchise stores, meaning that there were third parties that owned those franchises, ran them, and paid them royalties. But what private equity did was say, oh, we should go buy those franchisees. Roll them into our bigger business and play a game called multiple arbitrage. And the way multiple arbitrage works is pretty interesting. What you do is you value the business at some multiple of revenue or some multiple of profits. And then let's say your business is valued by the market as a whole at 10 times profits. And then you realize you can go buy your franchisees in this case at 3 times profit. And voilà, by deploying capital and buying your franchisees at 3 times, the moment they become part of your fold in your bigger company, they're valued at 10 times earnings. So there's an obvious downside to this, right? It's at best a quick hit. You're creating one-time value creation because it's not sustainable. And the other kind of long-term problem with it is you're not actually creating more value for customers. You're just kind of moving money from one pocket to another or changing how you're measuring the value of that funny money that you may have created. In the end, like, it's kind of like the methamphetamines of entrepreneurship. It'll give you a nice quick hit, but it doesn't result in much long-term improvement. And in fact, it eventually comes to create health problems for the business. And one by one, all the tailwinds that had brought the chain to kind of the forefront and dominance, they had all disappeared, right? Amazon and these big box retailers were all very strong at this point. We weren't having many kids. The kind of consumerization of holidays had reached a crescendo. People weren't that interested in it anymore. And then came the death blow for the chain, the COVID pandemic. And then obviously, from the pandemic standpoint, like there were no parties. You couldn't do parties anymore because, well, the kids might cough on each other. And somebody might go to the hospital. So that was by itself just devastating to the chain. Like, who's going to buy birthday party balloons if, well, you might die from a disease if you go to the, if you go to the store to buy them? And parents sure as heck don't want to bring kids over to sneeze on each other and snot on one another. So that definitely hurt the chain in terms of the short term. But what also changed and what people didn't really realize was going to happen was The COVID pandemic brought a change in parents' attitudes towards birthday parties. And in, in preparing for this video and thinking about Party City, I went back and looked at some news articles from back in the day. And there was one from the Washington Post, which was really interesting, where parents talked about how they no longer felt pressure to throw these big fancy birthday parties for kids. Simpler, more real, more intimate with family and friends was what the kids were wanting these days. They didn't want 80 of their closest friends from their entire first grade class showing up and having a competition to see who can provide the biggest gift, the biggest balloons, and the biggest piece of cake. And so in the final death throes, Party City declares bankruptcy in 2023, gets out from a mountain of debt that had been put on it by private equity, and struggles to try to come out in a post-pandemic world to survive and adapt to what's happened. But by this point, you can see where this all ends. And that's where it ended this week. With the chain announcing that it's just giving up. The debt load that it even has is too high. The headwinds and the inflation and all the pressure on lower-income consumers is too high. The competition from all these other sources that are just better and more convenient is too high. And eventually, like most things, you can only survive those headwinds so long, and then the business has to give up. And so what are the lessons from this whole thing? I think number one is we should all be totally scared and wary of financial engineering. And it can be as big as what private equity did with the chains where it puts debt on there, takes it public, goes private, does multiple arbitrage. Those things are fine. There's nothing wrong with them. But you shouldn't confuse them with creating real value for customers. And, you know, understand that they only last for so long. And you just want to make sure you're not the person looking for a chair when the music stops. And then the second one, which I think is even more relevant, is you have to understand why your business exists. What are the tailwinds that cause it to be there? And then be careful when those turn into headwinds. When you start to see multiple things coming against you, like, eventually they'll kill your business. And you have to be ahead of those. And it's very easy to miss them. I've done it where they just happen one at a time. And then suddenly you look up and all the things that made your business great are now making it impossible to be competitive and to be profitable. And look, what should Party City have done differently? I think some of the smartest people in this whole thing were the folks back in 2005. Whether they knew it or not, they were ahead of the game. Their trends were going to change for Party City, and they were going to eventually kill the business. While it took nearly 20 years for that to happen, they got out at the perfect time. They got out at a peak valuation before things all went to crap. And I think that's the big lesson here. Like if you're going to mimic anybody and you want to be a player in this story, you either want to be Mandel who started the thing, or you want to be the investors who sold at the very top. And ain't nothing wrong with doing that as far as I'm concerned.