Not long ago, liquidation seemed inevitable for bankrupt department store operator Bon-Ton Stores Inc. (NASDAQ: BONT). The company's desperate attempt to restructure outside the bankruptcy process failed earlier this year when it couldn't find an investor willing to finance a comeback effort.

However, Bon-Ton may have found a way to survive. Mall owners Washington Prime Group (NYSE:WPG) and Namdar Realty Group are teaming up with asset manager DW Partners to bid for the company. If this group wins an auction later this month and receives bankruptcy court approval, it will be able to buy most of the company's assets and keep Bon-Ton's operations going -- at least for a little while.

Some creditors want to shut the company down

For several months, a group of investors that own about $251 million of Bon-Ton's second-lien debt have been demanding an immediate liquidation of the company. These creditors stand near the end of the line in terms of getting repaid. They have consistently argued that there is no realistic path forward for Bon-Ton as a going concern, and that delaying the inevitable would only cause the company to burn more cash.

This group of second-lien debtholders has partnered with liquidation firms to submit a cash-and-debt offer for Bon-Ton's assets, valued at $740 million. If they win the bankruptcy auction, they would immediately begin liquidation sales and wind down the company's operations.

The exterior of a Bon-Ton department store

Some creditors want Bon-Ton to liquidate its assets immediately. Image source: Bon-Ton.

However, Bon-Ton's management has shown a clear preference for keeping the company in business if at all possible. Bankruptcy lawyers for the company noted that Bon-Ton has tens of thousands of employees and supports lots of additional economic activity at malls and through its vendors.

Mall owners to the rescue?

A consortium of Washington Prime, Namdar Realty Group, and DW Partners recently signed a letter of intent to acquire Bon-Ton as a going concern for at least $128 million in cash. They would also have to assume a portion of Bon-Ton's debt, so it is difficult to evaluate the total value of this bid compared to the liquidation bid.

Washington Prime and Namdar Realty Group have ample incentive to keep Bon-Ton afloat as long as possible. Each one has about 15 properties anchored by stores across Bon-Ton's various retail nameplates, although some of these stores are set to close this month.

While Bon-Ton represents a relatively small portion of rental income for both mall owners, the loss of an anchor tenant can sometimes throw a midtier mall into a death spiral. Other tenants often have the right to terminate their leases or receive automatic rent reductions when an anchor store closes. Thus, buying Bon-Ton out of bankruptcy could be good for Washington Prime and Namdar Realty Group even if the company only breaks even.

This is just a Band-Aid

Bon-Ton plans to hold a bankruptcy auction next week, at which it is likely to choose the bid from Washington Prime, Namdar Realty Group, and DW Partners so that it can continue operating. However, a bankruptcy court judge will have to approve the deal, and the second-lien creditors are likely to fight hard to block the sale if they believe it will shortchange their claims.

Even if the going-concern bid is finalized, Bon-Ton is unlikely to survive for very long. The company has already cut costs as far as it can, so its turnaround plan relies upon stabilizing in-store sales, growing e-commerce revenue rapidly, and increasing merchandise margins.

With the economy currently near full employment and consumers benefiting from recent tax cuts, it's possible that Bon-Ton could achieve its ambitious goals in 2018 and 2019. But even in a best-case scenario, it will remain barely profitable. Meanwhile, Bon-Ton will continue to fall behind rivals on the technology front, as its small size and weak profitability prevent it from making big investments. Over time, this will make it harder for the company to compete.

As a result, when the next recession hits, it will be game over for Bon-Ton. If the struggling retailer can barely survive when times are good, it won't have a prayer when the external environment turns unfavorable.

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