As consumers rein in their spending, the high street is bracing itself for a volatile few months, with many high-profile retail businesses, some backed by private equity, expected to fall by the wayside.
Weakening house prices in countries such as Ireland, the Netherlands, Spain and the UK are already affecting consumer confidence in these markets, and the effect on consumer spending is likely to worsen as house values slide. Yet high street spending in less residentially-challenged markets such as Scandinavia, Germany, Italy and France are expected to be much more robust.
Against a backdrop of the weakening consumer demand and ultra cautiousness from the banks, some of the flakier deals put together at the height of the private equity’s short-lived love affair with the retail sector are already unravelling.
In January, Hermes Private Equity wrote off its investment in the UK-based discount booksellers, The Works, which it acquired in a £50m deal three years ago, after the retailer was forced into administration. Administrators Kroll have since closed 85 of The Works’s 210 stores, resulting in 450 job losses. The bookseller is rumoured to be on the receiving end of an opportunistic £15m takeover bid from Endless, a Leeds-based private equity house. Shoe shop chain Dolcis, backed by Epic Investment Partners and Scots entrepreneur John Kinnaird, also went into administration in January.
In March and April there was a fresh round of casualties on the high street. Ethel Austin, a value womenswear chain renowned as a pioneer of cheap chic and which was acquired by ABN Amro private equity for £122m in 2004, went into administration. Earlier that month, Sleep Depot, a bed retailer, and the toy chain Toyzone, both also called in the administrators.
Retail players will struggle if debt burdens too high
Robert Donaldson, head of M&A and private equity at accountants Baker Tilly, said: “The major problem facing private equity owners of retail businesses is they are all burdened with a certain level of debt. That means they have to perform to a certain level or else the banks will step in. As the consumer downturn slows sales, some private equity-backed retailers will inevitably find the weight of the debt burden they are carrying too great.”
In the case of the bingo-to-bookies business Gala Coral, existing backers Permira, Cinven and Candover have been forced to stump up more cash to avoid the banks pulling the plug on the business. The company was bought for £1.24bn by Candover and Cinven in 2004, with Permira stepping in to acquire a stake in 2005 at the higher valuation of £1.89bn. It has been reported that these three buyout houses backers have stumped up an additional £125m of new equity in exchange for the banks loosening their convenants and enabling £83m of senior debt to be paid off.
One reason for the severe shortage of buyers of debt is that approximately £8 billion of debt used to fund the Alliance Boots mega-buyout last year still remains unsyndicated.
Anne Hoffmann of Graphite Capital believes this will mean that mezzanine finance and “good old-fashioned debt instruments” are going to play a bigger play a bigger part in future retail deals. She says: “The more marginal deals simply won’t get funded, but I think very good deals will remain able to do so.”
Other private equity deals in the retail sector that are showing signs of strain include Fat Face. This active outdoor clothing retailer was acquired by Bridgepoint for £360m in March 2007 at the peak of the debt-fuelled buyout frenzy.
On a smaller scale, Ossian Retail Group, owner of the Internacionale fashion chain and the Au Naturale interiors chain, is struggling after costs got out of hand last year. Ossian was acquired in a £45m buyout by the Glasgow-based private equity house Penta Capital, Graphite Capital and Bear Stearns in 2006. Distressed debt player Agilo recently bought £25m of debt provided by Barclays at the time of the buyout amid reports it plans to dismember the business.
Corteciel, a Spanish clothing retailer with 1,100 stores, which was acquired by PAI, Permira and CVC in 2005 finds itself in a similar position. To the dismay of some Permira insiders, it was recently written off as a “zombie” company by Edward Eyerman, head of European leveraged finance at ratings agency Fitch. Cortefiel’s senior bank debt was recently quoted at 67 per cent of its par value,
which would also suggest that its equity has become worthless.
Richard Morley, of NBGI private equity, says: “There was some frothiness in the market [for retail M&A, and specifically private equity investment in retail] over the past couple of years and some relatively high prices were paid. Obviously, this creates a degree of risk in a downturn. While the better retailers with strong niche positions will continue to perform well, even if consumer spending weakens, I think that weaker businesses – and especially those that are overly geared – are clearly going to struggle.”
At the best, Morley predicts that heavily-indebted retailers will have to rein in their growth plans. At worst they could go the same way as Icoseles/Gateway and Magnet.
This is article was published in the May 2008 issue of EVCJ – the European Venture Capital & Private Equity Journal.