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Retail:The finance flowWill money start moving in 2011?
Foreword The retail industry is central to the UK’s economy: it employs in the region of 2.9 million people – 11% of the total UK workforce – and in 2010 UK retail sales stood at over £293 billion. Yet it is clearly facing severe challenges at the moment. Although the high street has been struggling for some time, the news keeps getting worse, with many retailers recently reporting their worst months on record. The pressures being created by high inflation - particularly in relation to commodity prices - and the rise in VAT and National Insurance contributions have really come through with full force during the spring of 2011, and have materially impacted upon consumer spending, with retailers suffering as a result. According to the latest figures from the British Retail Consortium, UK retail sales values for May 2011 were 2.1% down on a like-for-like basis compared with the same month a year earlier. In particular, food sales slowed dramatically, though other areas such as clothing, footwear and homewares also suffered. Furthermore, it looks unlikely that conditions will improve quickly: the continuing low interest rates and relative support from the banking sector are still masking a lot of the fundamental structural issues retailers are facing, primarily the significant over-capacity on the high street. As a result, banks will continue to be cautious when it comes to providing funding, especially where new facilities and new relationships are concerned. But it is not all doom and gloom. Certain strategies, especially those focusing on the online space and those where there are elements of technological innovation, are working well, and the banks and specialised retail lenders, though cautious, will back the businesses with the most robust propositions. There is also significant private equity money available for investment in the sector. Although there are certainly stormy times ahead for many in the retail space, strong support from the advisory community and sensible strategic planning should help retail businesses plot a course through the turbulence until calmer conditions prevail. Barry Knight Head of Retail Grant Thornton UK LLP2 Retail
About the surveyDuring the first quarter of 2011, Remark, the research and publications arm of theMergermarket Group, carried out a third major survey of mid-market opinion onbehalf of Grant Thornton. On this occasion, 200 CEOs and CFOs of UK businesseswith turnovers in the £25-250 million range were surveyed. All answers were treatedconfidentially and have been reported in aggregate. The statistics relating to the retailsector are drawn from a meaningful proportion of this national sample. Contents Foreword 2 Business outlook Economic conditions hamper recovery 4 Some optimism 6 Funding and strategy Poor access to capital 8 Specialist lending issues 10 Few big failures 12 Strategies to counter the downturn 14 Closing remarks In it for the long haul 16 Contact us 17 Retail 3
Business outlook Economic conditions hamper recovery Of all the respondents to the national survey of mid-market businesses carried out during the first quarter of 2011, those active in the retail sector clearly shared the most gloomy outlook on the UK economy and the prevailing financing environment. Overall, almost a quarter of the survey’s in generations had severely impacted retail respondents believe that the upon trading during the sector’s most financing environment will deteriorate important period of the year, and this over the coming year, while a further contributed to the surprise contraction in 30% see no likely improvement (see the overall economic growth figures for chart 1). What’s more, a full 50% of those the fourth quarter. If one adds to this the that rated the market as static or declining cumulative effects of the VAT rise and are not predicting an improvement in inflationary pressure brought about by conditions until 2013 or beyond, by far the rising cost of fuel and many key the most pessimistic forecast among all foodstuffs, it is understandable that the sectors (see chart 2). retailers might not be as sanguine as Among those retail areas feeling those in other industrial areas. The most the worst of the effects are businesses recent consumer confidence figures focusing on the sales of higher value certainly back up this bleak outlook, items such as cars, furniture and with a sharp decline in the latest figures carpets, and certain electrical goods. published at the end of May 2011 by the In contrast, the retailers of essentials – Nielsen Company and the British Retail ie supermarkets – have fared better, Consortium (BRC). as have DIY chains. In many respects this is understandable. To begin with, immediately prior to the survey being carried out the worst winter4 Retail
Chart 1 – How do you see the financing environment developing in the next 12 months? Improving Static Deteriorating 47% 23% 30%50% Chart 2 – If you selected Static or Deteriorating, when do you believe the environment will31% become more favourable? H2 2011 H1 2012 H2 201219% 2013 or later 0% Retail 5
Business outlook Case study: kiddicare.com Today, Peterborough-based kiddicare.com is the UK’s leading specialist online retailer of baby products, though its origins are firmly in traditional retail, having been founded in 1974 by Neville and Marilyn Wright. In 2000 the company began its move to online by developing a proprietary technology platform from which to grow its business. This strategy has led to major growth in recent years – the business has grown by 75% in the past three years alone – and kiddicare.com now generates over 80% of its £37.5 million turnover online. In late 2010, when kiddicare.com’s founders decided to seek a succession solution for the business, Grant Thornton’s Corporate Finance team was mandated to run what became a highly successful and fiercely competitive sale process. In February 2011, the company and the rights to its highly regarded technology platform were sold to Wm Morrison Supermarkets plc for £70 million, representing a first step for Morrisons in developing its online business. According to Tim Hansell, Corporate Finance Director at Grant Thornton: “kiddicare.com is a high quality business which attracted significant interest from a broad range of strategic trade and private equity buyers, with around 20 indicative bids being received for the business.” Mike Hughes, Corporate Finance Director at Grant Thornton, adds: “This process has provided further evidence that strategic trade buyers are very definitely back in the retail M&A market. Businesses such as kiddicare.com, with a strong buyers’ brand name, a scalable technology platform and significant operating capacity, can expect to continue to be top of buyers shopping lists in the months ahead. Expert comment: Stephen Robertson Director General British Retail Consortium Households’ disposable incomes continue to be squeezed by uncomfortably high inflation and low wage growth, while uncertainty over the effects of government cuts is hitting consumers’ sentiment about future finances. The VAT rise since last year is flattering the sales figures for most non-food goods, while renewed weakness in the housing market made life particularly difficult for retailers selling furniture and household goods. This new evidence of weak spending shows how important it is to support this soft patch in the recovery by keeping interest rates low.6 Retail
Some optimism Case study: Lookfantastic.com Created in 1997 lookfantastic.com specialises in the sale of salon hairThe statistics coming out of the survey do also show and high-end beauty products for both men and women, stocking oversome cause for optimism. 12,000 lines in total. However, the Sussex-based business is no ordinary47% of respondents believe that the In addition, there was some relief for e-commerce operation: it emergedfunding environment will improve over the sector during April 2011, when fine out of the Crown’s Salon Group, athe next 12 months, while 50% of those weather combined with multiple public family-owned chain of franchised hairthat rate the short-term prospects as holidays and the ‘feel good factor’ created salons, which since 1992 has alsostatic or deteriorating expect some by events such as the Royal wedding operated a programme to trainimprovement in conditions at some point combined to drive retail sales upward. hairdressers to NVQ Levels 1–3. during 2012. However, as the BRC has warned, The programme has trained over Certainly anecdotal reports suggest this is unlikely to be representative of 2,000 hair stylists to date.that a number of areas within the retail retail growth trends in the short-term, And these origins have played anlandscape are faring better than others. which are more likely to be driven by important part in fuelling theOnline sales in particular are forecast to the negative reactions of consumers company’s strong growth in the onlinegrow more significantly than those in the and retailers to developments in the space. The network of salons acrosshigh street. According to recent figures wider economy. London, Sussex and Kent – as wellfrom the BRC, while online, mail-order as the training programme with itsand phone sales slowed in May of this strong social responsibility angle –year, growth was still running 10.4% had proved attractive to manyabove the same month in 2010. high-end salon and beauty brands andSimilarly, there have been some notable enabled the business to build up thesuccess stories among retail businesses highly-successful online side.with a high IT element or other areas In late 2010 the founders ofof innovation. lookfantastic.com, advised by Grant Thornton, sold the business to the rapidly growing retail company The Hut Group in a deal backed by its existing private equity investor Balderton. For the founders, the move represented an important opportunity to take lookfantastic.com into a new phase of growth along as part of an ambitious and rapidly expanding retail group. For The Hut Group, the acquisition dovetailed well with its aim of penetrating the luxury goods and health and beauty markets in general, as well as consolidating its position in the online retail space. Retail 7
Funding and strategy Poor access to capital One issue that came through clearly from the survey is that compared to their peers in other sectors, mid-market retail businesses are facing especially tough conditions when it comes to accessing bank funding. In total, 60% of retail respondents rate The extent to which lenders will place the banks as being more conservative high demands on retail businesses seeking now than they have been over the past funding is graphically demonstrated by 12-18 months, and a further 13% see Chart 4. Questioned about the main no change. By comparison, if all sectors focus of banks’ attention, cash flow are taken into account, less than 40% of remained the key measure, as it had respondents rate the banks as more across all sectors. However, for retail conservative. In contrast, only 27% of respondents it is cited in almost every respondents are seeing any improvement single instance, compared with 66% of in banks’ appetite to lend (versus 38% responses across the whole sample. of the whole sample). What is more, the differential between the whole sample and retail respondents is uniformly higher across the various key metrics, from cash flow to business plans and historical earnings, suggesting that retail businesses looking to raise capital are much more likely to have to tick all the boxes for banks to take notice. 27% Chart 3 – Compared with 60% the last 12-18 months how would you describe banks’ current appetite for UK mid-market lending? Banks are more conservative Banks are less conservative No change 13%8 Retail
Expert comment: Charles Lamplugh Lead Relationship Director – Retail Lloyds Banking Group Life as a lending banker is not easy at the moment. Trading is very challenging and many retailers are behind budget. The key for both the banker and the retailer is communication and, to use the trust that has been built up through the relationship. We know that businesses will be behind plan but together we need to work on a revised plan which, if it takes a few weeks to put together so be it. We want it to be workable as we are all in this for the long-term.90% 66% 60% 57% Chart 4 – 43% Based on your 39% experience over 38% 37% the past 12 months, what are banks looking for in mid-market businesses? Retail OverallStrong cash flows Clear business plans Historical earnings Sector conditions quality Retail 9
Funding and strategySpecialist lending issuesThe fact that retail groups are finding the lending environmentdifficult is not a new phenomenon – the banks have treated theretail sector with considerable caution for some time now.This is further reflected by the results of At one level, this indicates that it has financing tools that are employed withinthe survey, which show that over 50% of been difficult for retail businesses to form the retail sector. To a significant extentretail respondents have banked with the new banking relationships for a number this complexity centres around the factsame lender for over five years (and of years. But it is also a reflection of the that much of the capital needed by retailalmost 90% for three years or more). often highly specialised nature of the borrowers is held off balance sheet because of the nature of leasehold arrangements. In addition, there are other areas of lending tailored to the sector such as foreign exchange facilities Expert comment: and trade insurance. Tim Hansell Director, Corporate Finance Grant Thornton UK LLP Chart 5 – For how long has Notwithstanding the current weakness in consumer confidence, your current debt investor appetite still remains high to provide equity funding to support provider been growth in certain niche fast-growing segments of the UK retail sector, providing you with such as online retail. debt finance? With the ongoing channel shift from the high street to online Retail continuing to build momentum, this is underpinning future growth potential for a number of niche online retailers, notwithstanding the Overall current economic backdrop. However, lenders are still cautious about providing leverage to ‘new to bank’ retail customers, and leverage multiples in retail/online transactions continue to be conservative, particularly where the off balance sheet rent roll is significant. Funding for retail deals continues to be challenging, and presenting well-thought-through business plans that will stand up to the rigours of lender credit committees is more important than ever. 54% 35% 33% 28% 31% 7% 12% 0% <1 year 1 to 3 years 3 to 5 years >5 years10 Retail
Few big failuresDespite the obvious problems retailers are havingsecuring funding, as well as the deteriorating consumerconfidence and pressure on disposable incomes,there have actually been relatively few major failures.Among the handful of high-profile Expert comment:groups to have ceased trading inrecent years are music retailer Zavvi, Barry KnightWhittard of Chelsea, the Officers Club,Woolworths and MFI. But of course Head of Retailthere are other potential candidates out Grant Thornton UK LLPthere: despite battling hard to fight theconditions, retail groups such as HMV Conditions for many retail businesses have undoubtedly been tough in recent years and look likelyare still facing real challenges to survive to remain so for some time. However, there areintact as high street sales of CDs, several tools that, with the correct advice, can beDVDs and games have lost ground to employed to ease the pressure. To begin with,online competitors. working capital constraints can be improved by the better management of creditor payments, employing ‘creditor stretch’ tactics, while Time To Pay (TTP) arrangements can be tailored by HMRC to suit the ability of the retailer to pay its tax bills. Developments in asset-based lending also mean that there may be a viable alternative to traditional cash-flow-based lending for some retail companies. Meanwhile, for businesses already in difficulties, Company Voluntary Agreement (CVAs) and debt for equity swaps can both be brought into play as part of a rescue plan. Retail 11
Funding and strategy Strategies to counter the downturn According to the survey, the main strategic priorities for retail respondents are largely in line with those of their peers across other sectors, with a strong focus on building earnings and growing market share. One noticeable difference, though, the conditions for retail companies have is in the responses surrounding cost been sub-optimal for some time now, cutting strategies: as it is across the whole many of the ‘firefighting’ measures sample, cost cutting is the third most have already been put in place and firms important strategy for retail respondents. are already likely to be following However, it is interesting to note that it sophisticated best practice models in was flagged by a significantly smaller areas such as supply chain management. percentage of retail respondents (33%) than overall (49%). Underlying this is the fact that, for many retail businesses, cost cutting is not a realistic strategy: rent, rates and staffing costs are typically the 60% most significant outlays, and retailers are restricted in the ways they can reduce their spending in these areas (minimum wage regulations, long-term lease contracts, etc). Furthermore, given that Chart 6 – Do you expect to complete No any significant 41 transactions over the % next 12 months? Retail Overall Yes 59 % 40%12 Retail
Expert comment: Mike Hughes Director, Corporate Finance The survey also provided little evidence Grant Thornton UK LLPto suggest that retail businesses are likely In the last six months we have seen one or two ‘stand-out’ M&Ato try and acquire their way out of the transactions, such as Wm Morrison Supermarkets plc’s £70 milliondownturn, with M&A ranking low on acquisition of kiddicare.com. This opportunity attracted a significant numberthe list of priorities. In total, only 15% of of trade offers from both the UK and overseas, and also a high level ofretail respondents cited consolidation and interest from the private equity community. The final price and deal multipleM&A as being a high priority, compared was driven by the quality of the opportunity and the strong strategicwith 22% of the overall sample. rationale for the buyer. Overall, in terms of M&A the online space with itsNevertheless, some 40% of retail ability to scale quickly and capture market share from the high street appears to have fared better than traditional retail businesses.respondents expect to complete asignificant transaction over the next year,suggesting that M&A activity mightcome onto the radar on an opportunisticbasis for well-funded businesses. Expert comment: Stephen Baker Partner, Corporate Finance Grant Thornton UK LLP Given that many retailers have already worked through cost cutting actions, more dynamic strategies may be required to counter the continuing downturn and drive growth. As well as driving online capability, options to widen product offer or add selective contribution enhancing locations, whether organically or via acquisition, should be considered, albeit financing such actions will need compelling arguments and creative solutions. Retail 13
Funding and strategy Chart 6 – Have you explored alternative sources of finance? 66% No, but under certain circumstances we would 34% Yes, but we decided against it 0% Yes, and we now use alternative Interestingly, out of the survey sample, retail sector sources of finance companies are among the least likely to have explored the potential for raising capital from alternative funding providers to support their growth strategies. But opportunities do exist, especially from within the ranks of private equity backers both in the UK and further afield. Among this type of institution there is a long track record of supporting the retail sector, particularly in niche areas of the industry or where there is the potential to generate scale in an otherwise fragmented market. It is therefore likely that a good proportion of the M&A activity within the UK retail area will be linked to or funded by private equity backed businesses.14 Retail
Expert comment: Mo Merali Head of Private Equity, Grant Thornton UK LLP Private equity has been a consistent supporter of the retail sector and has reaped huge rewards from backing high quality businesses in the past. More recently, however, the record has been somewhat mixed, with the double-whammy of the consumer recession and over-leveraged businesses leading to some high-profile failures. Notwithstanding this, we have seen significant private equity interest in the sector-focused on businesses with robust propositions – typically those in a unique market position such as HobbyCraft. The winners – both investors and businesses will emerge from those who are willing to embrace innovation and technology in their business model as well as their approach to the consumer.Case study:HobbyCraftHobbyCraft, the UK’s leading art and craft retailer, was established in 1995 by Warren Haskins, who had recognised thepotential for launching an art and craft superstore in the UK after having investigated the well established hobbies andcrafts market in the US. By 2010 the company had built up a network of 47 out-of-town stores throughout the UK,each of which carries over 35,000 products and caters for more than 250 different art and craft activities. When the time came for the group’s management team to look at options to realise their investments in the business,the potential upsides of a sale to private equity backers were clear: a well-funded financial backer with stronginternational reach would offer not just the funding, but also the strategic expertise and contact network necessary totake the company into its next phase of growth. Grant Thornton worked closely with HobbyCraft throughout the disposal process, which was concluded inApril 2010 when funds advised by pan-European mid-cap specialist Bridgepoint Capital acquired the firm in a deal worthover £100 million. Importantly, the founder and management team were given the opportunity to reinvest in the companygoing forward. Commenting on the deal, Paul Stout of Grant Thornton said: “HobbyCraft is a unique business which has gone fromstrength to strength and has defined the market for arts and crafts in the UK. The success and size of the deal withBridgepoint Capital is testament to the entrepreneurship and drive of Warren Haskins and the management team,and we have thoroughly enjoyed working with them throughout the process.” Retail 15
Closing remarks In it for the long haul While there may be some bright spots in the retail market – most notably in the online, non-store space – all the signs suggest that most British retailers will have to dig in for a long haul out of the current slump. But many will not make it: the latest available on how to put the necessary figures from the Insolvency Service on procedures in place, and how to access the administration of wholesale and retail the alternative sources of capital, be it companies in Q1 2011 show a 70% bank funding, asset-based lending or increase over the previous quarter and an private equity. 11% rise over the same quarter of 2010. However, there are options out there, both in terms of strategy and funding, Barry Knight and it is more important than ever that Head of Retail retail businesses seek the best advice Grant Thornton UK LLP16 Retail
Contact usFor further information on any of the issues explored in this report contact:David Ascott Geoff Davies Barry KnightT 020 7728 2315 T 01223 225630 T 020 7865 2150E firstname.lastname@example.org E email@example.com E firstname.lastname@example.orgStephen Baker Tim Hansell Chantal GoodmanT 020 7728 3100 T 01223 225616 T 020 7728 3299E email@example.com E firstname.lastname@example.org E email@example.comFor other queries please contact your local Grant Thornton office:Belfast Kettering NorthamptonT 028 9031 5500 T 01536 310000 T 01604 826650Birmingham Leeds NorwichT 0121 212 4000 T 0113 245 5514 T 01603 620481Bristol Leicester OxfordT 0117 305 7600 T 0116 247 1234 T 01865 799899Cambridge Liverpool ReadingT 01223 225600 T 0151 224 7200 T 0118 983 9600Cardiff London SheffieldT 029 2023 5591 T 020 7383 5100 T 0114 255 3371Edinburgh Manchester SloughT 0131 229 9181 T 0161 953 6900 T 01753 781001Gatwick Milton Keynes SouthamptonT 0870 381 7000 T 01908 660666 T 023 8038 1100Glasgow NewcastleT 0141 223 0000 T 0191 261 2631 Retail 17