Real Deals in Focus
There is no escaping the fact these are tough times for the retail-focused private equity industry but there is a general belief among their community that the nature of the sector will continue to throw up some interesting investment opportunities.
By Glynn Davis
This was the view shared by a number of private equity specialists who spoke at the recent Real Deals in Focus – Retail event in London, including Henry Jackson, managing partner at Merchant Equity Partners, who remains positive on the future prospects. “Because this sector enables you to differentiate and to build businesses through operational changes the industry remains interesting. We’re operational improvers who change businesses – from supply chain to management and how to display products – and although there are fewer distressed assets to look at there’s still a lot we can do to even a good business,” he explains.
This has typically meant debt funding has been there for the right deal even though there is an acceptance that it is much tougher to raise the backing for leveraged deals compared with a few years ago. “You don’t spend time on thinking about debt, it’s all about the business plan,” adds Jackson. Max Biagosch, principal at Permira, agrees debt financing is not ultimately a problem: “It’s fair to say retail deals are tough – especially of a size – as there are only a handful of [banking] players who understand retail. They are choosy, but rightly so. If you need the financing for a deal and you don’t get it then there’s something wrong [with the deal].” Despite this tough backdrop Roger Pedder, chairman of Clarks Shoes and Bargain Booze, says multiples of buy-outs have still been “aggressive”. “I doubt we’ll see the debt leverage of four or five years ago as the world is now less predictable but some of the [private equity] businesses are cash rich. There is a lot of carry-over of funds from 2008 that remains unspent. So there is a situation of dedicated money to be spent and a paucity of deals so they have been bid-up.”
However, the higher multiples have been specifically related to the few high quality deals that have come to the market, according to Roger Holmes, managing director of Change Capital Partners and former chief executive of Marks & Spencer, who says: “There is discernment and we are seeing more valuation differences on quality.” This situation has resulted in the auction process being employed, but Holmes says he is not a fan. “We’re happy to compete in auctions. For the right business we will [get involved] but only if we can see something different [in the target],” he explains. This point of difference is unlikely to be expanding the business overseas as Holmes reckons it is a big challenge – especially for certain retail categories. “Food cultures are very specific but maybe fashion could be done. But the retailer would have needed to have already made the first moves and then we could help them do it,” he adds. Although it did not involve an international aspect, Fashion has been an area that Change Capital Partners has benefited from, judging by its successful exit from Republic.
Being at the younger end of the market could be seen as adding risk but the Real Deals event’s participants largely agreed that the changing nature of the category also makes it an interesting one for private equity.
“Young fashion is faddish but if you can manage brands through their lifecycles and you can ride this. But you can’t get away from the fact that things that come and go in fashion. And now there are cost pressures around clothing that will have to be worked out,” suggests Holmes.
There have however been some benefits to retailers from the current tough backdrop – notably the ability to get a good deal on new space although Holmes says it can be frustrating that landlords give low rents to incoming retailers to avoid voids whereas the incumbents are stuck with their existing high rentals. Another area where retailers are benefiting is through technology.
“Technology is a great enabler as you can re-spec a product and can gain a margin point every year from execution gains,” suggests Biagosch. The internet is also providing great opportunities, according to Pedder, who believes it is very difficult today for new entrepreneurial retailers to create new retail businesses in physical stores because the “big guys can absorb them easily”. Online is the lifeline. Holmes does not agree entirely and has more of a positive view of the high street for new operators: “The internet is powerful but if a business is done with authenticity, integrity, and has clear handwriting then having stores enables it to be shown.
There is an opportunity on the high street.” What might also be a positive point for the industry, particularly at the luxury end of the market, is the potential that consumers will become “bored with the recession”.
Holmes’ view is that many consumers will continue with responsible retailing but that this will be tied in with spending on “special things”. For private equity, he says it is “about finding categories where it is healthy or good, but it is also about spending because it’s dull to be subdued all the time”.
Biagosch suggests one of the real deciders in the choice of investments Permira makes is if the business is fun. “I’ve never seen a successful business where the management is not having fun. If you find this then you’ll be successful,” he says.
Of all the retailers that he could buy, if he had an unlimited cheque book, Biagosch selects online fashion retailer Asos because he believes it is one of the few online pure play retailers to “crack” branding and it has a phenomenal growth model combined with excellent service.
Service is also regarded as a potential differentiator by Pedder who selects John Lewis as his dream investment. “It’s the only retailer that has service. This [element] has been so reduced by the highly competitive retail universe and there is a premium attached to it,” he suggests. Holmes agrees and also selects John Lewis as his ideal investment.
Jackson selects Apple – again with the key rationale being its exemplary customer service.
That the panel should choose service as the key element they would seek in a business is telling and maybe points to a future where there is an increasingly polarised marketplace with service-focused merchants and entirely price-driven operators making up a large proportion of the sector.
