KPMG / SPSL Retail Think Tank – White Paper #4 April/May ... - Hays

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accurate and timely data, particularly at a national level. Anyone with any experience of tryingto collect labour statistics (for example) from a retailer will readily understand this. Adding thecross-country differences in data collection methods and definitions make like-for-likecomparisons even more difficult and thereby less meaningful.Much of the debate about productivity centres on the input side. Output is measured either ingross output or gross margin terms, but were one to view it as “value added” in its broadestsense then the calculation becomes even more difficult to do. The RTT argues that were thisto be done, then the UK’s productivity performance would improve substantially.For all these reasons, the RTT considers that it is inappropriate to view productivity in theretail sector in the UK to be as low as it is often reported. Furthermore, the RTT isunconvinced that the productivity gap against other nations is increasing. The panelconcluded that because the real numbers are masked by property and occupational costs andplanning restraints productivity often looks worse than it otherwise would.The RTT also rebuffs the notion, current in some quarters that any sense of poor productivityin the sector is the consequence of ineffective and poor quality management, low labourproductivity, lack of general competitiveness and the slow adoption of ICT (InformationCommunication Technology).If this were true, overseas players would have come in and rapidly succeeded here, andgenerally they haven’t. For instance there are few examples where retailers are bringing inswathes of senior managers from overseas to replace UK counterparts. Instead the evidenceis that UK-sourced management is now venturing abroad and not only for expansionist UKstore chains such as Tesco but also for far smaller players such as Royal stationer Smythson.So just why are PE firms so interested in Retail?Tim Denison of SPSL commented that; “put most simply, the assessment criterion is whetherthe deal will deliver returns substantially above other mainstream asset classes i.e. equitiesand bonds.” The first reason for the interest, the Members all agreed, is because retail is acash generative business. Goods are often sold before they are paid for and strong cash flowallows fast amortisation of debt and when coupled with rationalisation of assets can mean aspeedy return for investors.As Richard Hyman of Verdict Research succinctly explained; “In these days of progressivelyextending payment periods, a growing number of retail businesses are able to sell their stockbefore they pay for it. Most of these deals depend one way or another on borrowing largesums to do the deal and then using cash from the leaner, fitter acquired business to pay back4
the debt. The acquired company in effect pays for itself to be taken over. Retailers are betterplaced than most to facilitate this because they are so cash rich.”PE houses look to capitalise on this fundamental strength of the retail sector by selecting theirtargets on the principal basis of two simple criteria. These are:-• the capacity demand for further significant rollout (estate expansion)• the potential for enhancements and extensions based on the strength of the brandCommenting on this, Paul Clarke of Barclays Retail & Wholesale Sectors explained; “Retail is‘instant’ compared to other businesses. It can happen very quickly. You can open new units,put on more sales, the growth opportunities are very good. The payback from capitalinvestment in a new store can be within 18 months which compared to other industries is veryquick.”Interestingly RTT Members did not agree unanimously that PE groups include a strongmanagement team as a third criterion, quoting recent examples of retailers whose seniorteams had been swiftly dismantled and replaced.Secondly, the current level of interest is fuelled by the large amounts of funds available attheir disposal and currently there to be invested. The ready supply of cash is driving demandfor deals. Thirdly, building upon this, retail deals have had a great track record for theinvestor; there have been some spectacular successes, take Debenhams as a recent case inpoint. There are great potential opportunities to be had through very straightforward financialengineering.A very strong motivator towards retail for PE groups can be a property portfolio of the targetretailer. Its value is a big attraction, and cash flows from it are predictable. A PE firm acquiringa property rich company will almost certainly have as its number one priority to separate noncorefrom core business elements. Freehold property is just such a tempting element. Armedwith a property portfolio it’s a simple matter to sell the estate to the highest bidder and leaseback the premises or to establish an OpCo/PropCo structure with greater borrowing capacityin the PropCo.The target retailer itself thus provides huge sums of money to pay off some of the acquisitioncosts making it a very attractive target. Admittedly it does, by doing so, become freer toconcentrate on its core activities. The downside is that it is saddled with ongoing rental feeswhich will have been negotiated at the time of the purchase and which, depending on therequirements of the PE firm for cash at the time of negotiation, may not be the mostfavourable possible.5
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