Analysis: Has private equity been good for retail?

Private equity hasn’t had the best start to 2013 - beds retailer Dreams and fashion specialist Republic, both owned by private equity companies, plunged into administration saddled by crippling debt burdens.

But do such failures mean the private equity model is failing retail as a whole? Even before the turn of the year, Comet - owned by OpCapita, which strictly speaking is not a private equity firm but adopts a similar model - went bust in November, and in January 2012 Lion Capital-owned La Senza bit the dust.

Former La Senza owner Theo Paphitis slammed private equity owners at the time, saying: “Some people go into retail thinking they will make quick money. This is why some private equity firms get it so badly wrong.” He said Lion Capital had “struggled” with the La Senza concept, and that investing in retail is a long-term commitment.

Nick Hood, head of external affairs at analyst Company Watch, which tracks corporate financial health, says private-equity ownership can result in more debt than a retailer can cope with.

“Private equity is trying to defy financial logic,” he says. He adds all the recent failures ended in similar ways.

“Whether it’s Dreams, Republic, Comet or La Senza, it had a negative net worth and huge debts. The balance sheets were shot to pieces.”

In it for the short term

Hood says private equity companies and the way they work are fundamentally opposed to the way retail needs to operate. Retailers face long-term structural change as online and multichannel change the way the industry operates, and businesses need to think strategically as a result. But Hood argues private equity bosses are programmed to think only of their investment and increasing the value of the business within around five years, which is when they typically sell it on.

“They don’t think beyond five years. They want to be in, make their money and out.” He maintains the psychology of private equity deals doesn’t help - some companies make several deals in the hope that a few will work, and don’t worry about those that don’t.

“The way they structure their deals makes struggling retailers vulnerable,” he says.

Hood’s other problem with private equity ownership is the secrecy surrounding some of the companies. In the case of Republic, for instance, he says: “The trading company sits at the bottom of a corporate structure, and on top there are nine UK holding companies above it. The debts are hidden.”

He regards the lack of transparency of many private equity businesses as a “moral issue”. “We are inducing people to trade with a company as dressed up to look stronger than it is. Where’s the open disclosure that the UK believes makes it a great place to do business?” he asks.

Success stories

But private equity has its defenders, of course and, not only that, it has plenty of apparent successes under its belt.

Shoe retailer Office, pets specialist Pets at Home, value player Poundland and sports specialist Wiggle are all
private-equity owned.

For Rob Templeman, former Debenhams boss and now non-executive chairman of gambling company Gala Coral, the form of ownership doesn’t matter. What’s important, he says, is the quality of management.

“You have to differentiate between capital structure and management ability. If a retailer over expands, it’s a management decision, not a financial one,” he argues. “You’ve got to say ‘why did it fail?’ as opposed to looking at what the ownership structure was,” Templeman says.

He points out that there have been more successful retail deals in private equity than bad ones - Boots, for example, has become a well-known long-term private equity success. He also points out that many retailers, including Jessops and HMV, that have gone under haven’t been private-equity owned.

Gareth Whiley, a partner at private equity firm Silverfleet Capital, which owns Office, agrees that the retailers that failed have largely been those that struggled to adapt to a changing retail environment. He adds that retailers were far keener on the idea of private equity five years ago, when financiers more generally were reticent to put money into retail.

“There was a dearth of people wanting to put money into the retail sector,” Whiley says. “The big reason retailers have gone down is because the model doesn’t work or they have got too many shops. Private equity is not causingthe changes.”

Templeman says the current dislike of private equity will pass. “It’s a moment in time,” he says. “Four to five years ago, everybody wanted to be owned by private equity.”

Vulnerable times

But Whiley admits private equity can sometimes contribute to problems such as retailers’ tendency to over expand: “I will concede we [the private equity sector] facilitated the expansion of stores. That exacerbated a bad situation.”

It is such large store portfolios, and the resulting high rent bills, that are causing problems for some retailers, Whiley says. Even a small drop in turnover can make a retailer vulnerable if a large rent bill has to be paid.

Jonathan Buxton, a partner at financial advisory firm Cavendish, says problems don’t just depend on the type of retailer, however. There are different types of private equity firms as well.

While some are more focused on the longer term, others are known for moving in on retailers when they’re at their most vulnerable. Sun European for instance is known for taking on retailers when they’re in dire need of
a turnaround.

Some of these deals go well - Epic, for instance, turned tea specialist Whittard of Chelsea around after it purchased the business in 2008 - others end predictably badly. “These companies come into very difficult situations and almost inevitably the business falls over,” Buxton says. “It is a little controversial, as they’re not doing it for free - they’re making money out of it.”

But he says in general the problems retailers face under private equity ownership are the same as they would face in any situation. “A lot of the situations that have gone wrong for private-equity haven’t been because of too much debt - it’s been because the market for the retailer has contracted,” Buxton says.

Whiley adds that the accusations of short-term thinking in private equity are unfounded. “Some people accuse us of being short term in nature but nobody’s going to buy a business from you that doesn’t have another five-year plan,” he maintains.

Hood says some private equity companies should be encouraged away from the sector. “Those private equity players who aren’t in UK retail for the long haul should be encouraged to recognise they have got a looming problem and consider getting the business into safer hands,” he believes.

Some have had their fingers burnt,and there are likely to be fewer deals done in retail in the coming years. But Whiley says there are opportunities to be found. “If you can pick a winning format and winning management team, even in a recession there are still businesses that are doing extremely well. Retail is undoubtedly a risky sector, but when it works it’s turbo-charged,” he says.

Despite high-profile failures there are many likely to inspire continued private equity interest in retail and most owners will aim to make their returns from success, not failure.