Business sales: retail makeover tactics

New Look has announced an IPO, Pets at Home has been sold to private equity house Kohlberg Kravis Roberts (KKR) and talk of the potential sale value of Matalan continues apace.

All this has happened in the first few weeks of a year that is set to see many more retail businesses put onto the market.

Because investors of all kinds have often shied away from retailers in the past 18 months, this is likely to mean a beauty parade of businesses trying to attract the attention of the money pouring back into the market.

But what can you do to smarten your business up ready for sale, and should you use the same tactics whether you are considering an IPO or sale to a private equity house?

BDO has carried out research among private equity managers to see how highly they rate investment opportunities in the next year. Nine out of 10 expect to see their overall investment rates grow and half are expanding their teams to respond to this.

However, while there will be growth in private equity investment in retail, the research also showed the industry will attract the least investment activity among the major sectors in 2010.

BDO corporate finance partner Alex White explains that private equity houses are falling into two camps when it comes to retailers - those that wouldn’t touch them with a bargepole, and those that are attracted. He says this means retailers need to spend time understanding who the buyers are and what they want.

At the moment, White says that there is more capital than there is deal flow, delivering higher valuations. But he warns retailers not to hold off too long in the expectation of getting a better return. “There is a window, as private equity has not invested in 12 or even 18 months, and there is an imperative to do deals. As more businesses come to market this will go away,” he says.

In addition, he believes the likelihood of tax increases and a period of rising interest rates is likely following the general election, which means now is the right time to raise the “For Sale” sign if you are a retailer with an attractive growth strategy.

High-profile hires

Last month Fat Face hired a new chief executive - Anthony Thompson - a high-profile name in the industry, with George at Asda, Gap and Marks & Spencer on his CV. He is understood to be incentivised to build the business for a sale or float. And former Vodafone director Peter Bamford has been named chairman of Supergroup, also understood to be preparing an IPO.

Arden Partners retail analyst Nick Bubb says that the management team is a make or break issue when a business is readying for sale. As well as the right chief executive, the finance role may also need to be strengthened prior to an IPO.

He says that how well known the chairman or non-executive directors need to be depends on how strong the chief executive is, and both City grandees or seasoned retailers can work well in the chairman role. For instance, he said that New Look needed a big figure such as John Gildersleeve to follow Phil Wrigley as it finalised preparations for the IPO it has now announced.

Gildersleeve is Carphone Warehouse non-executive chairman, and was previously on the board of Tesco.

Former DSGi chief executive John Clare is now acting chairman of JJB Sports and non-executive chairman of Dreams, among his several non-executive roles.

He says that having a well known retail name on the board will only make a marginal difference to the valuation that can be achieved, but adds: “If you are planning to float, having someone that the City knows, and knows positively - analysts, as well as institutional shareholders and potentially some media - can help. If you are going to sell to private equity then it is less important.”

However, hiring someone high profile is not a guarantee of an immediate sale. Ocado appointed Michael Grade, who was at the time BBC chairman, as its non-executive chairman back in September 2006. This fuelled speculation that Ocado was gearing up for a flotation, but more than three years later the online retailer remains in private hands and is still the subject of IPO speculation.

Retailers do however need to look at the make-up of their management teams though; and ensure they have the right mixture of skills and knowledge.

PricewaterhouseCoopers UK head of retail and consumer Mark Hudson says potential buyers will quickly perceive any lack of cohesion in the management team. “You don’t need to have a retail name in a management team - but experience among your non-executives of going through this process is good,” points out Hudson. He adds that those who have never been through a deal process do not know what to expect or how much information to give out to potential purchasers.

And other senior members of management need to be prepared to take on additional responsibility to keep the machine running smoothly. “When you go into this process it takes three to six months and you need to make sure that the business can function and grow if your chief executive and finance director are out of the picture for 50% of the time,” Hudson says.

White believes that high quality management teams de-risk an investment, but he does not think that they need previous experience of working with a private equity house.

Clare says that retailers considering a sale should focus on their numbers and being able to explain the reason they want to sell. “What are the opportunities for the business going forwards?” Clare asks.

Similarly, for Hudson, nothing beats a clean track record that can translate into future performance. With this is mind, he says that one issue it is crucial for retailers to clear up is any areas of risk or uncertainty on their balance sheet.

This includes getting rid of any underperforming stores as quickly as possible. Hudson says that ideally a company should have a clean sheet for at least a year.

Clare adds that what investors will look at is prospects for the next three to five years. “They want to see potential for growth so you need a good growth story. People won’t buy a business based on the last three years’ numbers. What you have done historically is a guide,” he warns.

Time to go private?

IPOs normally achieve lower multiples than private equity sales, as illustrated by Pets At Home, so Hudson says that those looking for a private equity purchaser need to think about where they are going to get a return from.

Bubb says that there is no shortcut to a convincing financial record. This requires both sales and profits growth, and an indication that the company is not being sold at its peak. He points out: “Sports Direct came at the top of the market and then struggled to hold profits.”

And cost cutting to shore-up profitability in the short term is not right, as a growing company should be investing money in its expansion.

However, Bubb says that although it was a “trendy attitude” several years ago that retailers’ values would be marked down for having too much cash, the financial turmoil of the past year or so has changed attitudes - Debenhams has been marked down for having too much debt more recently.

“I would prefer cash to debt,” Bubb notes.

White agrees that investors like to see some cash at the moment. “Because retailers pay rent and have a lot of operational leverage they are seen as more risky, so cash is seen as a buffer, if they have had a bad season for instance,” he says.

One of the hardest things to manage is that buyers are fixated on like-for-like sales, but White says there can be sensible decisions to run the business for margin. He adds: “Although it is painful if you are coming to market, now is the wrong time to start to mess with your basic proposition.” He advises that while it is acceptable to talk about it with potential buyers, you can’t try and change your story mid-stream, for example by substantially changing promotions strategy.

Not all retailers will be able to show they have maintained continuing profit growth through the recession. But for those that can’t, White says there must be at the very least an indication that profits have been stabilised before they try to go to market.

Once a company is achieving the numbers it would like in anticipation of a sale, it also need to be able to present the numbers in a way that gives investors confidence.

Gathering together high-quality information about the business is more important than ever, as potential investors can be thrown by smaller issues, advises White.

And when an IPO might be the way forward, this is even more crucial.

Clare highlights that retailers need to work to the appropriate accounting standards - the International Financial Reporting Standards (IFRS) - if they want to float. And a lot of privately held businesses don’t yet have this in place.

And there are also things to avoid that are essential to maximise the value of a business. Hudson says do not get involved in any major projects that could bog the business down while it is up for sale. He mentions major supply chain reconfigurations and putting in a new ERP system as things definitely not to begin.

Talking up the value

A sale process involves a retailer having to share much more information about their business than they are used to. There are two aspects of communication that retailers need to think about when preparing for the sale.

The first is that a track record of communication shows willingness to communicate with potential IPO investors. The second point is that bringing on board a financial PR in the planning stages for a sale can help to maximise the value achieved at sale.

“If the historic numbers are fantastic and the future numbers are fantastic then that will drive the sale,” says Clare. However, he admits: “I think financial PRs have an important role to play in helping to raise valuations. But businesses have come to market without financial PRs on board.”

Bubb adds that open dialogue with the market needs to start early. “There is no point expecting people to start listening to you if you have not been open before,” he says.

He points out that New Look continued being open, running events such as fashion shows for example, when it went private in the same way as it had done as a public company.

“With an IPO the regime for disclosure and other regulatory issues is important. Profile and news flow is important, because the management team might only meet with investors two or three times a year,” White adds. With private equity investors contact will be much more regular once the business is sold.

One area that retailers often talk up prior to a sale is their growth potential and, particularly in some cases, their international expansion plans.

Supergroup - which is considering an IPO - has rapidly expanded internationally in the past 18 months.

Beyond a certain size of business, Bubb says, an international plan is crucial, as growth won’t be maintainable in the domestic market. For smaller retailers it is not an issue.

Pets At Home has said that it does not have strong international ambitions yet, however, it does already have three stores in Australia, proving that the model can be translated to other markets.

International plans can enhance a retailer’s sale story, but for White this needs to be more than just ambitions. “It needs to be being delivered, rather than a just a few pilot stores. History is littered with examples of famous retailers failing when they go overseas.”

Pets at Home was sold to private equity after considering an IPO, and there are mixed feelings about whether twin-track sales are appropriate.

“Twin-tracks are often a good way of generating interest in something. There are some genuine ones - but others are around inducing private equity to pay more,” says White. He adds that potential buyers will be put off if they do not feel a certain level of comfort there will be a deal. “Buyers want confidence there is a deal to do and a relationship. The sales process needs to be more intelligent than it was at the top of the boom.”

Whether the route chosen is public or private, there is no doubt that many retailers will be going through the sales makeover process this year.