Helen Dickinson on retail: Private equity players need real buyout vision

There is no doubt that the retail sector has got off to an explosive start this year. We are only in February and already corporate activity continues apace as both Woolworths and Somerfield find themselves the targets of private equity players looking to take them private.

Such has been the activity from the private equity industry that we at KPMG decided to take a closer look, and had a journalist interview retailers and a couple of bankers that supply private equity investors with debt funding (an essential component of any buyout). The report makes for very interesting reading.

While we all know that private equity houses are investing in listed retailers because they believe them to be undervalued, what is not so well known is whether these privately owned 'buyout' companies are managed differently in order that their true value can be realised by their acquirers.

It is true that irrespective of ownership structure the fundamentals in a retail business remain the same - getting the right product, in the right place, at the right price - but the way management achieves its objectives differs in the public and private world.

While a quoted retailer is managed on a profit-centric basis - with its key aim of achieving the like-for-likes sales and earnings growth that City investors demand - a buyout's focus is on 'managing-for-cash' to ensure it can pay down the debt it has taken on.

This involves disciplines such as identifying operational inefficiencies, marking down slow-moving stock, undertaking sale-and-leaseback deals on freehold properties and introducing rigid return-on-investment hurdles on capital expenditure.

While various parties have suggested that some buyouts have been done at too high a price and that these businesses have burdened themselves with too much debt, our interviewees strongly dispelled any such suggestions. They argued instead that, regardless of the debt, they could ride out any economic downturn, and that having the wrong products on the shelves for a season was a far bigger issue for them.

For smaller, fleet-of-foot retailers, such stock issues can soon be corrected because they are able to change their product lines swiftly. Since they operate privately they can be much more aggressive with mark-downs compared with a quoted retailer, which would be concerned about the impact of such a decision on its future profit levels.

The success of many buyouts in creating value for their shareholders (these comprise the management and private equity fund) suggests there are lessons to be learned for the whole retail sector about how to recognise inherent value and manage a retail business.

Since we have seen many successful secondary sales and flotations of buyouts it is clear that more value can be extracted from these retail businesses after they have been sold on. This indicates that they had not just been used as cash generators to pay off the debt, but that solid businesses had been created.

Based on events so far this year, there appear to be few signs of any slowdown, and many people in the retail sector expect more deal activity throughout the coming months. The private equity industry has clearly proved it has a real interest in the retail sector.

However, it has to be careful that in all the frenzied activity it continues to bring retail expertise to the deal table along with its financial engineering skills.

At a business lunch I attended recently, a senior retail executive suggested that private equity players must continue to bring some 'retail savvy' to their deals, otherwise there might be some serious mistakes made. I hope that they heed this warning, as a failure to do so could have serious consequences for the whole of the retail sector.

- Helen Dickinson is head of retail at KPMG

30 SECONDS ON ... PRIVATE EQUITY BUYOUTS

- There has been a surge of investor interest in retailers over recent months. Typical buyouts see up to two-thirds of the purchase price funded through debt; low interest rates make this a more efficient capital structure than stock market listing. Retailers' high levels of cash flow mean that debt can be serviced easily.

- At the end of January, private equity (PE) firm Apax Partners, which has investments in more than 330 companies globally, said it would make an offer for Woolworths. Woolworths' shares rose 22% on the news. On 8 February, the store group's board announced it had rejected a £789m offer because it did not represent 'acceptable value'.

- On 9 February, Somerfield received a bid approach from acquisitive Icelandic investor Baugur Group that valued the company at about £1bn. Baugur already owns 5.5% of the store chain and is in the process of taking over Iceland owner Big Food Group.

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