UK Retail Briefing - April 2019
Analyst Comment
 
DEPARTMENT STORES IN TURMOIL
Debenhams has dominated the news stories over the last month and as we write this we can’t say with any certainty that the matter has been resolved. Mike Ashley’s reaction to the news that Debenhams had arranged a pre-pack administration with its lenders led to one of the most outspoken comments we can remember seeing.

He wrote:

“As normal, politicians and regulators fiddled whilst Rome burnt. These politicians and regulators have proven to be as effective as a chocolate teapot. I restate my call for the advisors to go to prison given their skulduggery in undermining shareholders and other stakeholders, such as employees and pensioners.” And there was more.

It is not clear what he can do about it. Sports Direct had invested £150 in Debenhams shares which is now worthless and the Debenhams management has acted in a way to thwart the clear wishes of a party that owned 30% of its shares.

10 days after the outburst, Sergio Bucher, Debenhams CEO decided to leave the business. The chairman, Terry Duddy, has taken over as the interim CEO.

So – where does that leave us?

Shadow boxing
Sports Direct built up a 30% stake in Debenhams, but had not made a firm bid. On 8th April it offered to underwrite a £150m equity issue as part of a comprehensive refinancing but on condition that the Lenders agreed to a write off of £148m of debt and that Mike Ashley would be appointed CEO. Sports Direct also continued “to give active consideration to its pre-conditional possible offer for Debenhams at 5p in cash per ordinary share announced on 25 March 2019”. However, the proposed Equity issuance would be an alternative to the 5p per share offer. That £150m offer was increased to £200m early on April 9th.

The administration
The fact that none of these proposals was definite was Debenhams’ excuse to bypass Sports Direct and organise the pre-pack deal with its lenders, later on April 9th. Debenhams argued that it needed extra funds urgently and that there were too many conditions attached to the Sports Direct offer.

The business that has gone into administration is the holding company. The trading companies (Debenhams and Magasin du Nord) continue to trade normally. The administrators immediately sold those operating companies to an entity controlled by the Lenders. These Lenders also then made £200m available to the operating companies. That is, supposedly, enough for the company to continue its restructuring plans. There is talk that up to 50 of the 165 Debenhams stores would have to close, though none would go before next Christmas.

Management
There’s a general supposition among commentators that one of the main factors for Debenhams was a dislike of Mike Ashley. If so, nothing has actually appeared in print to that effect. But one of the conditions of the SDI (Sports Direct International) bid would have been that Mike Ashley would become CEO and that there would be an almost complete change of senior management.

SDI had already used its power to remove the chairman, Ian Cheshire, last January and also to remove Sergio Bucher, CEO, from the board. But Bucher carried on as CEO and having put a refinancing in place on April 19th he decided to leave the company.

Terry Duddy, the chairman has stepped in as interim CEO. His background is in Argos, hardly the rights pedigree for a fashion retailer. This seems to us to be the worst possible option, Mike Ashley has been (perhaps temporarily) fought off, and yet the company is left with no clear leader just when it most needs it.

Was Bucher worth backing?
Sergio Bucher, formerly from Amazon fashion, was appointed CEO in October 2016. Since then sales have fallen by 3% and operating profits by two thirds. We are now 2.5 years since his appointment and like-for-like sales in the first half (to the end of February) fell by 5.7%. Far from there being any improvement, the decline seems to have accelerated.

Perhaps the truth is that he was in an impossible situation. He took on a position where he was constantly firefighting to hold costs down to try to support the balance sheet, when the stores were desperately in need of reinvestment. His expertise should have been in the merchandise but arguably he never really had the opportunity to do much about it. The recent accelerating decline points clearly to a lack of success both with the stores and the product offer.

But could Mike Ashley and Sports Direct do any better?

What about Sports Direct?
The one thing lacking in all the recent announcements from Sports Direct is a sense of a strategy. Are we to believe that Mike Ashley could run a group with so many completely different businesses? At the moment there's Sports Direct itself - lower mass market, low price clothing with a sports bias, Evans, a bicycle specialist, House of Fraser - upper mass market department store with a strong branded element, and Flannels a very up market niche clothing brand. He has even made an offer for Findel (which has been rejected).

He has said that he would focus all his time on Debenhams, but that immediately raises the question of what would happen to the rest of Sports Direct. And who would be directing the recovery of House of Fraser?

Does SDI really have such management strength in depth? It worries us that these recent moves are just several steps too far. Mike Ashley is spreading himself much too thinly. And we just feel that there is too much evidence that retail conglomerates struggle to work - Look at Sears, Kingfisher, Arcadia, Storehouse, Metro, PPR, to name just a few. Retail management is most effective when it concentrates on one business with one target market.

Where next?
The Debenhams saga is far from over. The Lenders who currently own the operating businesses have said that they will sell them on. SDI could make an offer for them again.

In the meantime, is the restructuring plan at Debenhams actually working? The problem for us is that the focus on the plan is all about cutting costs and closing stores. There’s too little about the merchandise, investing in the stores and how to drive the business forward in what it is a highly competitive marketplace. On top of that, the latest results are significantly worse.

So – more questions than answers. We assume that there’s no way that the administration can be reversed. The future of the business lies with the lenders who are the current owners.

But what can they do? Backing the existing management is hardly an option as their CEO has decided to leave.

Should they back Mike Ashley? But the concern there is that he is spreading himself too thinly and has no proven expertise to turn round a business like Debenhams. Or would he want to convert them all to Sports Directs?

Worth saving
We think that the business is worth saving. We see no reason why there shouldn’t be a great future for Department stores in the longer term. The performance and strategies of the likes of John Lewis and Selfridges tend to support that view, but we have to admit that two of the top three in the UK are in deep trouble.

But to succeed, Debenhams needs time and financial backing. It needs a clear strategy which needs to be focussed on a clearly defined target market. Debenhams has focussed on cutting costs and SDI’s statements have been all about funding and bidding for the business. There has been nothing about what it would actually do with the business. In fact we don’t really know what will happen to House of Fraser either.

And for Debenhams, uncertainty is probably the worst thing of all.