KILL OR CURE

Doctors differ; patients die. This cliché might aptly sum up the perceptions that people hold about the latest craze in retailing – Company Voluntary Arrangements (CVA’s)

I touched on this phenomenon in blog sixty-three. Just to recap, a CVA occurs where a company seeks to avoid going into administration. It is a form of insolvency, where the company is allowed to continue operations while taking the opportunity to take stock of its business strategy and off-load debt. It requires the support of seventy-five per cent of its creditors for this to happen.

In the retail context it has become a very popular tool. Retailers are arguably undergoing the most hazardous period for a long time. Consumer spending and confidence has dropped significantly. The on-going onslaught from online retailers continues unabated. Wages are rising. Rental costs have also been rising and business rates in the UK have also increased dramatically in the past couple of years. Net result? Trouble for all retailers, including the “biggies”.

Over the past year in the UK around fifteen major retailers or restaurant chains have pursued the CVA route as a mechanism for survival. “Biggies” such as Maplin and Toys R Us have entered into administration. In addition we have the spectre of business rates. To highlight the costs associated with such rates, toys R Us faced an annual bill for £22 million.

For many years it could be argued that power lay in the hands of landlords and retail developers. Rental agreements were based on twenty-five year, upwards only arrangements. In the good times large retailers in particular were relatively complicit in this approach: based on their optimism that consumer spending would continue to rise. For the most part this was an accurate view. Sure, there were dips and troughs – short-term decline in sales. However it was exacerbated by the major global recession which “kicked in” around 2009. Since then costs have continued to rise. Online retailers not bound the costs of business rates and rental agreements, have continued on their growth trajectory, eating into the sales revenue of the traditional bricks and mortar retailers.

The UK government, despite platitudes and genuflection to small retailers in particular, has continued to see business rates as an easy option when it comes to raising revenue. In 2017 this income source for the government raised a total of £27.3 billion: a quarter of which came from the retail sector.

In the face of spiralling costs, high profile retailers such as Next and House of Fraser have screamed “enough”. Faced with these increasing costs, they have spotted an opportunity (through a CVA) to reduce their store portfolios, re-group, refuse to continue with existing rental agreements and generally streamline their operations. The rationale for this is based on the need to cut costs and compete on a more level playing field with their online oppressors.

It sets us up for a classic case of “who blinks first”. Landlords are firmly in the eye of the storm here. Previously they have enjoyed an unfettered advantage by being able to enforce long-term, upward only agreements. Now retailers are fighting back and demanding a better deal.

Next recently renewed agreements with landlords with nineteen outlets. They achieved a net rent reduction of around twenty-eight per cent. Other retailers are also arguing that landlords have to be more flexible – given the fact that many of them are prepared to negotiate and reduce existing agreements.

Landlords are up in arms over CVAs. They see themselves as being the victims. Other creditors have a vested interest in keeping retailers alive and well. They argue that reductions and cancellations of existing lease arrangements allow retailers to shed a major cost and restructure, while they take the hit. Retailers as a consequence are seen to be rewarded for poor strategy. They can regroup and move on. Landlords, if they agree to such an arrangement may receive as little as ten pence in the pound in the settlement figure.

The evidence as to the success of such as strategy points to the fact that many CVAs do not work. If retailers see it as a short-term fix then they are mistaken. A Deloitte report indicates that four key success factors need to be in play before there can be any confidence that such a strategy may work.

  1. Creating the correct and balanced property portfolio. Closing stores to reduce costs is myopic unless they are closed as part of an overall strategy review.
  2. CVA’s only work as part of a wider restructuring of the business.
  3. It requires the full support of key financial and other stakeholders.
  4. It must be based around a comprehensive communications plan.

As of mid-May 2018 retailers such as New Look, Carpet Right, Mothercare, House of Fraser and Select are pursuing rent reductions through CVA’s.

Are the landlords correct in their views about CVA’s?

Clearly they have been complacent and casual in their approach – given the inbuilt advantage to upward-only agreements. It can be argued that they deserve a thrashing.

Equally it can be argued that retailers are taking advantage of the situation. For instance in the case of Carpet Right, landlords argued that it has over £60 million of freehold property on its financial statements. This is estimated to be more than double its market capitalisation. This has been signed over to its banks. This has led to accusations that generally retailers following the CVA route are dodging their responsibilities to a key stakeholder in the process: the landlord.

The answer to this question probably rests somewhere in the middle in my view. Landlords arguably have set themselves up for such exploitation. They have ignored the realities of the market-place; where the need for so many outlets has declined, forcing retailers to rationalise their portfolio.

Retailers arguably are exploiting the opportunity. Landlords and owners of shopping malls, retail centres and on the high street clearly are not going to benefit from closures and “for rent” signs. A study by Colliers, the real estate advisory company indicates that across fifteen town centres in the UK, there is a vacancy rate of almost thirteen percent (2017) – an increase from twelve per cent in 2015.

Negotiation is inevitable and certainly for the foreseeable future it will be “downward” only. We might even see as shift to what tends to happen in the USA: namely rental agreements that are based on annual turnover.

The other “elephant in the room” is that of increasing business rates. This is an indictment of lazy government in my view. It is all too easy to slap on increases without paying proper attention to the changing landscape that faces retailers who have large tracts of physical outlets and stores.

Adjustments need to be made to reflect these changes. Currently we are not witnessing any meaningful changes in approach to the application of business rates from policy-makers. This is apparently a “non-negotiable” cost: it is imposed on retailers. While platitudinous discussions take place with them, I would argue that their views are largely ignored when it comes to fixing the business rates increases.

CVA’s will not cure the ills of a particular retailer. It can lead to short-term benefits. If a properly created overall strategy review takes place then it is possible it will work. It is not a cure however. Whether it will kill the retailer is open to debate.

 

Advertisements

HOUSE OF CARDS

Another venerable British retailer: House of Fraser has run into difficulties. In early January 2018 it reported very poor sales. It also announced that it would have to rethink its overall strategy, particularly with respect to its physical stores portfolio.

This should send warning signs to us in terms of the on-going challenge for traditional “bricks and mortar” retailers grappling with online channels and the ever-growing threat from that quarter.

House of Fraser is rapidly looking like the House of Cards. It has around sixty stores in the UK, most notably iconic locations in Glasgow and Edinburgh. Around one-third of these Department Stores are reported as being unprofitable. Hence the need to rapidly rethink the extent of their continued presence on the high street.

Without meaning to sound like a long-playing record, it once again the highlights challenges of remaining relevant and competitive for Department Stores such as House of Fraser in light of the changing way in which shoppers now engage with retailers.

In 2014 it was acquired by the Chinese conglomerate, Sanpower.

The ongoing problems in the early months of 2018 were exacerbated by the rumours of closures of stores such as the one in Belfast.

C Barrier, the owner of Hamleys toy stores is about to become a new majority shareholder.

In March, Sanpower agreed to inject around £15million into revitalising the stores and the online channels.

Another bellwether of the retail scene in the UK appears to be going the way of others, such as BHS. A familiar story with a potential familiar ending perhaps.

It is also seeking Company Voluntary Arrangement (CA) with its creditors in order to extricate itself from the crippling debts that it has developed in the last couple of years.

This is an interesting and well-worn route for many companies in a similar position the House of Fraser. Essentially it involves a binding agreement with creditors to allow a proportion of its debts to be repaid over an agreed time period. It needs seventy-five per cent of the creditors to agree to this before it becomes a legal agreement. Conveniently in the case of the House of Fraser it provides a mechanism for renegotiating rent agreements with landlords.

We should pick up on this because sky high rents are proving to be the bane of “bricks and mortar” retailers in the face of competition from online retailers, who are not hidebound by such crippling costs. In the case of the House of Fraser, the ability to get a CVA from its creditors, particularly its landlords is problematic. They are becoming increasingly cynical about the ease with which retailers can escape legally acquired debts: thus leaving the landlords with little option but to accept the revised repayments. In the UK, the rental problem has been heightened by the practice of long leases being employed by landlords and upward renegotiations of such leases in terms of price increases.

The other “elephant in the room” relates to the increases in business rates announced more than two years ago. While this has had significant repercussions for small independent retailers, hefty increases are now beginning to bite into the cost structures for much larger retailers with multi-sites across the country. Another nail you might say in the “coffin” for such operators.

House of Fraser has set a goal of removing around thirty per cent of its physical space. We can expect to see a major rationalisation of its stores. Because of the scale of its operations – it currently employs around 6,000 people, the implications for them and retailing in general look to be pessimistic over the coming months. At present its annual build for leases and rents comes to around £140 million. This is a serious millstone to have hanging around its neck. It makes it less agile than its online competitors for starters.

One feels that any future investment by the new majority shareholder, C Banner is dependent on the CVA going through. As noted earlier this is far from being a certainty at present.

Lest we lapse into nostalgia for the Department Stores, it is not all down to an uphill struggle against the spiralling costs of business rates and rental agreements. Sluggishness in the market in terms of people not spending as much as before is also endemic to the overall retail sector. We have witnessed a fifteen per cent fall in the pound since the vote on Brexit in 2016. Inflation has risen to over three per cent – one per cent higher than the target as laid out by the UK government.

Put simply there are too many outlets on the high street. With over twenty per cent (and rising) of market share held by online players in the UK, this over-capacity will have to be addressed by all of the “bricks and mortar” stores sooner rather than later.

While I do not believe that we will see the elimination of the need for a physical presence, there is a chronic need for readjustment of the portfolio of stores.

I also believe that that is not enough. Retailers such as House of Fraser still have a role to play. I believe that it was close at least one-third of its current portfolio of physical stores.

The real question is should be addressing now is what do we do inside the remaining stores?

We have preached the importance of fully embracing the importance of experiential marketing and the need to redefine the purpose of physical stores and what they offer to the shopper. In the Department stores such as the House of Fraser is it enough to attract a range of well-known brands into concession areas and hope that this will pull people into the stores? I think not. Shoppers can now access brands such as Jo Malone across many different retail channels. They might “pop in” to the House of Fraser to see the new lines and categories but will (in many cases) make their purchases from other retail channels offering a better price.

To be fair to House of Fraser it has shown some degree of innovation since being acquired by Sanpower in 2014 with respect to its digital marketing strategy.

It has introduced digital mannequins and I-Beacon technology into many of its stores. It has updated its app and it has set itself a target of generating fifty per cent of its sales from digital channels.

Back to the physical stores! Space is space. Does it matter who uses this space? It does not have to be exclusively used (in this case) by House of Fraser. Why not use such space for gyms? Personal trainer facilities? As long as there are companies out there prepared to pay for the use of such space then it generates revenue and (if handled properly) can turn a cost into a revenue generating stream for the retailer.

Will House of Fraser survive? I believe a slimmed down version (in terms of physical outlets) allied to imaginative use of space and a revamped omni-channel strategy will lead to a rejuvenation in fortunes. However they have to move quickly and make hard decisions. Some iconic stores may have to go such as the location in Edinburgh. It has to avoid becoming nostalgic and maudlin (hard-nosed new shareholders will not allow this to happen). It will have to fully embrace the wider notion of entertaining shoppers and re-defining what goes on within the store.

Let’s see what happens in the coming months.