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.

 

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