What happened to Edcon?
In May 2007, US private equity firm, Bain Capital, completed its acquisition of Edgars Consolidated Stores [“Edcon”] for R25.7bn (US$ 3.7bn) in South Africa’s largest ever buyout. The deal valued Edcon at a 9.3x the group’s earnings before interest, tax, depreciation and amortisation [“EBITDA”] and represented a 61.6% premium to the 30-day average share price in the period before the parties said they were in talks. Not surprisingly, Edcon’s board unanimously recommended the offer.
However, on 30th June 2015 Edcon announced an exchange offer on its unsecured euro bonds due 2019, confirming what everybody already knew, that it could no longer afford to pay it debts.
What went wrong?
In the bond market we used to say that companies failed for one of two main reasons, they either 1) no longer needed to exist (e.g. typewriter manufacturers) or 2) their capital structures were unsustainable (i.e. they had too much debt). In Edcon’s case it seems to be a little bit of the former and a lot of the latter.
Bain financed its acquisition with nearly R19bn of debt, equal to 73% of the purchase price and 6.8x Edcon’s EBITDA. This amount of debt was unheard of for a large South African retailer and high even by international standards. None of this would have been an issue if Edcon had been able to grow. The growth potential of the South African economy was a “significant factor” in Bain’s investment decision. However, since the acquisition the South African economy has suffered from disappointing economic growth, rising unemployment, declining consumer confidence and decreased lending to households.
To counter the economic challenges, Edcon’s competitors invested heavily in stores, product offerings, systems and (except for Mr Price) increased credit sales. Edcon’s high levels of debt meant that it lacked the flexibility to invest in its business. Edcon freed up cash in 2012, by selling its credit book to ABSA. ABSA tightened lending criteria and in the quarter ended December 2014 Edcon’s credit sales declined 12.1%. Edcon also made various missteps including merchandising errors that impacted same store sales. The net effect was that Edcon’s share of the non-food retail market is down 9 percentage points from 32% in 2007. At the end of their last financial year, Edcon’s interest burden was R3.1bn while EBITDA of R2.7bn was still the same as at the time of the acquisition. Edcon’s capital structure has clearly become unsustainable.
Edcon has also struggled to keep its business model relevant. Edgar’s’ (51% of revenues) department store model is under pressure from dynamic new entrants to the market like Cotton On, Zara and Forever New, while Woolworths’ combination of its high quality clothing brand, Country Road, and great food make it the new one-stop shop. The discount division (40% of revenue) faces a tough competitor in Mr Price, while CNA (8% of revenues) is struggling to exist in a world of online content and downloadable music and films.
Does this mean that retail is a bad idea in South Africa?
No, South African clothing and footwear sales grew by 9.3% on average between 2007 and 2012 and are forecast to grow by 7.1% through 2018. The share prices of Truworths and Foschini are nearly double what they were at the time of the Edcon buyout, while Woolworths is up over 300% and Mr Price up over 700%. All of these companies have higher EBITDA margins than Edcon, while the most recent same store sales are up 9.2% at Mr Price, 5.5% at Foschini and 3.4% at Woolworths (Truworths is down 0.8% and Edcon down 1.6%).
What are the take away messages?
Don’t overpay, don’t take on too much debt and get your strategy right!
(Sources: Personal experience of various Edcon debt deals, Google Finance, Business Day, Bain Capital, Finance Week, Edcon, Financial Times)
Dr Andrew Louw CFA