Is Ed­con reach­ing its nadir?

Finweek English Edition - - INSIDE - BY WAR­REN DICK

If re­cent re­ports are to be be­lieved, the tale of Ed­con, owner of some of t he countr y ’s most es­teemed re­tail­ers, might be reach­ing its nadir. The com­pany has a range of is­sues con­fronting it at the mo­ment, which as the cards cur­rently lie, are all con­tribut­ing to a po­ten­tially dis­as­trous end­ing.

Th­ese in­clude, in vary­ing de­grees, the de­te­ri­o­ra­tion of its un­der­ly­ing busi­nesses in line with slower con­sumer de­mand; t he ret­i­cence of Bar­clays Group Africa to grant credit to its cus­tomers; and the de­mands of try­ing to grap­ple with its big­gest prob­lem: the group’s cur­rent cap­i­tal struc­ture. Po­ten­tial prob­lems with the cap­i­tal struc­ture be­came ev­i­dent as soon as Bain Cap­i­tal bought and then delisted Ed­con from the JSE in 2007. Back then, for ev­ery R1 in eq­uity they in­vested, four times that amount in debt was as­sumed to fund the trans­ac­tion. The cap­i­tal struc­ture re­quired the most op­ti­mistic of as­sump­tions be re­alised in or­der for the com­pany to thrive, and by de­fault pay down some of the enor­mous debt it had as­sumed.

To­day, Ed­con has no eq­uity cap­i­tal – in fact, it’s neg­a­tive to the tune of R5bn, hav­ing been com­pletely eaten by losses sus­tained over the years. While this makes it tech­ni­cally in­sol­vent, the sit­u­a­tion has been per­mit­ted to con­tinue so long as there has been cash to meet its obligations. But even this premise is un­der threat.

The com­pany re­cently re­ported third-quar­ter re­sults end­ing De­cem­ber 2014 (what should be the busiest and most pros­per­ous quar­ter of the year for re­tail­ers). This re­vealed that re­tail sales ad­vanced just 0.5% (to R8.8bn) over the De­cem­ber 2013 quar­ter. While the com­pany gen­er­ated profit be­fore in­ter­est of R783m, this was more than sub­sumed by fi­nanc­ing costs of R860m.

The bal­ance sheet re­vea ls t hat Ed­con’s long-term debt has stayed con­sis­tent at R22.3bn over the last year.

Short-term in­ter­est bear­ing debt (now R388m) has gone up from the same time in De­cem­ber 2013, but has fallen since the end of March 2014 (when it stood at R1.2bn). This was more than likely as­sisted by an in­crease in trade payables, which rose by over R2bn to R7.79bn.

Clearly, push has now come to shove. Ed­con’s four re­tail clus­ters and its con­tri­bu­tion to group rev­enue com­prise Edgars (51%), CNA (6.9 %) a nd Dis­count – which in­cludes Jet (39.6%), and Edgars Zim­babwe (2.4%). In terms of op­er­at­ing profit, Ed­con and Dis­count each made about R1bn for the 9 months end­ing De­cem­ber, while CNA and Edgars Zim­babwe were marginally prof­itable. The com­pany has one more source of in­come: its share of the in­ter­est and fees that it charges credit cus­tomers, which gen­er­ated an op­er­at­ing profit of R780m in the pe­riod.

Nat­u­rally, for a com­pany in this po­si­tion costs are be­ing cut left, right and cen­tre in or­der to pre­serve cash f low. Group Ser­vices – the name of the line item for cor­po­rate over­heads – al­most halved be­tween De­cem­ber 2013 (R3.57bn) and De­cem­ber 2014 (R1.93bn). How much more can be cut re­mains to be seen.

In ter ms of it s debt, Ed­con i s funded through a va­ri­ety of sources, but pre­dom­i­nantly f r om f oreig n de­nom­i­nated (dollar and euro) f i xed i nter­est bonds which ma­ture in March 2018. In the in­terim, a rand­de­nom­i­nated f loat­ing rate note comes due in April next year. Based on the yields its debt is trad­ing on at the mo­ment, it’s highly un­likely that Ed­con would be able to re­fi­nance th­ese were they to come due now.

Be­sides the debt hold­ers (cred­i­tors), the ef­fect on l isted prop­erty could be enor­mous. Ed­con ac­counts for ap­prox­i­mately 4% of all listed prop­erty rentals across its port­fo­lio of re­tail, industrial and com­mer­cial space. Naeem Tilly, a listed prop­erty an­a­lyst at Av­ior Re­search, says: “Jur­gen Schreiber (Ed­con CEO) has been meet­ing with prop­erty funds to ad­dress the sit­u­a­tion and has stated that un­der­per­form­ing stores would be closed or re­sized. Those that could be closed upon ex­piry of their leases could well in­clude the likes of Edgars in Kil­lar­ney Mall and Mel­rose Arch,” says Tilly.

But it’s not all bad news. “We hear from listed prop­erty com­pa­nies that some stores are en­joy­ing re­ally strong trad­ing – like Edgars in the Hypropowned Canal Walk,” says Tilly. “Edgars i n dom­i­nant shop­ping cen­tres are do­ing well. In some cases, like Edgars in Sand­ton City, the store has been ex­panded.”

So dire i s t he sit ua­tion for al l con­cerned t hat a l arge amount of f lex­i­bil­ity might be af­forded to Ed­con than would or­di­nar­ily be the case for a smaller op­er­a­tor. In the worst case sce­nario, where the com­pany would en­ter busi­ness res­cue pro­ceed­ings with pos­si­ble liq­ui­da­tion, there would be a pro­tracted legal battle and a highly un­cer­tain out­come. It’s in ev­ery­one’s best i nter­est to keep t he com­pany go­ing, par­tic­u­larly as it is fun­da­men­tally prof­itable.

The word on the street is that Brait, fresh from mint­ing cash fol­low­ing the sale of Pep­kor, might be in­ter­ested in an ad­vance on Ed­con. Whether it’s Brait or a large in­ter­na­tional player, here is how a po­ten­tially happy end­ing could play out: 2. While play­ing hard ball up­front, cred­i­tors like listed prop­erty own­ers and other sup­pli­ers will grant the group sig­nif­i­cant flex­i­bil­ity in closing down or re­siz­ing poorly per­form­ing stores. Trade cred­i­tors might waive in­ter­est costs/penal­ties to help Ed­con stay afloat. 3. The buyer wi l l pay R1 t o ac­quire Ed­con, i n ex­change for as­sum­ing i ts debts. But prior to the sale be­ing con­sumed, the po­ten­tial buyer will ne­go­ti­ate a “hair­cut” on the debt. This will be a write­down in the or­der of 40c-50c on the rand (or euro, or doll ar, depend­ing on who you are). For such gen­eros­ity on the be­half of cred­i­tors, the deal will be sweet­ened with op­tions to ac­quire shares at a nom­i­nally low price in the fu­ture, thereby al­low­ing debt hold­ers to re­coup some of the losses from the hair­cut. 4. The new owner will need to pump around R4bn of eq­uity into the com­pany. This will get the fi­nan­cial po­si­tion onto an even keel – still highly in­debted, but with enough cash flow to ser­vice the debt and con­tinue in­vest­ing in the busi­ness. Af­ter two years of im­proved fi­nan­cial per­for­mance, Ed­con will be par­tially listed on the JSE. This will al­low the buyer to re­alise some value, and a mech­a­nism for debt hold­ers to sell their shares.

One al­ter­na­tive to t he sce­nario en­vis­aged above would be to have the good busi­nesses carved out of Ed­con and sold separately. But it re­mains to be seen whether cred­i­tors would al­low that to ever see the light of day – they would likely pre­fer to take their chances in busi­ness res­cue.

So here’s hop­ing for the best, but ex­pect­ing the worst. 1. Un­der­per­form­ing and mar­ginal brands will be dis­posed of, re­al­is­ing a rel­a­tively small amount of cap­i­tal that will go to­wards pay­ing down debt.

PO­TEN­TIAL PROB­LEMS WITH THE CAP­I­TAL STRUC­TURE BE­CAME EV­I­DENT AS SOON AS BAIN CAP­I­TAL BOUGHT AND THEN DELISTED ED­CON FROM THE JSE IN 2007.

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