Edcon’s big red hanger moment
Breakup looms for retail icon
Walk through the doors of Edgars’ elephantine flagship store in Johannesburg’s upmarket Melrose Arch precinct, and you’re likely to see the saleslady reapplying her lipstick.
That may not seem unusual: her job, after all, is to be primped and primed. But attentive visitors will note that the lipstick is being reapplied every few minutes simply because there are so few customers for her to serve.
Edgars isn’t alone in feeling the chill of the household spending crunch in Africa’s second-largest economy, as cash-strapped consumers are now in their worst position in 15 years thanks to power cuts, escalating living costs and tax hikes. But among retailers, it is the most vulnerable.
This is because Edgars’ owner — the 86-year-old Edcon, which also owns CNA, Boardmans and Jet among other iconic brands — stands just as forlorn as that Melrose Arch store, which seems as gleaming and untouched as when it opened its doors seven years ago.
It’s a corporate disaster tale with little precedent in SA.
Until 2007, Edcon was the crown jewel of the retail sector. Then the Boston-based private equity giant Bain swooped and bought the company for R25bn in the country’s largest private equity buyout.
Almost immediately, the financial crisis hit, and everything changed.
Today, analysts speculate about whether Edcon can survive, as it faces job cuts; a battle to keep its market share; and a crushing R5bn in debt obligations within a year, and another R26bn in the next three years.
Last month, Edcon offered bondholders a deal which would result in them effectively writing off a large chunk of Edcon’s debt — getting, as part of one option, only 40% of the face value of their bonds (see page 21).
In exchange, the Financial Mail has learnt, Bain is now willing to give up about 30% of Edcon’s equity to them — a compromise illustrating the gravity of its plight.
This deal, which is believed to already have been accepted by more than 90% of bondholders, at least keeps the wolf from the door. Though ratings agency Standard & Poor’s said earlier this month it believed “default to be a virtual certainty” on its debt, this now looks unlikely.
But what is certain is that the Edcon of yesterday won’t be around in a few years.
The smart money is now on Edcon being broken up and sold — already Bain has said “noncore assets” are on the auction block, presumably including its cellphone business and call centres.
Alec Abraham of Sasfin Securities sees a breakup of
‘‘ IN SOME CASES, THE BANKS, THROUGH WHICH OUR SUPPLIERS FACTOR OUR RECEIVABLES, HAVE BEEN MESSAGING TO SUPPLIERS THAT THEY SHOULD REDUCE THEIR EXPOSURE TO EDCON
EDCON ANNUAL REPORT
Edcon as inevitable. “Edcon could be a shell of its former self within a year,” he says.
Hammering home its plight, the litany of warnings in Edcon’s recent annual report would have chilled even the most optimistic.
“We have recently experienced increased pressure from suppliers as a result of recent news reports surrounding the sustainability of our capital structure. In some cases, the banks, through which our suppliers factor our receivables, have been messaging to suppliers that they should reduce their exposure to Edcon,” it said.
The potential consequences of being starved of trade credit (60 days usually) and being forced to pay on delivery are dire. If this happens, “we would have a significant liquidity crisis and would not likely be able to find alternative financing to fund our trade payables”, Edcon warns.
But there will be a raft of knock-on consequences on the shopfloor.
“Edcon is not in a position to compete effectively off its weak balance sheet or attract top people,” says Evan Walker of 36One Asset Management. “It will continue to lose market share.”
Quite which divisions could come under the hammer remains to be seen. Arguably the biggest prize would be the 719-store discount division — housing Jet, Jet Mart and Legit — which turned in a pre-interest profit of R1,22bn on sales of R10,99bn in the year to March 2015. Edgars, the 533-store chain, also posted a commendable pre-interest profit of R1,3bn, but its margins were lower than the discount division.
But splitting Edcon apart wouldn’t be easy. Former CEO Steve Ross is reluctant to venture an opinion on what should be done but cautions against a wholesale break-up
of Edcon.
“The challenge of breaking it up is that, for the purposes of efficiency, there are lots of consolidated operations . . . We wanted an efficient platform where several (of the brands, such as CNA, Boardmans and Jet) used the same back office. This makes carving anything out a significant challenge,” he says.
Walker agrees. “It could be done but it will be hugely complicated to pull the business apart. Edcon is too intertwined. It has shared functions including central distribution across its brands.”
Separate Jet from Edgars, for example, and distribution costs could soar. But there may be no option.
As independent analyst Syd Vianello says: “I do not think what they are doing is enough to save them. They cannot go on losing over R2bn a year.” How it got to this point is a tale in itself. Spectators who had front row seats to this horror show are astounded at the alarming change in fortunes that led to this predicament. “They were the family store. The largest clothing retailer in Southern Africa, the darling of the local sector, there wasn’t much they could do wrong,” says Vianello.
Ross, an American, got most of the credit for this success. He was the supermerchant hired in 1998 by the late Graham Mackay (the former CEO of SABMiller which in the late 1990s held 21% of Edcon) who scoured the globe to find the right man to fix the business.
As a former executive at Macy’s, Sears, and Lord & Taylor, Ross’s pedigree preceded him. The fastidious turnaround agent quadrupled Edcon’s sales to over R20bn and led an impressive turnaround.
“[Ross, finance director Steve Binnie and operations director Mark Bower] were a dream team,” says a portfolio manager who asked not to be named. “They worked tirelessly to clean Edcon up — they scrutinised every part of the business from purchasing to advertising, costs were cut, things like internal staff relations were improved.”
Though he left Edcon in 2012, Ross still spends half his time in SA. This week, he told the Financial Mail that though Bain may have made the odd misstep, it was also incredibly unlucky. “Partly, the challenge has been because of coincidence. The world financial meltdown and the timing of the deal were fairly close,” he says.
Ross says though he is not close to the company it seems from the outside that a few things could have been done differently. “It seems to me that a better job could have been done in managing the growth of the debt in the initial phase.”
After the deal was done, Ross’s management team were conservative in the way they handled Edcon’s cash flow. But as the pressure to slash the debt increased, some more questionable risk decisions were made. Of course, Edcon’s plight matters more directly to Ross because he and many of his team put their own money into the company alongside Bain as part of the 2007 private equity buyout. “I have a big investment in Edcon and I hope someday to realise that investment [such as] if it is sold . . . Most of the top management invested at the time, so it’s rather important for us.
“I continue to hope that Bain knows what it is doing,” he says. Under Ross’s leadership, Edcon bulked up to 900 stores, adding stationery chain CNA and Boardmans to a portfolio that included Jet, Sales House, Cuthberts, ABC and Red Square. This made it an attractive prospect to a private equity buyer.
Says Vianello: “After he’d fixed it up, he really believed that Edcon was worth much more than what the market thought, that [the market] wasn’t fairly valuing the company.”
Ross enlisted the help of Australian advisers Caliburn Partners to seek out private equity players interested in buying the company. At the time, private equity was red-hot: Shoprite, Primedia, Consol and Alexander Forbes were all being courted by potential private equity buyers.
Three bidders made it to the final stage in the prized auction for Edcon: Bain Capital, Kohlberg Kravis Roberts (KKR) and Black-