Debt mountain means grim tidings for Edcon

05 July 2015 - 02:02 By Ann Crotty

On the home page of its website Edcon proudly announces it is the largest non-food retailer in South Africa and has been in operation for more than 80 years. By the end of this week the question many people were asking was: for how much longer?This week we got sight of the 2015 annual report with its detailed list of "risks relating to our business and industry", which become more disturbing every year.This list includes that the banks used by Edcon's suppliers "have been messaging to suppliers that they should reduce their exposure to Edcon". Also, that Edcon, which owns Edgars and Jet, could face near-term liquidity problems and have to sell assets or cease operations.It might be possible to dismiss the warnings as necessary attempts by the board to ensure it has legally covered its bases - except there was more disturbing news.On the same day, investors were given "an invitation" to participate in a restructuring of a portion of Edcon's debt mountain. The holders of à 425-million (R5.8-billion at today's value) in bonds issued just 18 months ago are being invited to take a 60% cut on the face value of their bonds and accept a lower interest payment, which will be rolled up.story_article_left1And then, at the end of the week came the inevitable credit rating cut by S&P and Moody's.Retail analyst Syd Vianello said he was stunned when he heard that almost half the bondholders targeted by the restructuring indicated they would accept the proposed deal.But he admits he was equally stunned that investors were prepared to buy the unsecured bonds 18 months ago."The bondholders are now being asked to switch from something that is worth almost nothing to something worth less [and] because the interest is being rolled up bondholders won't even get the much lower interest payment until 2022 when the bonds are redeemed," said Vianello, who pointed out that seven years is an unfathomable length of time given Edcon's circumstances.The upside for Edcon, says Vianello, is annual savings of around R700-million if all bondholders accept.Bondholders who do not accept the offer could start moves to put Edcon into liquidation on August 1 if the struggling retailer fails to pay the coupon (interest) due on the bonds last Tuesday.Edcon is allowed a 30-day extension on this, which is presumably why it targeted July 28 for finalising the proposed restructuring.But moves to liquidate is unlikely.The debt at stake represents just 11% of Edcon's debt exposure. And unlike most of the other debt instruments, these bonds have no security. Nudging Edcon towards liquidation would serve no purpose for these bondholders as they would be close to the end of a long line of creditors."All of Edcon's assets, even the pencils, are being used for security for one of the bonds or loans, except for the 2019 bond," remarked one analyst exasperated by the never-ending crisis.This is not the first time the retailer has been perilously close to the brink.mini_story_image_hright1In the second half of the '90s profits plummeted more than 60% and by 1999 the share price had dropped to around R14 from a mid-decade high of R170.The slump coincided with South African Breweries' decision to unbundle the bulk of its controlling stake in the retailer when it transferred its primary listing to London in 1999.But before it abandoned ship SAB oversaw the appointment of US executive Steve Ross in 1998. Within a few years Ross put what he renamed Edgars Consolidated (Edcon) back onto a strong profit trajectory.Strong enough that after a 10-for-one share split in 2005, Bain Capital Partners paid R46 a share in a headline-catching R25-billion private equity deal in 2007. The deal was funded by debt that was piled onto Edcon's balance sheet.story_article_left2Now the problems facing Edcon look to be more intractable. Whether, even in the best of times, a private equity deal is the appropriate structure for a capital-hungry company in a growing industry is debatable.As it happened, 2007 was not the best of times. Implementation of the deal, which was strongly opposed by the PIC, which wanted to hold onto the asset, coincided with the early fallout from the worst financial crash since 1929."In the traditional private equity model, you buy a business, gear it to the hilt and run it hard. In the post-financial crisis that model doesn't work," says Sasfin analyst Alec Abraham."The risk associated with huge debt and lower levels of consumer activity are too great; it's not possible to run a 100%-geared business without high levels of activity."From day one of the private equity regime Edcon management was obsessed with margins and the business was starved of cash. The situation was compounded by poor senior appointments.One former executive, referring to the appointment of foreign executives and the seeming disregard for local consumer habits, said Bain Capital did not seem to have much respect "for South Africa or South Africans"."The decision to sell the debtors' book to Absa was a terrible mistake, forced on them by cash constraints," said the former executive.The choice of replacement for outgoing CEO Jurgen Schreiber will be closely watched but few in the investment community believe the company will be able to find another Ross.sub_head_start Quick tally of deal's winners and losers sub_head_endEdcon shareholders who took up the R46-a-share offer from Bain back in 2007 look to be the primary beneficiaries of the largest private equity deal South Africa had ever seen at that stage.It was an extremely attractive price for a share that had been trading at close to R2 about five years earlier.While most of the shareholders were delighted with the offer, the Public Investment Corporation, which held less than 5%, was not. It wanted to hold on to a quality asset instead of being forced to cash it in, even at an attractive price.The taxman was also unhappy about the deal. The private equity structure meant that a highly profitable company with a low-geared balance sheet was loaded up with debt; servicing that debt meant there were no profits on which to pay tax.mini_story_image_vright2The fiscus lost billions. Eight years later there is still little prospect of Edcon resuming tax payments.It is difficult to see what benefits the 2007 deal has had for labour. Despite its cash constraints, the group has managed an impressive increase in store numbers, although not in line with industry growth.The number of full-time employees has dropped from its 2008 level, which means that, in line with all the other retailers, it is relying heavily on part-time staff.At end-March, Edcon had 18200 full-time staff from a peak in March 2008 of 21000.Also amongst the winners is outgoing CEO Jurgen Schreiber who has been paid in line with those of his well-paid peers in the retail industry, although Edcon's performance has not matched its peers.Presumably Edcon's remuneration committee believed Schreiber could not be held responsible for any of the problems that come with the crippling debt burden.In 2013, he received remuneration of R11-million with no bonus. This was increased to almost R12-million last year, again with no bonus. This year, as Schreiber was heading out the door and back to Canada, he was handed remuneration of R20.1-million, which included a bonus of R7.5-million.sub_head_start Edcon tipped to muddle on sub_head_endBy the end of the week, analysts were betting on whether Edcon would resolve its debt woes before Greece. For both there's almost an inevitability that something dramatic has to be done but, also for both, there's the likelihood that the dramatic option will be staved off."Whatever happens at Edcon it's going to be very difficult," said Sasfin analyst Alec Abraham, who reckons the "muddle-through" option will prevail, but only just.The detailed "Risks relating to our business and industry" section of Edcon's 2015 annual report gives some idea of what the "muddling through" option might look like. It's not pleasant.story_article_right3The possibility of tougher terms and conditions for additional credit could affect the group's agreements and payment terms with vendors, which prompts the possibility, says Edcon, that "we may face further liquidity pressure if our suppliers require us to pay upfront or upon delivery of products". If it can't get additional credit or secure improved "accommodations from key customers" or sell assets on favourable terms, "our liquidity position, which is severely constrained, could decline further".Huge chunks of the risk section describe the extreme difficulty of operating under severe cash constraints. It describes the grim reality that Edcon exists on a funding knife-edge and is dependent on a number of external factors, over which it has no control, remaining "benign".If its operations can generate sufficient cash to keep its suppliers onside and service its debt, it will face a major challenge only in 2018 when a chunk of bonds is due for redemption.If it cannot walk the tightrope, it could try to speed up the sale of "non-core assets". But this may not generate sufficient cash. Then comes the sale of core assets, which include Edgars, Jet, CNA, and Boardmans.Analysts are divided on whether or not the players in this highly competitive market will fight for parts of the group. The list of possible local bidders includes Pepkor, Foschini, Truworths and Mr Price. Given the recent inroads being made by international operators, these should also be considered as potential buyers.acrotty@worldonline.co.za..

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