HMV and Game are selling parts of their business to preserve the core. Nicola Harrison reports on crisis disposals.

Both HMV and Game are suffering in a tough market and the case for emergency surgery is strong

As Game exemplified last week, it is easy for retailers to find themselves forced to sell off parts of their business as they urgently restructure financially, often with their banks breathing down their necks.

Lenders will fund expansion in the good times, but can just as easily pile on the pressure for surgery in the bad.

And as rising costs coupled with subdued demand leads to sales and profits being put under pressure, banks are having more influence on the strategies of retailers – particularly those in the emergency room.

Last week Game confirmed Retail-week.com’s story that it is seeking to hive off all or parts of its overseas business as it seeks to stem losses. The retailer is understood to have hired Rothschild to seek buyers. 

The banks have granted Game breathing space by relaxing their terms, but along with that came caveats, including a revised strategy that addresses the future of its international business.

HMV too was forced into restructuring as its debts piled up and its lenders sought action.

The entertainment retailer was forced to sell off bookseller Waterstones last year to reduce spiralling debt, and is in the process of trying to dispose of its robust Live division, which was formerly seen as key to its turnaround strategy.

Such fire sales are not unique to this downturn, says Peel Hunt analyst John Stevenson. “Distress sales are nothing new,” he says.

The case for restructuring

PricewaterhouseCoopers partner Mike Jervis cites Next as a good example of a retailer that went through extensive restructuring amid tough conditions, but which came out stronger the other side. 

In the 1980s the fashion group acquired a series of businesses including mail order specialist Grattan and Dillons convenience stores. None were retained as the early 1990s recession bit, but their sell-off allowed Next to focus on its core business.

The trend is back. Anglo-French electricals group Kesa sold its UK chain Comet to private investment firm OpCapita last week. While it was not a distress sale in that Kesa was not forced to offload the business, Comet is itself very much embattled, and Kesa sold in a terrible market for electricals, illustrated by the £2 price tag.

Motivated sellers

Selling amid tough conditions will often not deliver a good price, says Jervis. “If you’re selling off parts of your business, it’s best to sell from a stable environment so it is not seen as a distress deal,” he advises. “You need to create competitive tensions – if you’re running out of money it’s hard to do that.”

But price is not the only concern. Retailers must also consider the wider effects a distress sale can have.

Singer analyst Matthew McEachran says that when a business is forced to sell some of its operations, uncertainty is created. He says damage can be done to staff morale, as well as to customer loyalty, as consumers worry about the longevity of a business after reading about its troubles. “It can create an awful lot of disruption,” he says.

Zolfo Cooper head of retail Dan Coen says that while selling strong parts of a business to appease the banks may be a necessity in the short term, it can backfire over  a longer period. “It can be a way of trying to stem the tide by buying time, but it doesn’t solve the problem if the core business is faltering,” he says.

But good can come of forced emergency surgery, says Richard Fleming, UK head of restructuring at KPMG, which is administrator to fashion chain Peacocks at present.

He says that a sale can ensure the survival of a part of a business – and therefore jobs – that has been potentially under-invested for some time. “Selling a good business stops it from deteriorating,” he says. “Hopefully it will be released into the hands of an owner who has capital to invest.”

In less parlous times a sale can also have benefits on the core business of the seller, says Fleming. “Hopefully by deleveraging, it allows the core business to invest. The other positive is it reduces operational complexity,” he says.

The bottom line

JJB Sports sold its gym division in 2009 as it strove to pay down debt. It was a small but cash-generative part of the group. “It was the crown jewel of the business, but they needed the cash,” says Stevenson.

He argues that while selling off a strong part of the business was not ideal, it kept the banks happy and enabled JJB to focus on retailing. Without that sale, there was a chance that the banks may have pulled the plug.

McEachran says that for a lot of retailers fire sales “are about getting the bank off their backs and refocusing on the bit that needs most help”.

But Fleming sums up perfectly the dilemma of whether to offload good bits of a business or bad, and the likely benefits of either course. “What do you take to the pawn shop, your Desperate Housewives DVD box-set or your diamond ring?” he asks.

There will no doubt be more instances this year of retailers being rushed into the financial emergency room when parts of the business may have to be amputated. But in some instances, the medicine prescribed may not be enough to save them.

Playing on - Game’s prospects

Both HMV and Game are suffering in a tough market and the case for emergency surgery is strong

Both HMV and Game are suffering in a tough market and the case for emergency surgery is strong

The computer entertainment specialist enjoyed incredible growth at the peak of the last games cycle, when the popularity of games exploded as the Wii console drove non-gamers into stores.

However, another peak of the cycle seems a long way off and a lack of hardware has sent Game sales into freefall. As a result the retailer cautioned last month that it was unlikely to meet its EBITDA covenants when they are tested on February 27 for the period to January 31.

But after Game revised its expected loss for the year from £30m to £18m – some say due to suppliers improving their terms – the banks agreed revised terms for its facilities, giving the retailer breathing space. Game must now provide an updated strategic plan for approval by its lenders. “This plan will cover all aspects of the business’s activities and strategy, including its overseas operations,” Game said in a statement.

Game broker Peel Hunt’s Stevenson believes its UK arm could turn a profit in 2013, but that the losses in the overseas business are acting as a “drag” on the group. “It is therefore likely that Game will seek to exit certain territories,” says Stevenson in a note, adding: “Overall, the international subsidiaries face the same video gaming market related challenges as the UK.”

Stevenson remains upbeat on the outlook for Game: “Unlike music, film or book markets, Game can look ahead to the launch of new major consoles as a material earnings event for the industry.”

He points to the new Wii U launch this year, as well as a new Xbox that is likely to be announced. “The challenge for Game is to navigate the tough market until new hardware launches, noting initial volumes may well be limited. Investors may gain some comfort from the intervention of industry stakeholders, which are clearly supportive of the business at this time.”

The sale of Game’s overseas business is not a done deal, however, because likely buyers are not obvious. Its main global rival, US specialist Gamestop, is itself pulling out of overseas territories, including the UK.

Singer’s Matthew McEachran remains cautious: “Management will now need to update their strategic plan, which we believe will have to reflect a more radical store closure plan, especially overseas, along with a more aggressive multichannel strategy.”

Fade out - HMV’s live fortunes

HMV is in a stronger position than when it sold Waterstones, but with the Live division performing strongly, some question whether it should be sold

HMV is in a stronger position than when it sold Waterstones, but with the Live division performing strongly, some question whether it should be sold

The entertainment retailer has been through hefty restructuring in the last 12 months at the behest of its banks. It sold bookselling chain Waterstones to Russian oligarch Alexander Mamut for £52m in May last year. That appeased lenders for a time, they had based a refinancing deal on the ability for HMV to pay down some of its debt.

However, terrible trading continued through 2011 at HMV as it struggled to cope with stiff competition from online players including Amazon and iTunes, as well as with structural changes in its markets. As a result, HMV warned there were “material uncertainties which may cast doubt on the group’s ability to continue as a going concern in the future”.

A sale of its Live division, which includes the HMV Apollo in Hammersmith in London, looks like a good route to raise cash. It is a strongly performing, growing business, and at one time looked like the future for HMV so it is no surprise that some observers worry that hiving it off cannot be a good thing.

Zolfo Cooper’s Coen says: “There’s no obvious solution for the core business, they have to return cash to stakeholders. They got a good price for Waterstones and I think they’ll get a good price for Live. But they bought Live in order to facilitate a turnaround of the core business.”

However, HMV is in a stronger position now than it when it had to sell Waterstones. Banks last month showed their support by waiving certain covenant tests as a result of HMV suppliers stepping in and backing the retailer, including taking 2.5% equity in it.

HMV also said that even if the current trading patterns continue, it expects to be able to reduce net debt by about 50% over the next three years. Chief executive Simon Fox said the agreement with the banks puts HMV in a “materially different place. We have solved a significant potential crisis”.

That means the Live division will not itself be a distress sale and a good price can be achieved. Fox said last month there is a “reasonably high probability we’ll end up with a sale of the [Live] business.”