As Icelandic investors consider exiting high-profile retailers, George MacDonald asks whether the stores sector can look forward to a raft of deals in the year to come

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Two years on from the collapse of Icelandic investor Baugur into administration, the auction of some of its retail interests seems finally poised to begin.

Food group Iceland could be sold as early as this year, Retail Week revealed last week, and would-be buyers have expressed interest in legendary toy specialist Hamleys.

Disposals would set in motion the final act in one of the most dramatic episodes to be played out in retail in the first decade of the new millennium - the rise and fall of Baugur and its fellow Icelandic financial adventurers.

It was on February 6, 2009 that the audacious Baugur, which had bought up swathes of the high street starting with famous toy store Hamleys in 2003, was put into administration by its principal creditor, Icelandic bank Landsbanki.

Landsbanki itself had already been brought low by the banking crisis of 2008 and retail-watchers speculated that its resolution committee - the body charged with maximising the value of assets as part of the winding up process - would quickly auction Baugur’s stable of retailers.

But Landsbanki insisted that there would be no fire sale and it would work with the retailers’ management teams to create long-term value. Now Landsbanki sees the opportunity to realise some of that value, although it has also said that it is not at present interested in selling its holdings in department store group House of Fraser or jeweller Aurum, owner of the Goldsmiths chain.

Signs of improvement

The interesting question is to what extent the decision reflects Icelandic dynamics specifically, or is indicative of an improving climate for retail sector deals. In recent months there has been a raft of sales including shoe specialists Office before Christmas and Jones Bootmaker this week.

Despite the cloudy outlook for retail in 2011, Landsbanki head of communications Páll Benediktsson told Retail Week: “The market is getting better so it’s time to start proceedings.”

In fact there have already been successful exits by Icelandic groups from retail investments. Last year - when there were several big private equity deals despite jitters about retail prospects - Mountain Warehouse was sold to Lloyds Development Capital in a deal valuing it at £50m.

That transaction enabled Icelandic fund Kcaj - which along with associated business Arev was destabilised during the Icelandic economic crisis - to make a return of more than three times its original investment and the cash raised was used to help ensure a full return to creditors who had backed a voluntary restructuring of the fund.

Arev and Kcaj also had a minority stake in Jones Bootmaker, which was sold to Brantano-owner Macintosh Retail Group in a deal estimated to be worth £40m.

Such exits and continued investor interest in strong retailers may have convinced Landsbanki to test appetite for some of its own assets despite the cold trading climate.

The turnaround of Iceland by founder Malcolm Walker, who returned to the retailer in partnership with Baugur in 2005, has made it one of the sector’s stars once again. Walker, who owns about 24% of Iceland, tried to take full control of the grocer last year but his £1bn offer was rejected. It is understood that Landsbanki now believes the business, in which it has a 67% stake, could be worth as much as £1.5bn.

And Hamleys, in which Landsbanki has a 65% holding, is now able to add profitability to its trophy status. Hamleys returned to the black in its last financial year when it made a pre-tax profit of £100,000 and EBITDA soared 80% to £4.6m.

It is thought Hamleys’ iconic status may make it appealing to a Middle Eastern sovereign wealth fund such as that of the Qatari royal family, which last year paid £1.5bn for department store Harrods. Private equity sources said a price of £100m was being talked about for Hamleys - a “staggering” EBITDA multiple of more than 20 times, notes one observer.

The appeal of Hamleys and Iceland has prompted speculation that Landsbanki is attempting to sell them first because they are most assured of a good price and will help set valuation expectations when exits are eventually made from Aurum and House of Fraser - where more value can be created before disposals would be considered.

But if sufficiently high offers are not made there is little doubt that Landsbanki will not be forced into sales.

The overall winding-up procedure is likely to last another four to five years so although Benediktsson told Retail Week it is “very likely” that retail assets will be sold in the next three years, immediate disposals are not essential.

And in the light of confusing comments made by Landsbanki over the last week about its intentions, some wonder whether Hamleys and Iceland could yet be retained for a while.

One source with close connections to the Icelandic financial world says: “There’s no pressure. They’re working to long-term horizons with good quality assets.”

Another observes: “There’s a lot of uncertainty about what’s going to happen about deals. They will sell assets - it’s just a question of when. They’re not in a rush and they’ve always looked at a several-year process.”

Attractive investments

Certainly there is no indication that other Icelandic banks with big holdings in UK retail plan disposals imminently. Kaupthing for instance controls 90% of fashion group Aurora but the retailer’s chief executive, Mike Shearwood, does not anticipate any significant change of ownership in the near term.

“We’re working very well with Kaupthing,” says Shearwood. “At some stage over the next few years they’ll want to realise the value of assets but at the moment there is no desire to.”

Icelandic-backed retailers aside, there are signs that retail generally is still an enticing sector for private equity deal-making.

Research just conducted for advisory firm Grant Thornton shows that retail is seen as the second most attractive investment sector for 2011, sandwiched between business support and industrials in positions one and three respectively.

The study, for which 100 private equity executives were polled, showed that 35.9% expected the “consumer, retail and food” sector be the most active in deal terms this year. At the end of 2009, by comparison, consumer businesses were in fifth position.

Grant Thornton head of retail Barry Knight says that the sector remains interesting to private equity groups because many of them have experience of the industry and there are some strong retail performers with plenty of scope to grow.

However, company valuations are falling. The research found that valuation expectations among private equity firms fell to 6.2 times EBITDA in the fourth quarter of last year from 6.8 times in the third - a decline of almost 9%.

Best price

So why would sellers of a retailer choose to do so now, when valuations are slipping. The answer is that the best should be able to command multiples acceptable to buyer and seller alike.

One private equity source says: “In general, retailers that have seen through this tough period have done well - there’s been a strong profitability and some have had a record year. For buyers, they’re resilient and strong.”

Jeff Blue, former Baugur managing director and now managing partner at Aspiring Capital, which was involved in the £150m Office transaction, says that private equity groups have plenty of money to spend but some forms of debt are still difficult to come by. Private equity firms may have to put more equity into deals than they might have done in the past, which brings the consequent risk of dilution of returns.

But Blue expects “growing interest in revisiting the retail sector” among private equity groups. Key, he says, will be what has so frequently been - the combination of a good growth story and a good management team.

At the other end of the scale from the trophy assets and growth stories - including online specialists - likely to interest mainstream private equity houses, are the distress situations that will appeal to turnaround buyers.

During the recession restructuring specialists such as Hilco, owner of Habitat and Allied Carpets through its Valco arm, were able to spot opportunity. And just before Christmas Gordon Brothers bought jeweller HPJ, which it sees opportunity to remodel and rebuild. Other turnaround specialists such as Endless may also spot chances to make money as retailers hit turbulence in the fierce headwinds this year.

Distress signals

Better Capital boss Jon Moulton, who acquired several troubled retailers as founder of private equity firm Alchemy, thinks more retailers will hit the wall this year. He says: “When interest rates rise we expect a rise in failures, which will also be encouraged by a drop in discretionary spending.”

Knight says: “The general view is that retail is not looking good for 2011. Perversely, that’s why some private equity houses think it could be a good year - there’s the opportunity for some bottom fishing.

“A lot of distressed situations are with the banks at the moment and the banks’ willingness to put retailers through a process and bring out a phoenix could be a characteristic of deals.”

While private equity firms of all hues look poised to spend money on retailers, will their interest in deals be

mirrored by trade buyers? Last year for instance, Halfords cast its slide-rule over specialist retailer HobbyCraft. And last week it emerged that Argos-owner Home Retail Group was among the parties interested in acquiring Blacks Leisure.

Knight thinks acquisitions of online retailers may occur but downplays the prospects for conventional mergers and acquisitions by retailers. “If it’s a niche retailer that fits we could see some odds and sods but what we won’t see is people bidding for a retailer purely to add brands and space,” he concludes.

Despite the uncertain outlook it appears that deals of all sorts are still on the agenda. Several sales are ongoing at present, ranging from online maternity specialist Kiddicare to electrical enthusiasts’ store Maplin. If Hamleys and Iceland are sold by Landsbanki, they look as if they could be in plenty of company.

Landsbanki’s UK retail interests

66%

Aurum

65%

Hamleys

35%

House of Fraser

67%

Iceland