The prospect of retail IPOs is rising, but the shaky economy and recent cash calls could make talk of floats so much hot air. By George MacDonald
After years in which retailers abandoned their stock market listings to fall into the arms of private equity suitors, there are signs of a change in direction.
Over recent weeks a crowd of store groups has signalled that they are considering IPOs. Last week it emerged that Pets at Home, the specialist retailer backed by private equity group Bridgepoint, is mulling a £700m flotation.
Pets at Home has been discussing timing, valuation and potential appetite with City advisers including Goldman Sachs, JP Morgan Cazenove, NM Rothschild and Bank of America Merrill Lynch.
Other retailers thinking about IPOs include grocery home shopping group Ocado – even though it has yet to turn a profit – fashion retailer Blue Inc, Superdry owner Supergroup and online discounter M and M Direct. It is also expected that at some point the backers of retailers such as New Look, Poundland and Peacocks will also look for an exit – potentially via IPOs.
But how realistic are these retailers’ ambitions to secure a public listing in the foreseeable future? While retail stocks have performed strongly for much of this year, ongoing tough trading conditions and a decidedly mixed performance from the previous round of retail floats could undermine investor appetite for a new generation of companies.
At the end of June, half way through the year, general retailers’ valuations had risen 38.1 per cent in 2009 while the All-Share index was down 1.9 per cent.
The uptick reflects better than expected performances by store groups – albeit from expectations that were brought lower than Gordon Brown’s popularity rating in the aftermath of last autumn’s collapse of Lehman Brothers. Retailers’ relative performance has encouraged some to pursue more actively the option of a float, even though conditions remain unstable.
Reasons to float
Traditionally there are two prime reasons why companies float: to provide backers with an exit and/or to raise funds for growth, benefiting both the business and shareholders.
Fashion group Blue Inc, which has been talking to brokers about floating, exemplifies both.
Blue Inc chief executive Steven Cohen and his partners bought the business almost four years ago. Over that period the fashion retailer has increased sales from £15m to an estimated £74m next year. Cohen says the time frame is the right one over which to consider “appropriate corporate structures” and options for access to capital, such as an IPO.
He admits the process is at a very early stage. There remain hurdles to be jumped and a successful Christmas will be critical, but from conversations with brokers Cohen is convinced that investor appetite exists for companies that meet the requisite criteria.
“For the right business, there’s potential,” says Cohen. And he believes Blue Inc fits the bill. “We’re hitting our targets. The business has grown significantly and there aren’t that many companies that have delivered such growth,” he says.
Cohen’s point about “the right business” is echoed by Altium Securities analyst Dave Stoddart. Among the most recent retail IPOs he cites value homewares group Dunelm, which came to market in 2006, as the type of company that would probably still get backing if it were to float next year. “If somebody’s bringing a growth story, that’s eminently floatable,” he says.
Seymour Pierce analyst Freddie George also cites Dunelm as an example of the type of retailer that would win backing. This week the value homewares group posted a 5 per cent rise in like-for-likes over the 26 weeks to June 27 and emphasised the opportunities being thrown up, such as for store acquisitions.
George believes that Pets at Home, for example, would be likely to pull off an IPO because it shares similar characteristics with Dunelm. He observes: “I’d have thought Pets at Home is ideal. It has done reasonably well during the recession, it’s niche and there are good opportunities to grow.”
But other retailers, particularly those that were bought off the market by private equity groups or have been traditionally highly secretive, are likely to face intense scrutiny. The other two most recent retail floats, department store group Debenhams and discount giant Sports Direct, illustrate some of the reasons why.
Debenhams floated in May 2006 and was valued at the close of the first day’s share trading at £1.72bn. Last week it was valued at £1.09bn, reflecting a big increase in its value over the most recent three months, but Debenhams’ time as a public company has frequently been controversial.
Although acknowledged to have traded well through the downturn, profit warnings, complaints that its private equity backers had enjoyed most of the value before its IPO and concern at the level of debt it was saddled with have all dogged the retailer. Earlier this year it staged a £323m share placing, partly to assuage debt fears. Investors’ experience, says Stoddart, means that in future “the re-float of a private equity vehicle is going to be valued much more lowly”.
Investors’ experience of Sports Direct has been similarly fraught. It is the newest retailer on the Official List, having floated in March 2007 when it was valued at £2.2bn. Last week it was worth just £461m. During its time as a public company the retailer has been embroiled in one controversy after another – whether about corporate governance or founder Mike Ashley’s unpredictable behaviour. It is an experience that investors will not want to be repeated among any new IPO candidates.
But Seymour Pierce analyst Freddie George believes such worries are overdone and that there would still be investor appetite for floats. Ups and downs are simply part of business and investment life, he insists. “People have very short memories,” George points out. “Debenhams floated at about £2 and people still took up the placing at 80p.”
New kids on the City block
Assuming the absence of such concerns and a credible growth story, the market is likely to be open to new retail arrivals. But a whole host of variables will influence the success of a share offering – not least the business outlook.
Stoddart believes that 2010 – certainly early 2010 – may be optimistic timing for any retail IPO aspirants. “We don’t know what state the economy is going to be in in the next 12 to 18 months and that impacts earnings in all sectors,” he says.
Additionally there is political uncertainty as a general election looms. Stoddart says: “While 2009 might turn out to be better than expected, we are not yet persuaded that 2010 promises much of an uplift in prospects.
“What looks like an unsustainable fiscal deficit would suggest that we should not be looking for government spending to continue driving the economy. By the time we get to the 12-month horizon that we base our recommendations on, there will have been a general election and a newly elected Chancellor might be getting to grips with this very issue. The consumer might have some of the wind taken out of their sails.”
Floating into such a market would be difficult, Stoddart says. However, he acknowledges: “The further we get into next year, the better prospects become.”
One private equity source is similarly sceptical that retailers will be welcomed by the market in early 2010. He says: “I’m hearing from the City that there’s demand building up [for new share issues] and there’s a lot of positive noise. But the final quarter is looking quite scary and it sounds like bankers are
trying to drum up business.”
Another potential fly in the IPO ointment could be the cash calls being made by already listed retailers. Aside from Debenhams’ fundraising, electricals group DSGi raised £310.6m through a share placing and grocer Sainsbury’s raised £445m to fund expansion. “If we continue having rights issues and the like, that could crowd out IPOs,” Stoddart warns.
However, on the flip side, falling gilt yields could encourage a shift into equities. Low gilt yields typically lead to higher equity prices as investors seek out the best returns.
A few years ago there was a trend among many investors to hold only the biggest companies, but that has moderated and George believes smaller retailers would also be attractive to investors. “There are now quite a lot of funds focused on the FTSE 250 to 350 so there should be no problems,” he argues.
In the end, whether retail IPOs go ahead will ultimately depend on the same factor as has always been the case – the pricing of the shares. The signs are, analysts say, that retail valuations would be more “realistic” than they were in the most recent past and would therefore attract investors.
George again uses Dunelm as an example. He puts the retailer on a PE rating of just under 12 times and thinks that level is likely to be appropriate for those eyeing IPOs at present. Stoddart agrees. “The go-go days of high teens valuations have gone,” he warns.
The message is that those retailers with “sensible” valuations and a convincing growth story to tell are likely to be viewed positively, should they take the plunge and come to market.
But any retailer hoping to float next year will have to deliver over the vital Christmas period. Cash through the tills will be the only guarantee of cash being offered for the shares.
Value creators: the highest ever retailer returns
The point of an IPO is ultimately to reward shareholders and two names stand out for generating the best returns in retail: Lord Kalms and Sir Geoff Mulcahy.
The pair, ferocious rivals throughout their retail careers, generated impressive sums for shareholders at Dixons – now DSGi – and Kingfisher respectively.
£1,000 invested with Kalms when Dixons floated in 1962 would have been worth £1.2m by the time he stood down from day-to-day involvement with the retailer in 2002. Over the same period, a £1,000 investment in the All-Share index would have grown to be worth £115,000.
A £1,000 investment with Mulcahy when he joined Kingfisher in 1982 would have been worth £29,250 by the time he stood down in 2002. Over the same period, the same investment across the stock market would have returned £12,660.
Both Kalms and Mulcahy built their businesses by acquisition and innovation, such as Dixons’ launch of Freeserve and Kingfisher’s development of B&Q’s big-box category-killer stores.
Another outstanding instance of retail value creation was the transformation of Asda by Archie Norman and Allan Leighton, turning a business on the edge of collapse into one for which Wal-Mart was willing to pay £6.7bn.
Potential retail IPOs
- Blue Inc
- M and M Direct
- New Look
- Pets at Home