Edcon feels first pangs of private equity deal
December 3, 2007
By Tom Robbins
Cape Town - Financing costs are higher than trading profit at Edgars Consolidated Stores (Edcon), as the country's biggest clothing retailer is being stretched to meet interest repayments under its new US private equity owner.
Half year net losses were R971 million. Had Edcon forgone the Bain Capital deal, which came with punishing interest repayments, it would have turned a profit ahead of the R678 million earned in the same period last year.
In May - just months before August's credit crunch in the US and Europe - Bain bought Edcon for R25 billion in the country's biggest private equity deal to date. But, typical of such deals, it added R17.26 billion in European debt to the company's previously debt-free balance sheet, to help pay for the acquisition.
Edcon's trading profit in the half-year to September was R947 million but interest charges alone amounted to R1.19 billion, the retailer said on its website last week.
Roy Chapman, head of financials and industrials at Sanlam Investment Management, said that with net financing costs higher than trading profit, there must be "concern" about meeting interest repayments. He cautioned it could become more difficult.
The transaction is seen as a global test of emerging market leveraged buyouts, where buyers seek to grow operating profits at a higher rate than interest repayments.
Bain is having to live with local interest rates that are rising far higher than expected, resulting in a sharp slowdown in retail spending among already overindebted consumers.
Edcon believed it would be able to fund debt service obligations, as well as capital expenditure plans, through cash flows and by taking on further debt already available to it.
Adding fuel to the fire is the fact that Edcon's interest repayments have climbed further in the last three months of the half year, while retail sales growth has slowed.
Chapman said that over the next six to 10 months the retailer would likely have had "a very tough time", considering that muted sales growth was likely to lead to price markdowns. "A lot will depend on how they trade but it is likely to be a testing time for Edcon."
While the risks of gearing up companies are significant - and even successful deals frequently experience close calls along the way - the rewards can be far higher than at firms with "lazy" balance sheets.
Syd Vianello, retail analyst at Nedcor Securities, said that after stripping out mostly non-cash items relating to the private equity deal, but including the hefty interest repayments of R1.19 billion, the firm had lost just R38 million, "which wasn't bad" in the current climate.
Vianello said October had been a tough month for clothing retailers and Edcon sales had likely gone backwards.
In the half year to September, retail sales grew 8.6 percent to R9.02 billion, but the trend is down; in the quarter to the same month, growth slowed to 6.6 percent.
However, in that quarter credit and financial services profit climbed 46.8 percent to R113 million as Edcon was able to charge customers higher interest rates under the new National Credit Act, which gives firms greater leeway on rates.
Bad debts as a percentage of average debtors also fell marginally, from 11.4 percent in the year to March to 11.2 percent in the quarter
While it is unusual for private equity-owned companies to publish results, Edcon executive manager for investor relations Tessa Christelis said the company had issued euro denominated bonds on the Irish exchange, which required that financials be disclosed.
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