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HMV Group May Need to Sell Waterstone’s to Buy Time

HMV May Need to Sell Waterstone’s
Selling the 311-store Waterstone’s chain might fetch as much as 75 million pounds ($119 million), according to Nick Bubb at Arden Partners. Photographer: Adrian Brown/Bloomberg

HMV Group Plc, the U.K.’s biggest music and DVD retailer, may need to sell its Waterstone’s bookstore chain, suspend its dividend or offer shares as time runs short to develop a business model for the digital age.

The retailer probably needs five years to shift its business away from CDs and DVDs and become a web- and mobile phone-based destination, said Mark Mulligan, an analyst at Forrester Research. With a banking covenant test due in April and suppliers having credit insurance reduced, it may need to buy time to implement such a strategy, analysts say.

Selling the 311-store Waterstone’s chain might fetch as much as 75 million pounds ($119 million), according to Nick Bubb at Arden Partners. Eliminating the dividend would save about 31 million pounds for the Maidenhead, England-based retailer, which is diversifying into live music venues to boost sales as competition increases from supermarkets and online retailers.

“It would let them clear the decks to play another day,” said Bubb, who rates the shares “neutral.” “The danger is, they don’t sell Waterstone’s, and die a death of 1,000 cuts.”

HMV shares have fallen every year since 2005, plunging 66 percent in 2010, and trade at a price-to-earnings ratio of less than three. They declined 3 pence, or 13 percent, to 20.5 pence in London trading today, the lowest since a 2002 initial public offering. HMV’s market value of 87 million pounds is a fraction of the 845 million pounds that Permira Advisers Ltd. offered for the company in 2006.

Not For Sale

HMV said this month that profit would be at the lower end of analyst estimates and the covenant test would be “tight.” The retailer also said it will close 60 U.K. outlets in 2011 after reporting a 14 percent decline in same-store sales at U.K. and Irish HMV stores in the 10 weeks ended Jan. 1.

Selling Waterstone’s “would be the last thing they would want to do” as HMV might be viewed as a distressed seller and have difficulty getting a realistic price, said Sanjay Vidyarthi of Execution Noble who has a “sell” rating on the shares.

There’s also a lack of suitable buyers, Vidyarthi said, while a sale would scuttle a four-store experiment in combining HMV and Waterstone’s stores. Bookstores worldwide have struggled, as Inc.’s Kindle wins sales away from hard copies. Borders Group Inc., the second-biggest U.S. book chain, hasn’t posted an annual profit since 2006 and is seeking to refinance debt, cut costs and restructure vendor agreements.

Waterstone’s has not been put up for sale, said Paul Barker, a spokesman for HMV.

‘Run on The Bank’

U.K. entertainment retailers have struggled to contend with competition from Tesco Plc and The 99-year-old Woolworths Group Plc and U.K. music chain Zavvi Group both went into administration in December 2008.

HMV, whose debt excluding deferred financing fees nearly doubled to 151.6 million pounds by the October end of the first half, said this week some suppliers had their credit insurance levels reduced. Credit insurers seek to protect wholesale merchants against risk of non-payment, and suppliers could demand tougher terms from the retailer to compensate.

Suppliers losing credit insurance cover is “like a run on the bank,” said Garry Wilson, managing partner of Endless LLP, a U.K. private-equity firm specializing in turnarounds. If HMV’s suppliers reduced average credit terms to 30 days from 60 days, “you’re looking at 30 or 40 million pounds being sucked out of the business,” he said.

Industry Support

HMV said it has had no trouble obtaining merchandise, and seven music-industry executives pledged support yesterday in a letter to the London-based Times. The managers, from companies including Sony Music U.K. and Ireland and Warner Music U.K., said “nothing has changed” in supplier relationships.

“We haven’t stopped any shipments,” said Peter Lassman, chief executive officer of Lasgo Chrysalis, a DVD, CD and book distribution unit of Chrysalis Group Plc. “Their record with us has been impeccable.”

Suspending the dividend would help HMV cope with debt, said Vidyarthi. The retailer cut its first-half dividend by 50 percent to 0.9 pence a share and analysts expect a 55 percent reduction for the year to 3.3 pence, according to the average of 13 estimates compiled by Bloomberg.

Citigroup Inc., one of HMV’s brokerage advisers, estimates that the company won’t pay dividends “for the time being,” citing the proximity of the banking covenant test, and the “opaque earnings outlook.” Citigroup analysts led by Richard Edwards have a “hold/speculative” recommendation.

Share Sale?

The reduction of credit-insurance is potentially so damaging that Endless’s Wilson predicts HMV will have to seek new funds through a share sale. Shareholders “are going to have to step up to the plate,” he said.

The board will consider dividends at the end of the financial year, as it does every year, HMV’s Barker said. He called talk of a capital raising “speculation.”

To broaden its business, HMV bought Mama Group, an operator of live music venues including London’s Hammersmith Apollo, last year. HMV seeks to generate 15 million pounds in earnings before interest and tax from live entertainment by 2012-2013. That compares with group pretax profit of 68.9 million pounds in the year through April.

HMV also acquired a half interest in 7digital to supply electronic books, music and videos. At its stores, the retailer added ticket sales, electronics such as mobile phones and Apple iPad tablets, and entertainment-related clothing.

“HMV’s been very half-hearted about this digital business,” said Forrester Research’s Mulligan. “It’s failed to integrate its brand online.”

Mamut Stake

Some investors see the shares as worth owning. Russian multimillionaire Alexander Mamut raised his stake in HMV to 6.1 percent on Jan. 11. He owns a majority stake in Russian mobile phone retailer OOO Evroset, and his SUP owns the San Francisco-based LiveJournal blogging site. Mamut’s office didn’t respond to e-mailed requests for comment.

Most analysts have a different opinion on the stock. Of 14 recommendations monitored by Bloomberg in the last six months, only Nomura, the company’s joint brokerage adviser, has a “buy” on HMV.

“The core business is declining so fast, management can’t cope,” said Kate Calvert, an analyst with Seymour Pierce who has a “sell” rating on the shares.

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