Marks & Spencer Buyout Seen as Stock Below Peak: Real M&A

Marks & Spencer Group CEO Marc Bolland
Marc Bolland, chief executive officer of Marks & Spencer Group Plc. Photographer: Scott Eells/Bloomberg

Marks & Spencer Group Plc, the 128-year-old store chain, is offering private-equity shoppers the biggest bargain in more than seven years versus its main U.K. clothing competitor.

Chief Executive Officer Marc Bolland, who took over in 2010, has failed to revive the retailer’s shares, which are languishing 55 percent below their peak prior to the onset of a global recession five years ago. The seller of apparel, specialty foods and housewares is valued at 6.2 times earnings before interest, taxes, depreciation and amortization, after this month reaching the steepest discount to rival Next Plc since 2005, according to data compiled by Bloomberg. It is also cheaper than 85 percent of similar-sized chains worldwide.

Marks & Spencer “at this level, could always be vulnerable to a bid,” Paul Mumford, a London-based fund manager at Cavendish Asset Management Ltd., which manages $1.2 billion in assets and holds Marks & Spencer stock, said in a telephone interview. “It would be perfect for a private-equity firm. It’s cash generative, it has a decent brand name, a food side which gives it a defensive quality and a portfolio of shop property in fairly prime positions.”

U.K. Mainstay

Marks & Spencer, which is trading 16 percent below the value of a spurned takeover bid in 2004, had its first profit drop in three years as sales growth slowed. While faced with a pension-fund shortfall, the 5.4 billion-pound ($8.5 billion) company owns real estate and a stable food business that could attract a buyout, according to Brewin Dolphin Holdings Plc. With the chain generating three times more cash relative to its stock price than peers, Societe Generale SA said it could be taken private for 430 pence a share, a 28 percent premium.

Daniel Himsworth, a spokesman for Marks & Spencer, said the London-based company wouldn’t comment on takeover speculation or its valuation.

Marks & Spencer, which traces its roots to 1884, is the U.K.’s largest clothing retailer by sales. The company runs more than 1,000 stores, most of which are located in the U.K. and Ireland, according to its 2012 annual report.

After posting net income of 822 million pounds in the fiscal year ended in March 2008, Marks & Spencer had a 38 percent drop in net income in 2009 and earnings have never fully recovered, data compiled by Bloomberg show.

‘Going Nowhere’

Bolland, who took over in May 2010 vowing to rejuvenate the Marks & Spencer brand, instead has overseen two years of slowing sales growth and a fall in annual profit in fiscal 2012. In May, he lowered sales forecasts as conditions worsened in the U.K., where the economy is mired in a double-dip recession.

“Has the business moved on? I don’t think it has,” Freddie George, an analyst at Seymour Pierce Ltd. in London, said in a phone interview. “The earnings are going nowhere for the last couple of years. Women’s wear is a major problem.”

Same-store sales of general merchandise, which is mostly apparel, fell 6.8 percent in the quarter ended in June, the worst performance since 2008. The division’s leader announced this month plans to step down in a management shuffle.

Marks & Spencer’s shares, which peaked in May 2007 at 749 pence, closed yesterday at 337.1 pence, down more than more than 6 percent since Bolland took over.

Today, the stock fell 1 percent to 333.7 pence in London.

Including net debt, the company was valued yesterday at 6.2 times trailing 12-month Ebitda, compared with 8.2 times for Leicester, England-based Next, the U.K.’s second-largest clothing retailer by sales, according to data compiled by Bloomberg. On July 12, it was valued at a 27 percent discount to Next, the cheapest since 2005, the data show.

Buyout Opportunity

Marks & Spencer also trailed the median multiple of 11.5 times Ebitda for department-store chains with a market value of more than $1 billion, data compiled by Bloomberg show.

“When things are weakened like this it makes it more of a possibility” for a buyout firm to step in, Jean Roche, an analyst at Panmure Gordon & Co. in London, said in a phone interview. “It needs a face lift. You wouldn’t have to answer to the stock market so you could make changes more quickly. It could be a real opportunity.”

Marks & Spencer could attract private-equity suitors because it generates cash and still has a leading market-share position in U.K. apparel with a well-known brand, Mumford at Cavendish said. The chain has a free-cash-flow yield of 9.6 percent, compared with an average of 3.1 percent for similar-sized rivals, according to data compiled by Bloomberg.

Property ‘Buffer’

A U.S. retailer seeking to enter the U.K. or European market could buy Marks & Spencer, improve the product line and benefit from its brand awareness in the region, Mumford said.

Tim Green, who helps manage more than 24 billion pounds at Brewin Dolphin in London, including Marks & Spencer stock, said the chain’s food business could appeal to a buyer, while its portfolio of properties provide an “embedded buffer” for the company. Food sales climbed 3.9 percent in fiscal 2012, even as general merchandise revenue declined 0.9 percent.

Food “is the part of the business that is reasonably well-fixed,” Green said in a phone interview. Any bidder “may look to the company in its current form and just seek to run it more effectively. What is clear is the business is not trading to its potential.”

About 30 percent of Marks & Spencer’s stores are franchises, while the remainder are owned or leased by the company, according to the retailer. With the estimated market value of the owned properties at about 5 billion pounds, a buyer could potentially use the real estate to partly finance a bid, said Anne Critchlow, a London-based analyst at Societe Generale.

Bid Analysis

A private-equity firm could acquire the retailer for a price of 430 pence a share and use debt to fund 50 percent of the price, Critchlow said. The buyer could then sell property and pay down borrowings with the company’s cash flow for a return on equity of 22 percent after five years, she said.

“Financially, in theory, it stacks up at 430 pence,” a 28 percent premium to its stock yesterday, Critchlow said. “I’m assuming they sell 4.3 billion pounds of property and that helps the bid work. That’s the key enabling factor in the bid model, the presence of freehold property and the ability to sell it.”

Critchlow said her analysis doesn’t take into account property interests that have been pledged toward the company’s pension plan, which had a shortfall of 1.3 billion pounds as of March 2009. Marks & Spencer put 800 million pounds of funding in place to fill part of that gap as of May 2010, including increasing the plan’s interest in a property-backed partnership.

Debt Load

Marks & Spencer also has 1.82 billion pounds of net debt, more than three times Next’s 604 million pounds, according to data compiled by Bloomberg.

“The pension and the debt would be an issue” for a buyer, Panmure’s Roche said. Critchlow also cited debt as a practical concern for an acquirer.

A turnaround of the retailer would involve investing in the brand, said Dan Murphy of restructuring firm Alvarez & Marsal in London. Private-equity firms tend to focus instead on cutting expenses and paying down debt, he said.

Buyout firms “focus on all the cash efficiencies, pricing, promotions and margins, but it misses the point of a brand-led retailer like M&S,” Murphy said in a phone interview. “They would only exacerbate the problem. They don’t understand the concepts of brand because they are interested in a three- to five-year exit window.”

Still, there is room to cut operating expenses and improve the business, Societe Generale’s Critchlow said. Marks & Spencer’s operating margin was 6.9 percent in the latest fiscal year, compared with 13 percent in 2008.

Cheaper Now

At current levels, Marks & Spencer would be a smaller acquisition for a potential buyer than when the company fended off a hostile bid in 2004 by billionaire Philip Green, whose Arcadia Group owns the Topshop fashion chain. The 400-pence-a-share attempt failed after Green was unable to garner the support of the firm’s board and the retailer promised to repurchase 2.3 billion pounds of stock to placate shareholders.

Green’s proposal valued the company at 9.1 billion pounds, compared with the current 5.4 billion-pound market capitalization.

“It’s a lot cheaper to buy,” Cavendish’s Mumford said. “With the shares languishing at a low level, it could make an attractive takeover proposition.”

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