Reinventing British Retailers -- The Hard Way

Bookseller WH Smith PLC is one of Britain's most widely recognized retailers; millions have prowled the aisles of its shops over the years looking for a good read. But the company has fallen on hard times. Hurt by competition from discounters, it posted a 29% profit drop for the six months through February. By mid-April, the company's stock had plummeted nearly 40% from its peak last July.

Now a white knight has come to the rescue. Permira, a pan-European private equity house, has offered to take WH Smith private in hopes of resuscitating one of Britain's grand old retail names. While the offer is considered generous, the two sides aren't expected to reach a deal for weeks. "A private owner with a plan will have much more of a stomach for a gritty and risky turnaround strategy," says Simon Burke, the retail veteran leading Permira's bid.

The pending takeover of WH Smith is just one of more than a half-dozen recent deals matching private equity investment groups with struggling British retailers. In 2002, Arcadia Group, owner of trendy but troubled women's apparel stores such as Topshop and Dorothy Perkins, was taken private by retail entrepreneur Philip Green. Then last year mass-market department store Debenhams, high-end department store Selfridges, and women's retailer Oasis Stores all fell into private hands. Among the buyers: a consortium of private-equity firms called Baroness Retail, led by CVC Capital Partners and Texas Pacific Group; Canada's Wittington Investments; and Noel Acquisitions, owned by Baugur Group, Iceland's retail investment group. In all, retail private equity deals in Britain soared to $5.2 billion in 2003, according to Dealogic, a London research firm. That's a 49% jump from 2002, and nearly three times the levels seen in the U.S. that year. "There will be quite a bit more of this," says Richard Hyman, chairman of Verdict Research Ltd., a retail consultancy in London. "The environment is right, and it's ripe." So far in 2004, Britain has seen $2.2 billion worth of deals. Bankers say possible future targets include Marks & Spencer Group PLC (MAKSY ) and Woolworth's Group PLC.

Why the sudden shopping spree? Analysts and bankers say private equity firms are attracted to British retailers' strong brand names and healthy cash flows amid a consumer spending boom. WH Smith, for example, has a net cash position of $50 million, even though flagging earnings have sent its publicly traded shares to bargain-basement levels. "It's a logical response to the market's neglect of retailers," says Martin Clarke, a partner at Permira. "The market doesn't always appreciate that retail is a volatile business. Private equity is all about taking a long-term view."

Inroads by discounters such as supermarket giant Tesco and Asda Group (WMT ), a unit of Wal-Mart Stores (WMT ), promise to crimp profit margins further. That means publicly traded retailers are going to have to change the way they do business -- or let private equity firms do it for them.

By Laura Cohn in London

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