Buyout chiefs leave a trail of ruin on the high street

26 July, 2020 London


50% Growth in the number of casual dining outlets between 2010 and 2018

£48bn Spending by private equity firms on retailers and casual dining groups since 2000

£1.1bn Debt pile of Pizza Express, owned by China’s Hony Capital

When Karen Jones and Roger Myers brought a slice of Parisian café culture to southwest London in 1989, the locals lapped it up. In those days, pubs were for drinking and restaurants were for eating — but their bistro on the fringes of Richmond Park paid little mind to prevailing orthodoxies, encouraging customers to order a croque monsieur or a glass of merlot no matter the time of day. The menus were handwritten in cursive script, the gold lettering adorning the windows was inspired by long walks in the French capital.

The founders knew their novel venture had truly captured the middle-class zeitgeist when it emerged as a favourite haunt of the fictional, chardonnay-swilling diarist Bridget Jones.

Café Rouge has fallen a long way since those heady days. After opening more than 100 outlets, Jones and Myers sold the chain — by then bundled up with their other dining brands in the Pelican Group — to the leisure conglomerate Whitbread for £133m in 1996.

Just six years later, Whitbread offloaded the business to Tragus, now known as Casual Dining Group (CDG), for only £25m. It then passed through the hands of four different private equity owners — L&G Ventures, Blackstone, Apollo and KKR — whose attempted turnarounds all failed to recapture the early magic of Café Rouge. CDG’s collapse into administration early this month leaves the chain facing an existential crisis.

While the Covid-19 shockwave has left no high street brand unscathed, it has brutally exposed the less resilient operators and reignited debate over the shortcomings of private equity ownership. Critics say debt-fuelled expansion has left a legacy of bloated chains bereft of the financial strength needed to weather market shocks — and lacking originality.

“Great brands are built over the long term, but private equity takes a short-term view and to hell with the consequences — running businesses very hot and stripping out costs works near-term but leaves a hollowed-out husk,” said Peter Williams, co-founder of preppy fashion brand Jack Wills, which collapsed three years after private equity firm Bluegem bought a majority stake in 2016.

The shirt-seller TM Lewin and homeware brand Cath Kidston were among the private equity-backed retailers that quickly succumbed to the coronavirus. Bridgepoint-backed Azzurri, which owns restaurant chains Ask Italian and Zizzi, was sold to TowerBrook Capital Partners in a pre-pack administration this month. Pizza Express, which is owned by Beijing-based Hony Capital and has a £1.1bn mountain of debt, is heading for a restructuring. And fears are growing for Italian restaurant chain Prezzo, which employs 3,000 people, after owner TPG Capital kicked off an emergency sale process.

The juiciest returns for private equity on the high street came when retailers had grown fat in the boom years leading up to the 2008 financial crisis. The £1.7bn buyout of Debenhams in 2003, orchestrated by serial deal-maker John Lovering and backed by CVC Capital Partners, TPG Capital and Merrill Lynch Private Equity, became the poster child for the sector’s financial engineering.

To help pay down the £1.1bn of debt they loaded on to Debenhams, the new owners sold store freeholds and took out long leases. Within three years, they made more than three times the £600m of equity they put in — but their actions left Debenhams in a weakened position to navigate rough waters ahead. In April, the chain collapsed into administration for the second time in a year.

An even bigger deal came in 2007, when KKR backed a £11bn leveraged buyout of Boots, which dumped £9bn of debt onto the balance sheet. The chemist, part of American giant Walgreens since 2012, is cutting 4,000 jobs as the coronavirus ravages profits that had already fallen 47% to £167m last year.

As the rise of e-commerce made shops less valuable, private equity firms turned their attention to the casual dining sector, which was exploding as consumers opted to spend on eating out rather than a new outfit. The playbook was simple: buy a fledgling chain, borrow cheaply to expand quickly and hope the economic cycle lasts long enough for you to convince somebody to buy it after five years.

Taking a “cookie-cutter” approach to expansion, with the same decor, fixtures and fittings in each outlet, might work on a spreadsheet, but it leaves little room for variety and excitement for consumers.

“Private equity began piling back into the sector around 2010,” said Paul Hemming, a managing director at the consultancy AlixPartners. “The firms all started drawing up lists of the towns they wanted to expand into, but the problem was that everybody’s list had the same towns on it.” Between 2010 and the market peak in 2018, the number of casual dining outlets grew by 50% to 7,120, according to researcher CGA. The forthcoming closures are expected to hit commuter towns around London particularly hard.

Byron Burger, launched in 2007 by the Old Etonian Tom Byng with restaurant group Gondola, expanded to 34 sites before it was sold in 2013 for about £100m. The private equity buyer, Hutton Collins, believed it could treble the number of outlets, despite competition from Gourmet Burger Kitchen and Five Guys — the huge American franchise that made its UK debut the same year.

The expansion proved too much too soon. In 2018, Hutton Collins put Byron through a company voluntary arrangement, an insolvency tool used to shut outlets and reduce rent bills, and ceded control to fellow buyout firm Three Hills. When Covid-19 arrived, it swiftly overwhelmed the chain, which has lined up administrators from KPMG.

The hangover from the expansion binge has been worsened by increases in staffing costs, food prices, rents and business rates. The deteriorating market conditions sparked a wave of “vouchering” by Café Rouge, Bella Italia and others to lure diners, alongside a squeeze on suppliers, which took its toll on quality.

“A standard high street restaurant takes £12,000 to £15,000 a week and that used to make about £200,000 [profit] a year; now it gets you to about breakeven,” said Hugh Osmond, who helped to float Pizza Express in the 1990s and is now a partner at private equity firm Sun Capital. “All of the private equity firms that are charging into casual dining have not understood how the economics have changed. It was all completely buggered before Covid and there is no future in most of that sector.”

Defenders of private equity say the firms instil focus in management, who typically take a lower salary but a higher equity stake than counterparts in listed businesses, and that the strictures of quarterly reporting can push plc chiefs into taking even shorter-term decisions to hit targets.

Being away from the glare of the public markets has other benefits, too. “We don’t sit around in a room wasting time thinking, ‘How do we package this to make it look better than it is?’ ” the boss of a private equity-backed retailer said.

Successful online retailers, unburdened by the high fixed costs of high street rivals, are now on the radars of the buyout barons. Suitors are reportedly vying to buy a minority stake in sportswear brand Gymshark, which would crystallise a multimillion-pound fortune for its 28-year-old founder, Ben Francis.

On the high street, however, private equity firms are being replaced by vulture funds, which turn around struggling firms — or, more often, strip any remaining value from the carcass. For blue-chip private equity funds to invest again, rents and business rates will have to fall and shoppers will need to return.

“Private equity will come back to the high street,” said Claire Madden, a managing partner at Connection Capital. “It always does.”

Hopes dashed: business rates revaluation delayed to 2023
Until last week, retail bosses were clinging to the hope that the carnage on the high street would have a silver lining: surely it would prompt reform of business rates, writes Sam Chambers.

Those hopes were dashed when ministers postponed a property revaluation until April 2023, leaving chains facing the prospect of paying business rates based on 2015 values. A 12-month business rates holiday to help chains weather the Covid-19 crisis expires next March.

“When the rates kick back in, those retailers living on the edge are stuffed — it’s that simple,” said Chris Wootton, chief financial officer of Mike Ashley’s Frasers Group empire, who warned that more of its stores will close if business rates are not reduced.

Retail property has suffered an unprecedented decline in value in recent years, hit by the rise of online shopping and a surge in retailers’ operating costs. Even before the pandemic, the value of Britain’s shopping centres had fallen by 31% in two years, according to data firm MSCI.

Now, even more shoppers have been forced online. In June, almost one pound in three spent in retail was via internet shopping.

The total business rates bill for online giant Amazon is estimated to be tens of millions of pounds, whereas the last annual bill for Sainsbury’s was £567m. That iniquity has united retailers — but they have failed to come up with an alternative plan.

Some high street chains resented the business rates holiday being extended to supermarkets, whose profits will weather the crisis intact.

Business rates are a tough tax to avoid — if a shop is empty the landlord foots the bill — and are an increasingly important source of revenue for cash-strapped local authorities. The government concludes its “fundamental review” of business rates in the spring — but retailers need clarity now.

“Retailers are making decisions on store closures now, not in the spring,” said Superdry chief executive Julian Dunkerton. “We need a commitment from the government to reduce rates permanently. Halving rates would change the economics of town centres completely and allow independents back in.”


Source:  Sunday Times Business (26 July 2020), article by Sam Chambers