Is Edcon reaching its nadir?

If recent reports are to be believed, the tale of Edcon, owner of some of the country’s most esteemed retailers, might be reaching its nadir. The company has a range of issues confronting it at the moment, which as the cards currently lie, are all contributing to a potentially disastrous ending.
These include, in varying degrees, the deterioration of its underlying businesses in line with slower consumer demand; the reticence of Barclays Group Africa to grant credit to its customers; and the demands of trying to grapple with its biggest problem: the group’s current capital structure.
Potential problems with the capital structure became evident as soon as Bain Capital bought and then delisted Edcon from the JSE in 2007. Back then, for every R1 in equity they invested, four times that amount in debt was assumed to fund the transaction. The capital structure required the most optimistic of assumptions be realised in order for the company to thrive, and by default pay down some of the enormous debt it had assumed.
Today, Edcon has no equity capital – in fact it’s negative to the tune of R5bn, having been completely eaten by losses sustained over the years. While this makes it technically insolvent, the situation has been permitted to continue so long as there has been cash to meet its obligations. But even this premise is under threat.
The company recently reported third-quarter results ending December 2014 (what should be the busiest and most prosperous quarter of the year for retailers). This revealed that retail sales advanced just 0.5% (to R8.8bn) over the December 2013 quarter. While the company generated profit before interest of R783m, this was more than subsumed by financing costs, which amounted to R860m.
The balance sheet reveals that Edcon’s long-term debt has stayed consistent at R22.3bn over the last year. Short-term interest bearing debt (now R388m) has gone up from the same time in December 2013, but has fallen since the end of March 2014 (when it stood at R1.2bn). This was more than likely assisted by an increase in trade payables, which rose by over R2bn to R7.79bn.
Clearly, push has now come to shove.
Edcon’s four retail clusters and its contribution to group revenue comprise Edgars (51%), CNA (6.9%) and Discount – which includes Jet (39.6%), and Edgars Zimbabwe (2.4%). In terms of operating profit, Edcon and Discount each made about R1bn for the 9-months ending December, while CNA and Edgars Zimbabwe were marginally profitable. The company has one more source of income: its share of the interest and fees that it charges credit customers, which generated an operating profit of R780m in the period.
Naturally, for a company in this position, costs are being cut left, right and centre, in order to preserve cash flow. Group Services – the name of the line item for corporate overheads – almost halved between December 2013 (R3.57bn) and December 2014 (R1.93bn). How much more can be cut remains to be seen.
In terms of its debt, Edcon is funded through a variety of sources, but predominantly from foreign denominated (dollar and euro) fixed interest bonds which mature in March 2018. In the interim, a rand-denominated floating rate note comes due in April next year. Based on the yields its debt is trading on at the moment, it’s highly unlikely that Edcon would be able to refinance these were they to come due now.
Besides the debt holders (creditors) the effect on listed property could be enormous. Edcon accounts for approximately 4% of all listed property rentals across its portfolio of retail, industrial and commercial space. Naeem Tilly, a listed property analyst at Avior Research, says: “Jurgen Schreiber has been meeting with property funds to address the situation and has stated that underperforming stores would be closed or resized. Those that could be closed upon expiry of their leases could well include the likes of Edgars in Killarney Mall and Melrose Arch,” says Tilly.
But it’s not all bad news. “We hear from listed property companies that some stores are enjoying really strong trading – like Edgars in the Hyprop-owned Canal Walk,” says Tilly. “Edgars in dominant shopping centres are doing well. In some cases, like Edgars in Sandton City, the store has been expanded.”
So dire is the situation for all concerned that a large amount of flexibility might be afforded to Edcon than would ordinarily be the case for a smaller operator. In the worst case scenario, where the company would enter business rescue proceedings with possible liquidation, there would be a protracted legal battle and a highly-uncertain outcome. It’s in everyone’s best interest to keep the company going, particularly as it is fundamentally profitable.
The word on the street is that Brait, fresh from minting cash following the sale of Pepkor, might be interested in an advance on Edcon. Whether it’s Brait or a large international player, here is how a potentially happy ending could play out:

  1. Underperforming and marginal brands will be disposed of, realising a relatively small amount of capital that will go towards paying down debt.
  2. While playing hard ball upfront, creditors like listed property owners and other suppliers, will grant the group significant flexibility in closing down or resizing poorly performing stores. Trade creditors might waive interest costs/penalties to help Edcon stay afloat.
  3. The buyer will pay R1 to acquire Edcon, in exchange for assuming its debts. But prior to the sale being consumed, the potential buyer will negotiate a “haircut” on the debt. This will be a write-down in the order of 40c-50c on the rand (or euro, or dollar depending on who you are). For such generosity on the behalf of creditors, the deal will be sweetened with options to acquire shares at a nominally low price in the future, thereby allowing debt holders to recoup some of the losses from the haircut.
  4. The new owner will need to pump around R4bn of equity into the company. This will get the financial position onto an even keel – still highly indebted, but with enough cash flow to service the debt and continue investing in the business. After two years of improved financial performance, Edcon will be partially listed on the JSE. This will allow the buyer to realise some value, and a mechanism for debt holders to sell their shares.

One alternative to the scenario envisaged above, would be to have the good businesses carved out of Edcon and sold separately. But it remains to be seen whether creditors would allow that to ever see the light of day – they would likely prefer to take their chances in business rescue.
So here’s hoping for the best, but expecting the worst.
This article originally appeared in the 20 March – 26 March 2015 edition of Finweek. Buy and download the magazine here.
via Finweek