DealMakers - Q3 2020
Retail consolidation – is this just `the beginning?
Richard Isaacs and Ferdi Vorster
In the early months of 2020, South African retailers looked abroad to the developing crisis in China. Many foresaw the impact that the crisis was to have on stock availability for the forthcoming winter season and took appropriate pre-emptive action. It is unlikely that many would have foreseen the catastrophic impact that COVID-19 was to have in their home market, just a few months later.
As COVID-19 spread globally, South Africa officially registered its first case on 5 March 2020 and by 15 March 2020, our South African president, Cyril Ramaphosa, declared a national state of disaster with full lockdown from 26 March 2020. South African corporates responded by taking appropriate operational steps to retain cashflow and strengthen their financial positions, including stricter working capital management, reducing non-essential capex, postponing dividends and ensuring that necessary funding lines were in place with their lending banks.
Against a backdrop of collapsing share prices, raising capital seemed like an unimaginable last resort. Whilst this is a common theme expressed by many, experience from past financial crises has taught us that putting off a decision to raise equity often comes at a much higher cost of capital when needed later on.
Taking advantage of a strengthened position
With this context, and a broken ‘crystal ball’ in hand, corporate South Africa, and in particular indebted clothing retailers, took an early opportunity to strengthen their balance sheets. This was done with a view to arm themselves against an uncertain economic outlook, but also to place themselves in a better position to take advantage of a fractured trading environment, where consolidation opportunities would certainly unfold. Rand Merchant Bank (RMB) recently acted for both Pepkor Holdings and The Foschini Group (TFG) in their recent equity offerings, with both companies approaching equity markets on a front-footed basis, with the intention to (amongst other things) derisk their balance sheets and position the companies for growth. Both these offerings, which collectively raised close to R6bn, enjoyed significant investor support.
Following on from their underwritten rights offer, RMB further advised TFG on the acquisition of selected stores of value retailer JET, out of business rescue. With a strengthened balance sheet, TFG took advantage of a unique opportunity to acquire JET in a manner that would not only give TFG a significant entry into the increasingly important value retail sector, but would give them scale at an attractive price which would have been costly and difficult to replicate organically. Financial metrics aside, TFG was further able to ensure that over 400 retail stores across South Africa and its neighbouring countries continue trading and keep over 4,800 employees employed in the midst of a very challenging economic environment, with the impact of COVID-19 continuing to worsen unemployment levels.
Business rescue and M&A
COVID-19 has had a devastating impact on the South African economy. We continue to see a number of businesses struggling to stay open. The continued weakness in global markets, coupled with a second wave of infections abroad and an expectation of a further wave of COVID-19 infections in South Africa increases the likelihood that the number of businesses entering into business rescue will rise. Whilst we expect that consolidation is the natural course for a number of industries, when it is precipitated by business rescue, this naturally introduces challenges for buyers, outside of the ambits of normal M&A. Having been involved with a number of these situations, we believe that whilst business rescue often provides an opportunity to acquire seemingly good value assets at significantly discounted prices, buyers need to ensure that they have taken the right advice to ensure that they have the correct mitigants for the risks of buying assets out of business rescue. This includes issues such as working to rigid and accelerated timelines, limited due diligence and potentially limited to no indemnities or warranties. That being said, a strategic buyer with knowledge of the distressed asset is more likely able to navigate this challenging environment and better understand and mitigate the risks that operating under financial strain introduces, especially insofar as staff, suppliers and customers are concerned. TFG is a case in point of a strategic buyer who acutely understood the JET opportunity and whose ability to rapidly navigate the business rescue process ensured that they were not only successful in their bid for the majority of the JET business, but also managed to do so in a manner where they had structural mitigants in place insofar as limitation of liabilities, continuity of supply of stock and ensuring that not only were they able to save jobs, but they retained staff who are critical to the business.
A trend we expect to see continuing
As South Africa continues to relax its lockdown restrictions and as we wait to see what else 2020 has in store, we believe that we are sadly seeing only the beginning of the business rescue theme. The retail sector, like many others, will need to see smaller players consolidate or merge with larger peers in order to withstand the impact of a weakened economic climate and ever-evolving operating models. n
Isaacs is a Corporate Finance Executive responsible for Retail advisory and Vorster is an Investment Banking Director, both with Rand Merchant Bank.