Debenhams falls out of fashion

In the two years since its private equity owners refloated Debenhams, the retailer has lost more than half its value. Has the company got it wrong, or were investors sold a pup? By James Moore

Stung by the recent criticism that has come its way, the British Venture Capital Association has taken to sending around emails entitled "Why Private Equity is Good for Britain", containing case studies of success stories.

It is a fair bet that Debenhams will not be featured among their number any time soon. On Wednesday, the department store chain hit its nadir since its private equity owners sold the majority of it back to the public markets last spring.

At the time of the flotation, considerable scepticism was expressed about the retailer's growth prospects given the phenomenal amount of money wrung out of the business while in private hands. The shares were priced at the bottom of the range set by the bankers Merrill Lynch and Citigroup.

Investors fretted about what would be left for them, given that the private equity owners had almost quadrupled their £600m initial investment. The financial engineering they performed to reap this reward has left the group saddled with high fixed costs that require it to grow sales rapidly if it was to meet expectations.

But few of those who swallowed their misgivings and took the plunge at 195p a share can have dreamed the shares would perform quite as badly as they have. Because those sales have not been growing at anything like the rate required.

The all-time closing low of 89.5p that the shares reached on Wednesday was accompanied by rumours that the company was about to breach its banking covenants on its debt mountain of around £1bn.

Those rumours were probably put about by spivs looking to cash in by shorting the shares against the background of a credit crunch and rising concern about heavily indebted companies.

But it remains the case that, after three profit warnings in four months at the start of the year, Debenhams is a name that is often thrown back at the private equity industry by its legion of critics, being used as a stick to beat some of its leading lights by frustrated MPs as part of their ongoing inquiry in June .

Belatedly, it seems the industry has begun to wake up to the calls for it to be more responsive to inquiries, a plea again made by Wol Kolade, the BVCA's chairman, at a speech in Monte Carlo earlier this week.

While Merrill Lynch refused to comment, Texas Pacific Group, which led the takeover, hit back at charges that Debenhams' private equity owners under-invested in the retailer.

A spokesman for the firm said: "We did not under-invest. Additional stores – we added 29 – were opened under our ownership. The company has accelerated the roll-out programme since the IPO. We are still the largest shareholder, holding a stake of just over 13.2 per cent, in Debenhams and have great confidence in the company's future."

CVC also chipped in. A spokesman said: "Under private equity ownership, Debenhams invested efficiently for long-term growth. It has grown its sales area by nearly 30 per cent over the last three years. By any standard, that is laying down the foundations for future sales growth."

He added: "Overall, CVC has an excellent track record of listing companies in the UK. If you had invested £10,000 in all CVC's public offerings since 2000, including Debenhams, your investment would have grown by 2.6 times. If you'd invested in the FTSE 250 instead, your money would have grown by only 1.7 times."

A spokesman for Debenhams said: "The company has grown substantially since being taken private in 2003. Sales have gone up by £500m and profits have grown by 60 per cent. Margins have increased since the business was taken private as well. Some £150m a year has been invested and 40 new stores have been opened, creating 3,000 new jobs."

The spokesman said he accepted there had been problems – most notably with this year's poorly received militaristic menswear with its brass buttons and khaki colours. But he said: "The problems are being addressed. We have looked again at the menswear and we are midway through a store refurbishment programme. We accept there has been under-investment in the stores, but that dates back to before we were taken private."

He declined to comment on "market rumours" about the banking covenants, although the company told analysts that its debt position had improved last week and that cash flows were strong. Its chief executive, Rob Templeman, would hardly have said that if the company was on the verge of hitting the buffers.

But that does not change the fact that it has been a Debenhams disaster for those who bought the shares at the flotation, with the private equity owners taking much of the blame.

Critics have argued that they loaded the business up with too much debt and sold off its remaining freehold property, leading to the high fixed costs that have been causing such problems.

And despite the defence mounted by TPG and CVC, the criticism about under-investment in stores will not go away.

Richard Ratner, the respected retail analyst at the stockbroker Seymour Pierce, who has no axe to grind with private equity, said: "The fact is that this is a company that had been squeezed. A lot of their stores are very old-fashioned. They are just dark. You're not going to get people to buy anything if they can't see what they are being offered."

The sometimes less-than-sparkling service shoppers receive in Debenhams is put down to "cost cutting".

Mr Ratner also pointed to the company's habit of indulging in near-perpetual sales as a significant problem that needs to be addressed and that appeared to get worse in the run-up to its flotation. "They are on sale for as much as 16 weeks a year, and when you have a situation where something is sold at £50 one week and £30 the next with these Mega Days, customers get annoyed. There were a lot of them pre-float to fatten the volumes."

The poorly received menswear offering, the fact that Debenhams has been facing intense competition from the revival of Marks & Spencer along with a feisty John Lewis that is seriously impressing critics, and a difficult retail environment in general have just added fuel to the fire.

Mr Ratner said Debenhams' problems, the tired stores, merchandising issues and excessive sales, are fixable. But he warned: "It will take time."

Which has led to some questions over whether the company's suffering investors could be taken out of their misery by, ahem, another private equity bid.

Forget it.

The trouble is that potential bidders are likely to struggle in the current climate to raise enough cash to finance the takeover of a struggling retailer with a £1bn debt on its books.

"At the moment, you would find it difficult to borrow the debt, let alone the equity in the business," said Mr Ratner.

Investors hoping for a fresh consortium of private equity bidders to take the company off their hands are likely to be disappointed. They appear to have no option but to tough it out.

And perhaps it is unfair to blame the private equity industry practitioners for the company's problems. After all, if fund managers are willing to sell companies to them, and then buy them back after they have worked their financial engineering, they really have no one to blame but themselves.

Debenhams: almost 200 years of retail history

1778: Debenhams begins life as Flint and Clarke, suppliers of clothing and dry goods. William Debenham became involved in 1813 and the firm was renamed Clark and Debenham.

1905: First department store opened.

1919: Takes over retailer Harvey Nichols.

1928: Listed on London Stock Exchange.

1976: Bought Hamleys.The toy shop was sold for £30m in 1986, but continued to sell toys throughconcessions in Debenhams until 2000.

1985: Burton Group buys Debenhams in hostile takeover, gaining 65department stores,and Hamleys.

1987: Burton brings in American John Hoernerto revitalise Debenhams.He moves the chain back into the black, by focusing on the retailer'sown-brand productsand closing unsuccessful stores.

February 1992: Mr Hoerner named chief executive of Burton Group; Terry Green becomes head of Debenhams.

1997: Company expands overseas.A year later it begins trial runs ofcatalogues.

1998: Mr Hoerner demerges Debenhams from Burton, which is renamed Arcadia.

200o: Mr Green steps down as chief executive. Belinda Earl, the group'sformer trading director, takes over.

2003: Investors back a £1.7bn takeover from the private equity consortium Baroness Retail, formed by CVC Capital, Texas Pacific and Merrill Lynch Private Equity, over a rival bid from Permira. Debenhams is delisted and Rob Templeman, former boss of Halfords and Homebase, installed as chief executive.

May 2006: Debenhams returns to London Stock Exchange with CVC Capital and Texas Pacific holding on to 28 per cent of the shares. Debenhams acquires nine stores in Ireland from Roches Stores.

2007: Icelandic retailer Baugur buys5 per cent stake, fuelling speculation ofbid for the company. The Icelanders deny this after Takeover Panel requests they clarify their position, in effect ruling themselves out of hostile bid until December unless rival bidders emerge. Baugur stake later rises to 13.5 per cent.

Louise Dransfield