CVAs: the elephant in the room
2018 will probably go down in the annals of time as ‘the Year of the Retailer CVA’. But it could also conceivably be a turning point in what is an increasingly inequitable process says Stephen Springham, Head of Retail Research.
8 minutes to read
The retail doom mongers have had much to feast on in 2018, with a few high profile administrations (Toys 'R' Us, Maplin, Poundworld and East) and a number of controversial CVAs (New Look, Carpetright, House of Fraser, Mothercare and Original Factory Shop) shining an unwelcome spotlight on the retail sector.
Cue predictable retail soul-searching, calls of ‘Retail Armageddon’ and renewed proclamations of the ‘Death of the High Street’. Sadly lacking generally is a sense of perspective as to why the retail sector is apparently so challenged.
Why the distress?
Contrary to virtually every media report, the malaise is not consumer driven. The supposed ‘consumer squeeze’ actually ended in Q1, with wages growth again outstripping inflation.
But this has been a red herring all along and will have no more material impact now than it did over the preceding 18 months.
The UK consumer continues to spend, despite all commentary to the contrary. ONS figures showed that overall retail sales values in 2017 were up 4.5% year-on-year.
"The simple fact is that the UK retail market is over-supplied, both in terms of floorspace and number of operators."
Even stripping out inflation, retail sales volumes were still up by a far-from-disastrous 2.1%. Nor has there been a discernible slowdown in 2018 to date.
Q1 dipped slightly, but has been more than counterbalanced by a very strong Q2 (values ca. +5%, volumes ca. +3%), thanks in large measure to a sustained period of good weather.
The distress amongst some operators cannot be attributed to any single one factor or flashpoint. Rather, it is the result of a toxic mix of multiple cost and competitive pressures.
Some of these are fairly recent (e.g. rising staff costs, business rates revaluations, higher input costs), but most are longer-standing, deeper-seated failings coming home to roost (e.g. over-expansion, lack of investment, failure to move with the times, product shortcomings, lack of brand relevance).
The simple fact is that the UK retail market is over-supplied, both in terms of floorspace and number of operators. Periodically, something has to give.
Nor is the fact that a number of the CVAs have followed in quick succession a total coincidence. Retailers are renowned for their herding instincts and when one breaks rank in revealing its distress, others see it as a good time to ‘follow suit’.
The window for undertaking a CVA will not stay open forever, so anyone wishing to exploit it must do so sooner rather than later. A collective and periodic airing of dirty laundry, if you will.
"Retailers need to be run as retailers, by retailers, not as cash cows by financiers."
Private equity ownership (past or present) is often the monkey on the back of the elephant in the room. A common denominator across retail failures (recent and past) is a history of private equity ownership – BHS, Comet, MFI, Toys 'R' Us, Maplin, East, HoF, New Look, Poundworld, Original Factory Shop, Byron Burger, Jamie’s Italian, Prezzo, the list goes on.
Of course, it would be wrong to tar all private equity with the same brush – some private equity owners are clearly more forward-looking and visionary than others. But the ‘traditional’ private equity model has no place in retail.
Retailers may seem attractive to investors in that they are cash-generative, but they also are capital intensive (or rather, they should be if they are run properly). The notions of hefty financial leveraging, extracting cash, asset stripping and flipping may have worked (or seemed to have worked) in the so-called ‘good times’, but now have no place and are increasingly coming back to haunt.
Retailers need to be run as retailers, by retailers, not as cash cows by financiers.
Why the controversy?
CVAs are probably the most contentious issue in retailing at present. They bring to a head many of the simmering grievances of both landlords and tenants, while also laying bare many of the structural failings of the wider retail industry.
And also give the ghouls in the media plenty to feast upon in their constant endeavours to write off the high street. For retailers, CVAs buy breathing space, if not a stay of execution.
Rather than be liquidated outright, they can significantly reduce their cost base by ‘renegotiating’ their financial obligations, not least by cutting their rent roll and shuttering stores they no longer want.
Store closures always provoke disproportionate consternation in both the media and among the general public. However, few people outside the property industry will ever have been privy to any retailer’s full store list of P&Ls.
These always show huge variances in trading performance across the estate, but a common factor for high street retailers is an ‘ugly tail’ of severely under-performing stores, some of which may be heavily loss-making.
They may not always have been so, but trading patterns can change dramatically over the length of a lease term (10/15/25 years). To put it bluntly, there is not a single established high street retailer that wouldn’t want to jettison at least 10% of their store portfolio, if they were given half the chance.
This is why CVAs are met with such cynicism from landlords – they regard a CVA as ‘a get out of jail free’ card for the retailer, a way of worming its way out of legal and financial agreements that it previously signed up to voluntarily.
But given the current state of retail occupier markets and far from rampant retailer demand, landlords are effectively held over a barrel and have few alternatives other than to agree to whatever is proposed. Less a compromise, more blackmail on the part of retailers – if you don’t agree to these terms, we’ll go bust anyway and you won’t get any rent at all.
There is also considerable controversy as to whether CVAs reflect genuine distress, or whether retailers are abusing the system to simply exit underperforming stores and renegotiate lease liabilities that they previously entered into of their own free will.
Is a profitable publicly listed company with manageable debt and a solid balance sheet really on the brink of collapse? Trading underperformance and failing to match City expectations is a questionable definition of distress.
The mechanics of the actual CVA process spark yet further controversy. Officially, a CVA requires 75% creditor approval to be passed. But there is a distinct lack of transparency around 1. who all the creditors are and 2. how their influence is weighted.
The feeling amongst landlords is that their collective weighting is disproportionately low relative to the level of financial liability that they bear. Even if they vote against a proposed CVA en masse, it still seems likely to go through.
It’s much easier for suppliers and bodies such as the HMRC and PPF to vote in favour of something for which they will not have to shoulder any of the financial burden.
CVAs also have a damaging knock-on effect across retail property markets, with prospering operators seeking to establish comparable terms with their ‘distressed’ counterparts (e.g. Next reportedly seeking ‘CVA clauses’ in its property leases). Why should they pay a full rent, when their adjacent tenant is going cap in hand to the landlord on account of failings of their own making?
Expressed another way, why are successful retailers effectively being ‘penalised’? CVAs may be a necessary evil in retailing, but they are still deeply unsatisfactory.
If they prove the turning point in a retailer’s fortunes and that retailer goes on to prosper, then fine. If they just delay the inevitable and are the first in a string of subsequent failures, then absolutely not fine.
Thin or thick end of the wedge?
The rumour mill is constantly in overdrive as to which retailer will be next. Undoubtedly there will be further CVAs and administrations before the year is out.
But the tide is slowly starting to turn. With something of a groundswell amongst landlords, CVAs are likely to face greater challenge and scrutiny going forward. Indeed, the British Property Federation is becoming increasingly vocal in its lobby for the whole CVA process to be reviewed.
But to some degree, the damage has already been done. The uncertainty around CVA-based store closures and contagion-related shifting rental tones has left the retail occupier market in a state of limbo. Retailers are not committing until there is greater certainty and this is unlikely to materialise in the immediate future.
It is still disappointing to see retailer CVAs interpreted as ‘Retail Armageddon’ or symptomatic of the ‘Death of the High Street’. The fact is that the UK market is highly competitive and over-supplied.
As such, retailing has always been survival of the fittest – and some operators are fitter than others. Harsh as it may sound, maybe it is better in the longer run if the weaker ones are left to fail, rather than propped up by artificial means.