Six years since it paid R25bn to buy out fashion retail conglomerate Edcon, it's difficult to imagine US-based private equity specialist Bain Capital profitably flipping this large investment any time soon.
Simply put, Edcon's current debt is R19,5bn, a rather cumbersome number to whittle down when three years of sales - collectively topping R75bn - yielded just R5bn in profit before interest. For the record, financing costs during the last three financial years topped R8bn.
Edcon CE Jürgen Schreiber concedes Bain will probably be a part of the business for many years to come, potentially even after an IPO (initial public offering). "The IPO would be a deleveraging event, diluting Bain, which will then sit alongside public shareholders for some time."
It's not clear when Edcon intends pitching the IPO, but the fact is Bain will be enduring a much longer wait to exit its investment than was initially expected, or is the norm for private equity transactions, for that matter.
Absa Investments retail analyst Chris Gilmour says: "Edcon delisted from the JSE at the worst possible time, and has since missed the period when local retailers were the flavour of the month. Now the [retail] cycle has turned against it."
Gilmour says, though, that Edcon is "beautifying itself" to come back to market, which he expects will be sooner rather than later.
In terms of a makeover, Edcon's challenges are twofold. Firstly the operations, in particular the core Edgars department store brand, need to improve markedly on the trading performance notched up over the past half dozen years. Unfortunately, the current economic climate is not conducive to growing profits rapidly.
Secondly, Edcon needs to accelerate its degearing efforts at a time when store revamps and extensions require a further investment of R1,1bn in the 2014 financial year.
At face value Edcon's balance sheet seems dangerously stacked, notwithstanding a cut of R5,5bn in the year to March after the company sold R8,7bn of its debtors book to banking group Absa Unfortunately the remaining R19,5bn in debt still looms large, especially measured against the recent operating performance.
From a purely fundamental perspective the top lines of Edcon's income statement underline the need to shine up the core Edgars brand, which accounts for 58% of the group's all-important trading margin.
The results for the year to March showed only low, single-digit growth in turnover at R26,7bn and gross profits at R9,2bn.
But it's the lower rungs of the income statement that make for more startling reading, with a loss of R5bn notched up for the trading period - owing mainly to the hefty financing costs.
Even perusing Edcon's figures without the debt drag does not make impressive reading. Trading profit was crunched 25% to R1,36bn after Edcon incurred substantially higher store and operating costs of R9,2bn. Trading margins were eroded to 5% compared with the stouter 7% and 7,8% recorded in the 2012 and 2011 financial years respectively.
Nevertheless, Schreiber remains optimistic that Edcon's investment in its underlying businesses will pay off. "Our revamped stores do generally trade better," he says.
It is the quantum of the improvement in operational performance that will be key in the next few years.
A glance at Edcon's balance sheet, however, would raise some serious questions about how the company will fund its ambitious growth initiatives. In fact, some investors might find it worrying that Edcon's audited financials carried the executives' reassurance that the company was solvent and liquid with adequate resources to continue operating for the foreseeable future.
However, the reassurance was necessary, as Edcon finished the financial year with its liabilities exceeding its assets by about R1,5bn.
At this stage perceptions might be that Edcon is on a trading treadmill, its debt load hampering operational efforts to move the business forward.
Schreiber says that despite its investment commitments to re-establish more acceptable growth from operations the company is making a strong effort to cull debt to more manageable levels.
Since the financial year-end Edcon has managed to offload another R469m of its debtors book to Absa. Schreiber expects to complete the sale of a further R600m of eligible accounts later this year.
Edcon has described the sale of the bulk of the debtors book to Absa as "significant and transformative". Schreiber says not only does the arrangement with Absa reinforce the balance sheet but operational cash flows are enhanced since all Edcon's sales are effectively cash based. Shedding the book also means Edcon can focus on its core retailing competences.
Coupled with the debtors book sale was a process of "migrating" from foreign-denominated to rand-denominated debt. These initiatives might shave as much as R800m off the interest bill in the year ahead.
This could be crucial. Edcon's most recent cash flow statement showed a R784m decrease to R2,9bn in operational cash flow, which barely covered finance costs of R2,89bn.
But it seems unlikely, despite the interest bill savings and growth endeavours, that Edcon will move back into the black in the financial year ahead. It will be first prize if it registers a margin improvement without losing further market share in core trading formats.
One perceived hitch to restoring operational strength could be Edcon's recent settlement of a R2bn legacy tax issue. This is a big number that shifts Edcon's deferred tax balance from an asset of R1bn at end-March 2012 to a net liability of R537m.
However, it's unlikely the tax issue will hinder Edcon's efforts to get IPO ready. Edcon investor relations executive Debbie Millar stresses there is no cash outflow from the settlement with the revenue service. Essentially Edcon's assessed loss was eroded and its ability to deduct interest on "tainted" debt in the future affected. If the company needs to pay tax, based on use of remaining assessed loss and ongoing trading, it would not need to cash settle these until September 2014.
Common sense dictates also that Sars would prefer Edcon to be back in a taxpaying position sooner rather than later.
The X factor for Edcon in the medium term could be how successfully the core brands (Edgars and Jet in particular) can be expanded elsewhere into Africa (sales on the continent account for just 7% of total top line) as well the rapid roll-out of new, tested retail formats.
Some of the new international brand roll-outs will include Lucky Brand and Tom Tailor as well as the recently secured local franchise for UK-based high-end footwear boutique Dune
Schreiber returned from the US this week suggesting additional fashion brands were in the pipeline.
While the operational revamp slowly takes effect, it's natural that thoughts about interim measures to further cull debt might turn to the sale of individual retail formats (CNA being an obvious candidate and perhaps Edcon's insurance offering).
Schreiber scotches a suggestion of a sell-off. "I don't see a need for it. We have not even received offers for any of our businesses."
Another option could be splitting off and separately listing (with an appropriate fund-raising exercise) the stronger-performing Discount hub.
About this, too, Schreiber is less than enthusiastic. "Edcon is a fully integrated business, from our properties to technology and our operational services. To carve that up would be quite a task."
Source: Financial Mail, via I-Net Bridge
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