By Camilla Palladino
Marks & Spencer’s investors must feel as if they are on a roller-coaster ride. One week the UK clothing and food retailer’s shares plunge on disappointing sales, the next they are up on rumours that M&S might be the latest retailer to succumb to a bid from a private-equity house.
What this turbulence does indicate is that investors no longer trust M&S’s strategy to deliver a recovery. But they shouldn’t hold their breath for a private-equity bid, either. Things would probably have to get quite a lot worse before that would be doable. The best hope is that M&S will really shake itself up. But even that isn’t guaranteed.
Paying for prices
Take a look at what is actually wrong with the company. After a will-o-the-wisp recovery a couple of years ago, it is again losing market share. The reason? Its prices are totally out of whack with the rest of the high street. M&S might have held – or even trimmed – prices over the past few years. But in the meantime, cheaper rivals such as Sweden’s H&M have changed customers’ perceptions of what good value for money actually is. There has been rampant price deflation with Next, for instance, setting average selling prices 5% to 7% lower. Add to this M&S’s complex and cumbersome supply chain, which involves the group relying on middlemen that take big chunks out of its margins, and the problem becomes apparent.
But while M&S’s customers and investors may be alive to its problems, its management doesn’t appear to be quite so on the ball. Luc Vandevelde, the group’s chairman, seems semi-detached, spending a lot of time on other directorships and his private-equity business. Meanwhile, Roger Holmes, the chief executive, maintains that the current strategy is appropriate. Sales, he reckons, have suffered because of poor execution – quite something from the chief executor himself.
His proposed solutions, such as redesigned shopping bags and better store layout, look a bit like ineffectual tinkering. And though the group is also trying to simplify its supply chain and cut prices, that might not be enough to stop it from falling further behind.
Surely that makes M&S a sitting duck for a private-equity bid? Well, not quite. In spite of the renewed private-equity interest in retail dogs, exemplified by Permira’s recent approach to UK retailer WH Smith, M&S would be a very big bite to swallow. Assuming a 30% premium to the current share price, a buyer would have to shell out £9.7 billion to take the group private.
Of course, private-equity firms can link up into consortia and bid together. But while an unwieldy decision-making caucus is probably fine in boring quasi-utilities, such as Italy’s Seat Pagine Gialle’s directories business, it could cause problems in a fast-moving retail environment. What’s more, M&S
already has £1.8 billion of debt and isn’t terribly profitable. So a prospective private-equity buyer would likely have to stump up a significant proportion of equity to take it private, which would dilute returns.
So what should M&S do? The best answer is probably a real strategic revolution. Barring miraculous fashion collections that fly off the shelves even at current inflated prices, the group will need to bite the bullet, cut prices and invest in its supply chain to bring costs in line with rivals. This would trash margins and profits, at least in the short term. Just take a look at Boots, for instance. The UK chemist’s new chief executive’s plans to make it more competitive lopped 10% off pre-tax profit forecasts for this year. But in the longer term, the hope is that higher volumes would offset some of the pain of cutting costs.
Room for trimming costs
While M&S would need to spend a lot of money on modernizing its supply chain, there is also a lot of room for it to improve. The group is unique among major retailers in that it still relies on middlemen to get its clothes made. At the same time M&S is vastly more expensive than H&M, but it also has about half the operating margin. So moving to direct buying could be an opportunity for the group to recoup some of the profitability it would give away with price cuts.
While this looks like the best option, it is also a controversial one. And the question must be whether M&S’s present management has the credibility to pull it off.
Vandevelde has already alienated investors with his detachment. He might not be the best person to provide cover for Holmes during what would be a turbulent period. Moreover, it isn’t as though Holmes himself has been shining with a very bright light of late, as he fiddles with what increasingly looks like an untenable strategy.
As Boots and food retailer Sainsbury’s have shown, it usually takes managers untarnished by past mistakes to make such bold moves.
But even if M&S’s management does not get to grips with the situation, things will eventually have to change. Either shareholders will put in place someone who will shake things up, or the UK retailer’s shares will fall so far that a private-equity swoop becomes a real possibility.
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