While Anchorage Capital are now out of the picture, question marks remain over the future of Dick Smith. Anchorage Capital was not an investor to look a gift horse in the mouth when Woolworths opted to offload the Dick Smith chain in 2012. In a deal that cast Australia’s largest retailer as a mug punter, Woolworths accepted $20 million and the promise of a slice of any improvement in the financial fortunes of the computer and electronics chain. The promise turned out to be worth $74 million as
s Anchorage Capital bundled Woolworths out of the picture to allow the private equity firm a clear track to a lucrative public float that parlayed $94 million into a $520 million payday.
The Dick Smith fiasco was the first sign of Woolworths losing its mojo under CEO, Grant O’Brien, with shareholders pocketing a poor return on a business with annual sales of $1.5 billion and a more profitable outlook after closing 69 under-performing stores and writing off dead stock.
Woolworths shareholders were saddled with $420 million in write downs on the retailer’s accounts, but saw their losses line the pockets of Anchorage Capital, which floated Dick Smith on the Australian Stock Exchange in December 2013, just 15 months after acquiring the chain.
It was estimated that the Dick Smith chain had net tangible assets of $290 million and no debt when Anchorage Capital took control for a cash outlay of less than the $20 million initial payment to Woolworths.
Anchorage Capital was able to minimise its cash outlay by using funds from the Dick Smith business itself to pay out Woolworths, while priming the business to justify robust revenue and profit projections in its almost unseemly haste to pursue the Stock Exchange listing.
A number of analysts and investors were wary of the quick makeover by the private equity firm, but largely accepted Woolworths had been dudded.
To provide credibility to the hasty float, Anchorage Capital opted to retain a 20 per cent stake in Dick Smith.
The private equity firm is no longer a major shareholder in a Dick Smith chain that some analysts are starting to think is yet another private equity trainwreck.
Private equity’s poor record
Private equity has a relatively poor track record with Australian retailers, especially the retailers that have been floated as public companies, such as Myer, Repco, Collins Foods and, of late, Kathmandu.
Other private equity disasters in the retail industry have included REDgroup Retail, Australian Discount Retail, Godfreys and Colorado.
There have been some successes, notably JB Hi-Fi and the Reject Shop as public floats, and Witchery, Mimco, Rebel Sport and New Price Retail (Priceline) as trade sales, but private equity clearly has a patchy record in the Australian retail industry.
Courtesy of the extraordinary deal done with Woolworths, the Dick Smith business was off to a flying start under its private equity owners who immediately launched an aggressive store development program to replace the stores that Woolworths had closed at a substantial cost to its accounts.
Anchorage Capital said in 2012 it expected to maintain the then current network of 325 Dick Smith stores and to, “consider selective network expansion over time where appropriate”.
In three years, the network has expanded by a net 70 stores to 393 outlets, with plans to add a further 15 to 20 new stores a year for a target of between 420 and 430 within two years.
The store count includes one new concept developed since the chain was listed on the Stock Exchange in 2013, the 11-store Move and variant four outlet Move by Dick Smith chain.
Nick Abboud, Dick Smith CEO, is bullish about the chain’s growth prospects, telling a Bank of America/Merrill Lynch forum in early October that he headed the, “fastest growing consumer electronics retailer with the largest number of stores” in the Australasian market.
Abboud was somewhat more subdued by the end of the month, advising shareholders at the retailers annual meeting of a sharp downgrade in net earnings by $5 million to $8 million after a challenging October.
Abboud reported an improvement in sales over the fourth quarter of the 2015 financial year and the comparable first quarter of 2014, but conceded that gross profit was adversely affected by increased promotional activity and an unfavourable sales mix.
With the “challenging and competitive” conditions entrenched in October, Abboud said the retailer had sacrificed more margin as it launched promotional activity to stimulate sales and protect market share.
Abboud noted that the heavy promotional program failed to lift sales in October.
The profit downgrade sent Dick Smith’s shares plummeting to as low as 69.5 cents, before recovering at the close of trading last Friday at 81.5 cents per share. Nonetheless, that’s a far cry from the $2.20 listing price in 2013 so Anchorage Capital should consider themselves more than lucky.
While the downgrade and speculation that Dick Smith was facing cash flow problems triggered the sharp fall in the share price, analysts are concerned about the long-term viability of the business.
The analysts are wary of Dick Smith’s focus on expanding the store network rather than strengthening the performance of existing stores, a strategy that has foundered for Kathmandu and Myer.
Abboud enthused last month about a 7.5 per cent lift in annual sales to $1.32 billion for the 2015 financial year ended June 30.
With virtually the same number of stores as Woolworths had in 2012, the $1.32 billion was actually below what Woolworths was achieving, granted, in part, because of price deflation.
More telling though was the fact that like for like store sales were only up one per cent. Analysts are concerned that some of the new stores are not firing and the chain is paying the price for hanging on to around 30 stores that Woolworths had earmarked for closure in 2012 because they were under-performing.
In the first quarter of the current financial year, before the difficult October trading month, Dick Smith’s comparative store growth was just 1.3 per cent.
The first quarter result compares with like for like sales growth of 7.1 per cent at Harvey Norman’s Australian stores and 3.7 per cent for JB Hi-Fi.
The comparison with the other two chains suggests that Dick Smith secured a lesser share of small business spending between May and July from the Federal Government’s small business incentive package than its rivals.
Delivering his profit warning to shareholders, Abboud noted that first quarter sales were up 6.9 per cent with the 62 stores in New Zealand posting its best quarterly sales since 2012, albeit the result was arguably somewhat skewed by exchange rates.
Dick Smith takeover looming?
Abboud is confident the retailer is on the right track and can deliver sustainable results through new Dick Smith and Move stores, further development of online sales, a differentiated product offering built around private label and the launch of new categories, such as fitness and wearables and small appliances.
Nonetheless, Abboud and his board are nervous enough about the retailer’s position to engage Luminis Partners, a corporate advisory firm, to advise on strategy and a defence in the event of a takeover bid.
Move is a clever concept and arguably the best initiative taken by the retailer in the past three years. And new categories may provide some impetus to sales and earnings.
Abboud wants to build online sales to around 15 per cent of total company revenues, but the target has caused conflict in the business, with stores arguing that the online platform is cannibalising store sales, a proposition the CEO rejects.
Abboud is no doubt correct in the view that online sales are not damaging store foot traffic and sales and are not the culprit in what is reportedly a $100 million shortfall on sales budgets and a $26 million hole in earnings targets for the current financial year.
The more likely culprits are the retailer’s private label strategy and marketing.
Harvey Norman, JB Hi-Fi and The Good Guys have private label ranges, but they also strongly promote national brands that give them street cred.
Sources at Dick Smith concede the chain’s private label program has been bungled, particularly related to product sourcing from a Hong Kong buying office.
The retailer has recently lost three senior merchandising and marketing executives and the poor sales and earnings performance is reportedly creating ructions deep within Dick Smith’s ranks, even down to store level.
At the heart of the problem with the retailer is the fact that Dick Smith’s current management is making the same mistakes as Woolworths made over many years.
The chain has failed to develop a unique selling proposition or to impose itself as a specialist in its category, a problem reinforced by the private label strategy that stocks brands that have no connection with customers, especially tech-savvy, tech-hungry young people.
How important is a brand in the categories that Dick Smith is trading in? Think Nokia and Blackberry. Masters Home Improvement is a good example of a private label strategy going awry, and in the fast fashion electronic, mobile phones and gadgets categories, it is a high-risk game plan.
There is simply no compelling reason for a customer to bypass a JB Hi-Fi store to shop at Dick Smiths.
The Dick Smith board and Abboud’s team face a major challenge to tackle serious problems in the business that contrast markedly with the bullish full-year financial announcement.
Suppliers are already nervous about payments as analysts assert Dick Smith’s cashflow is negative and inventory levels are at historically high levels, in part, because consumers are not buying the private label products.
Private label products currently comprise 12.5 per cent of total revenues for Dick Smith, and the chain has expanded the range by 40 per cent in the past year.
With the drag of funding the private label ranges on cash flow, suppliers have been asked for upfront payments on marketing campaigns. But analysts claim the chain will need to increase its debt to address the structural problems in its inventory.
And in another looming bad news kicker for Dick Smith, David Jones is expected to terminate its electronics and home entertainment concession agreement.
The David Jones concessions reportedly only accounted for around three per cent of Dick Smith’s sales. But the sales proportionately represent better sales of higher end products and the alignment potentially offered a valuable brand positioning for the troubled electronics retailer.
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