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Debenhams / Mike Ashley

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It seems likely to me that what will actually happen here is that Mike Ashley will bid, because aside from anything else, the House of Fraser is not of critical size without combining with Debenhams and is losing money heavily.  As Mr Ashley does not have access to enough luxury brands, so he is having to fill the House of Fraser stores with Sports Direct stock which is badly weakening the House of Fraser brand. He needs to combine Debenhams with the House of Fraser fairly urgently I would say, especially now that Debenhams has signed off the Li + Fung deal which promises a pipeline of decent quality items into its stores.

Equally, I believe he will use a mixture of Sports Direct shares and cash to make such a bid, this being far cheaper for him than using just his own cash or the supposed £1billion warchest he has accrued. It will also allow him to unify the purchase behind one corporate entity and use any tax advantages to the full.

It seems to me that this possibility is being ignored by many writers, yet it seems very likely. The issue of the £220m bondholders is to a degree a red herring in this. It is akin to the entry price to being involved in this bid, as the bond holders have to be paid back in full if he makes a bid, equally if an administration event happens, the bondholders are the first to become indemnified and will simply swap their £220m for equity in the new entity via the administrator. That means the bondholders have to be bought out automatically as a part of the cost of buying Debenhams. Why should Mike Ashely want then to allow Debenhams to go into administration? He would totally lose his equity stake and have to bid for the parts of the group he wants from the administrator in a queue with any other bidders, without preference. That may then be more costly to him that just paying the equity cost now of a bid – say £150m plus the bonds = £370m = bargain price. The banking facility can then be renegotiated afterwards or combined with Sports Directs facility, probably with the same banks, but at a fraction of the cost!

So then it is down to the cost of the equity – a takeover at these share price levels would be very cheap – probably around £100m – 150m plus £220m for the bonds, and plus say another £100m to stabilise Debenhams would mean that the total purchase would cost less than half Mike Ashley’s £1bn warchest. I’d say that would be a bargain for him for such an asset.

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It is clear Ashley wants Debenhams and it would illogical not to merge it with House of Fraser. While the Li & Fung deal will help supply luxury brands, Ashley's interest far precedes that deal and he does have other channels. Flannels, its 'luxury' outlet, is performing better than its core business. 

I don't rule out a bid and I agree a cash-and-share offer would offer benefits, including the ability to unify the businesses. But Ashley has waited for firms to fall into administration before and has said he would seek to buy Debenhams if it did collapse, even if it wasn't the "desired outcome". Read the FT article here (https://www.ft.com/content/0f985558-4836-11e9-bbc9-6917dce3dc62

I'd also reiterate that, as cheap as Debenhams is, some rightly question its long-term attractiveness. It relies on leasing property rather than owning it and operates a model that is struggling to keep up with the digital age. While the bondholders may be regarded as a 'red herring', don't forget one crucial advantage of letting Debenhams fail is the ability to renegotiate property leases and other key terms. If he bids, landlords and others are not obligated to negotiate in the same way they would under a CVA etc... 

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Fair points Josh, but why would Mike Ashley let Debenhams go into administration? His 30% shareholding would become worthless and it cost £120m! That's a lot of money to recover. I do not think he'd be the only one looking to buy the company from the administrators either. There would be a queue, probably including Amazon [the stores would all make decent depots / large showcase shops], Li and Fung [they would surely want to protect this new co-operation and potential sales source] and so on. Even Philip Green could become involved. 

I look at the £120m Mr Ashley has spent so far, and it dawns on me, that if a pre-pack situation arose, he would be a real loser - the debt would be coverted into equity by the administrators as the bondholders would be at the top of the queue in such a situation. Those bondholders / banks would no doubt value Debenhams much higher than it is currently [as they are now doing with Interserve] meaning anyone wanting to buy them would have to pay through the nose. The cost could easily exceed the low amount you would have to bid currently in the open market for them. What's the point of that? Since Mr Ashley has already spent £120m, and needs to buy the bonds for a takeover, which in turn costs a further £220m, he might as well spend the further £120m for a formal bid and take over Debenhams via a conventional takeover bid. Any bid via the administrators following a prepack will probably cost him north of £200m and he can use Sports Direct shares in a takeover to cut the cost.

 

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Of course the other reason why Mike Ashley is so interested is that he is trying to move upmarket. His son has also been pushing the business in this direction and the Flannels part is seen as a future leader within the current Sports Direct model. The problem is that the House of Fraser purchase has in hindsight been problematic and loss making. It is clearly not a critical size, and is probably unstable financially meaning it is taking up a lot of valuable management time and money. It urgently needs to be combined with a larger entity to give it critical mass. Debenhams does that, and it is waiting to be bought at this price. 

Once it concludes its replacement £150m banking facility with the lenders, and then declines Mr Ashley's loan offer, I imagine he will have to bid. Otherwise, House of Fraser will become more unstable, more loss making, and more of a pointless investment. 

Another key reason for buying Debenhams is also to gain access to its digital offer. Whilst only 20% of its sales are through the internet, that is on a par with the best in the sector such as Next, and the House of Fraser badly needs to compete or become part of that offer. This is a growing side of Debenhams.

Lastly, I take on board completely your comments about CVA's but you must admit the current Debenhams board are unusually relaxed about this issue. I do wonder if deals have already been done behind the scenes as no shopping mall will want to lose such anchor tenants as Debenhams?

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Guest Mike Ashley to join

Well, now the Board are agreeing to let Mike Ashley come in and take over for a £150m loan, I guess we can expect a formal takeover from him shortly after that EGM as he will want to exert maximum control on the business. 

At least it will mean that staff's jobs should now be safer, I believe Mr Ashley will invest in the business and now will be able to move ahead with merging the House of Fraser with Debenhams. The back office synergies and deals with landlords should be sizeable.

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