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penned-by-mo · 5 years ago

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I met this pseudo civil rights enthusiast when I was in varsity who was slightly older than me, who enjoyed narrating what sounded like made up stories to me. He would start his ‘Him against all the powers that oppose black excellence’ tales with a line I was unfamiliar with at the time but later grew fond of: “Once upon a time in the projects”. I later learned that this was a line from an American stop-motion animated sitcom created by Eddie Murphy called The PJs. This line coming from a show adapted from the lives of black people was as genuine as any of his “black-love” inspired theories could go. Well, this is not about him but I do hope that wherever my dear friend is, he has embraced some ideology that is at least aligned to who his authentic self is.

Today we discuss Edcon, and like my dear friend did many a times, allow me to start with these beautiful words: “Once upon a time in the projects ...” in this case not The Projects but the world of Private Equity Buyouts. The story of Edcon began many moons back, on the 6th of September 1929 when the first Edgars store was opened in Joubert Street in Johannesburg by Eli Ross to be exact. Fast forward to close to a century later (just nine years shy off the century mark) where Edcon has over 1400 stores in more than 5 countries and has ten retail brands under its wings. This definitely sounds like one hell of a business case, a strong contender for the “started from the bottom” growth award don’t you think? So how did they get it wrong? Where did they go wrong?

I’m going to skip the rousing details of the beautiful struggle that was building a Retail giant like Edcon between 1929 and 1946 (when Edgars was listed on the Johannesburg Stock Exchange), and from 1946 to just before Bain Capital acquired it in 2007 to avoid throwing you in a whirlwind of thought created by being fed too much information (no such thing exists though). I’m going to talk to the Edcon that existed just before the Bain Capital deal, which surely has to be the most alive Edcon any of us can remember right? When I say “any of us” I am not expecting all the ones below 30 to have a clue of what I am referring to, but for those that do let’s go down memory lane quickly. It’s the 8th of February 2007 and Edcon has just released a statement about the R25 billion takeover deal that Bain Capital has just offered it in a “cut the charity nonsense, we are going private” buyout deal that would essentially mean that Dwight Poler and his guys were taking over Edcon, and not just that but they were taking it private (delisting it off the Johannesburg Stock Exchange). The headline was “South Africans love to shop – and to sell” when the US based Bain Capital clinched the biggest retailer in South Africa in one of the biggest private equity deals on the continent. The deal was structured mainly through the combination of two debt instruments that were denominated in Euros which were due in 2014 and 2015 respectively, debt is cheaper than equity so this was not a problem, all Edcon needed to do was grow.

In all the euphoria and overdose of serotonin levels that were most probably present in the boardroom as this deal was being signed, no one could have imagined that there would be an economic crash the following year. But beyond all of that, no one thought of the nightmare that would come with juggling revenue that is reported in Rands on one hand, and debt that is denoted in Euros on the other (currency and interest rate risk). The economic crash of 2008/9 led to three main things that would start the slow fall of the Edcon group (I think now is the right time to cue the Coffin Dancers theme song, let it play along in your mind as we slowly layout this painful demise): The depreciation of the Rand, the increase in interest rates (in an attempt to decrease inflation), and the impact on the consumer which led to a decline in economic activity. What Edcon relied on to service its debt was slowly dying off and now they were sitting with an enormous issue in their books, literally.

This is becoming somewhat of a sad story right? Not in the slightest. I need you to understand that the Edcon growth phenomenon that I likened to Drake’s song earlier on in the piece is not all based on organic growth, a large part of this was through the monopolisation of the Retail Market through the somewhat dotted but clear lines between the Retail and Property sectors. High rentals of retail spaces in places like malls meant that to compete against the likes of the Edcon group and Woolworth’s one had to have large monetary muscles to flex when needed, but if not then you were just never going to compete against such retail giants. This led to the large portion of retail floor space in these kinds of settings going to groups like Edcon, ever wondered why the space of an Edgars or a CNA at the mall is the size of the complex down the road where you buy your bread? But even beyond that why it is 3x and even sometimes 4 or 5x bigger than the size of other retailers in the mall? That’s what I am referring to, because they could afford to rent out that much space in the mall.

Edcon then slowly started infusing a model that was “misaligned” to its South African market. They introduced foreign brands like Mango, House of Dereon, Salsa, Diesel and many others under the notion that the South African market was looking to upscale the “quality” of their buying choice. A company that catered for LSM’s between 2-10 was attempting to sell high premium brands to its customer base which then led to a steep decline in sales. Edcon saw a consistent decline in sales over the years and in 2012 they needed a bit of breathing room; remember that debt that we spoke about earlier? It was still around, and it was making it hard for them to breathe. Their next move was to sell off R10 billion of this debt to ABSA, this made sense as a desperate cash injection measure but for a group like Edcon that also survives off of its credit book this meant that its movement around the use of credit to generate more revenue was going to be restricted now that they had handed over a bit of control to ABSA. Oh my dear Edcon, you are like a troubled teenager, reeling from the consequences of one bad decision after the other every single night (I am imagining that the song is still playing and we now see the faces of the Coffin Dancers in our minds).

So a company that survives off of its debt book cannot fully utilise it because those who are already in it can’t increase their credit purchases due to ABSA’s stricter measures and the new customers that it’s attracting are not responding well to the new international brands. This presented a bit of a conundrum for Edcon, but their problems were about to get even bigger. Enter Zara, a Spanish based retailer with hopes of branching out into the well sought after African markets. The Inditex Group had introduced their premium clothing stores to South Africa through the opening of their Sandton City (Johannesburg), Gateway Shopping Centre (Durban) and Tygervalley Shopping Mall (Cape Town) stores. The Sandton City store opened towards the back-end of 2011 and the Durban and Cape Town stores followed close after in 2012. Here was a retailer with enough monetary strength to stand against the giants and actually foot the outrageously expensive rentals charged by malls. Edcon was now not just fighting against a debt issue, a control over existing debt issue, a declining sales due to poor market reaction issue but also against the emergence of powerful competitors.

Like any troubled South African retailer caught in the belly of a contracting retail market, Edcon chose to expand into Sub-Saharan Africa. They moved into the Zambian and Mozambican markets with the hopes of diversifying some of the risk they had sitting on their books from their over-reliance on the South African market. Expansion works really well for companies when it is not done out of a desperate need to solve issues that need a more strategic restructure, as opposed to an operational one. This wasn’t at all bad, there was definitely value in branching out into other countries, this to date has seen them grow their presence into eight African countries (Namibia, Botswana, Lesotho, Ghana, Zimbabwe, Swaziland and the two that we mentioned above). While Edcon is doing a road trip through Africa searching for hidden treasure, back here at home we know we’re edging ever closer to the maturity dates of the two debt instruments that were used in funding the buyout. Do you think Edcon had enough money to pay back those Euro denominated debt instruments? You guessed right, they did not. The payment terms around the debt instruments were renegotiated and pushed back.

The debt levels had risen so heavily that it was no longer an Edcon issue but a Bain Capital issue. You know how in the world of credit the notion is: “If you owe the bank $100 that’s your problem. If you owe the bank $100 million, that’s the bank’s problem”, this is what Bain Capital was sitting with. An “ever-fixed mark” if we are going to quote Sonnet 116 and be poetic about this debt. So what happened next? The biggest private equity union on the continent ends in a not so bitter divorce in 2016, which saw Bain Capital handing over Edcon to Creditors in a debt-for-equity swap that reduced Edcon’s debt burden from R26.7 billion to R6 billion. This then led to some new developments at the Edcon offices as they were attempting to use their new found “freedom” to do better. They sold off Legit for just over R600 million, moved towards delinking their stores from the unnecessary international brands that they had partnered with, and getting the assistance of a more risk-tolerant RCS to buy back their debt book from ABSA. They were in the midst of a cost cutting exercise, which meant that growth would be halted a bit while they focused on getting their affairs in order.

In 2018 they went on to restructure their rental overhead expense by re-adopting the traditional model of having all brands in one house, this was an aggressive attempt at decreasing the size of their rental cost which essentially is not the easiest thing to do when an agreement is binding. This meant that contracts wouldn’t be easy to get out of but beyond all of that was the underlying issue around the exposure that the Retail Property Market was sitting with, almost everyone was exposed to “Edcon Risk” in some form with them renting out almost 10% of all Retail Space in South Africa (including mainstream mall space). In 2019 Edcon received a R2.7 billion bailout from the Public Investment Corporation, in an attempt to protect (I would encourage you to read this as ‘stall’) the impact to Edcon employees and the Retail Property Market, this came after the company had struggled to firmly get back on its feet after the exit of Bain Capital. In the beginning of 2020 Edcon went on to announce that it had sold off the CNA chain of stores to Astoria Investments, this was all in the bid to refocus on its core business through the realignment of its retail brands and operations.

Then came the CORONAVIRUS (the song has reached the build-up point now and we are definitely just about to witness the Coffin Dancers dance) and everything is turned upside down. A company that had been struggling to find its feet since 2009 was now thrown into the midst of a pandemic, there’s absolutely no way one can grow out of this now. Edcon had no choice when it came to the year 2020, they HAD to get it right. It was either that or close shop, well that’s not a far-fetched thought right now if one considers that Edcon filed for Business Rescue about two days ago due to what Grant Pattison (CEO) and the Edcon Board call ‘a R2 billion loss due to the virus’.

If there’s anything I would hope you picked up from this tale I just told, it has to be that Edcon’s issues have been long brewing. Here’s a company that has year-after-year (with a striking level of consistency) made one bad decision after the other or try make a good one in attempting to lessen the blows of the bad one they had made the day before, Edcon caused their own demise. Their Bain Capital debt issue coupled with a lacklustre approach to innovation and market response in terms of product offering, and a stale business model undid this beautiful story. Do I think this is the end for Edcon? Probably not, they’ve christened companies like Edcon “too big to fail” but we have demystified that myth. The truth is Edcon currently sits in a better position than it has in more than 10/11 years based on its Balance Sheet. But it is still not banking any profit and that is where your issues lie. If they fix their profitability issues then they are well on their way to fixing Edcon, how do you do that without dismantling the whole Edcon model and structure as we know it? That right there is a topic for another day dear friend. At this very moment the Coffin Dancers have concluded their dance and I should definitely be on my way.

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