(9fin) Douglas dressed up to the nines; relying on online sales to drive multiple re-rating
Douglas dressed up to the nines; relying on online sales to drive multiple re-rating (9fin)
By Chris Haffenden | Editor |
Douglas’ pivot to online sales is a makeover to gain a EV/EBITDA multiple re-rating and become more attractive as a future IPO candidate. Those checking out the €2.55bn refinancing as a par trade for the Germany-based Beauty Retailer must look beyond first impressions. The transaction is based on heavily-adjusted management adjusted EBITDA - with adjustments for Covid-19, plus achieved savings from store closures and it assumes permanent shifts in consumer spending behaviour. Douglas wants to sell the €300m HoldCo PIK with a 9-handle, with the €1bn five-year senior secured bonds coming at least 300bps inside at 5.5%-6%, say potential investors and analysts. In a less hot financing environment, a deleveraging of at least 2x, a larger sponsor cheque and bigger sub piece, would all be required, they suggest.
As 9fin’s deep-dive analysis from December outlined, if Douglas can execute its online business plan, the seniors were covered. We were less confident on the SUNs and had expected a larger sponsor contribution and/or an exchange offer with some equity upside.
Douglas was acquired by CVC in August 2015 for an EV of €2.87 billion (Implied valuation of EV / EBITDA of 9.2x) from Advent International. CVC currently own 84.2% of equity interests with the remaining 15.8% belonging to the founding Kreke family.
As part of the refinancing transaction, sponsor CVC is putting in a €220m equity cheque. This will come in as follow-on investment from the 2014 fund, said a source close to CVC.
However, as our capitalisation table above suggests, based on LTM adjusted December 2020 EBITDA and its acquisition multiple, their initial investment has no value. Sources polled for this article believed that 7-9x EV/EBITDA was appropriate.
Their injection does little to deleverage the group, mostly funding the €94m Store Optimisation Programme (SOP) paying €50m of fees, and covering the c.€50m of deferred payments, said one potential investor. Coincidently, the €220m injection equals the projected cash burn estimated by Moody’s over the next two years.
Douglas has made a good fist of it with its turnaround plan, but this is still 8-9x levered on current EBITDA, said a distressed analyst. Leverage for the refinancing should be 5x max through the senior with 1-1.5x of subs. “If they can boost online revenues - get their EBITDA to €350m - then a low to mid-teens multiple makes this a home run for the sponsor.”
The refi is inline with what we expected structure wise, said an existing holder of the senior and subs. “It’s very aggressive, but I think that the company can grow into it again.”
In the eye of the mouse holder
Douglas saw impressive growth in its online sales during lockdown, partially mitigating the drop in revenues from its bricks and mortar stores. Overall its share of revenues rose to 33% in FY20 from 16.9% in 2019 and 13.2% in 2018.
Online growth will be strong, this is what supports the credit story, said Wolfgang Felix from Sarria, the credit opportunities desk. The company previously held back on its online rollout on fears of self-cannibalisation. But by the same token it has a captive customer base and will be pushing hard to maximise its IPO valuation, he said.
Prior to lockdown, the online channel accounted for 14% of the premium beauty market, with a CAGR of 21% from 2014-2019, according to OC&C. Online penetration is still modest, admits Douglas, with pure-play online players having a limited presence.
In their latest earnings presentation they said that many customers that shopped online for the first time did return, and that they are expecting a permanent shift, said the distressed analyst.
Douglas management have said they are predicting double-digit growth of 10-20% per year from the online business, said the potential investor. But as the following slide (from Douglas’ earnings report) shows, online sales grew by 80-90% at peak points during periods of lockdown, but dropped to 40-60% as restrictions eased. In total online sales grew by 47% during the first lockdown, and 63% during the second.
The handback from online is key, said the distressed investor, what is the starting point - is it 40%, 50%, or 60% of sales?
Douglas says margins for its online business grew by 1.6% during 2020, adding that this growth came from economies of scale and was not down to increased marketing spend.
For the key first quarter (end-December 2020) which traditionally provides 50% of overall EBITDA, the online revenue share grew to 37% with Germany at 50.2% online (the country went back into lockdown on 16 December). The company says that its online EBITDA margin is 16%, but it doesn’t break out online EBITDA figures for its geographies, noted Felix.
Online adoption varies markedly across its markets, with just 5% penetration in Italy (2019 data), 9% in France, 11% in Spain. Germany and Netherlands are much higher at 22%, and Poland is 28%, according to OC&C.
With Spain and Italy bearing the brunt of planned store closures, there is a danger that they may not be able to transition as many customers as they would like online, cautioned the distressed analyst.
Lockdown has led to a step-change in online adoption from Spain and Italy, countered the source close to CVC. Overall, across its geographies, the online share is currently over 32% [FY20], but admittedly that is with lockdowns in place during this calendar year, with around two-thirds of stores currently open - albeit with some operating restrictions.
Germany is familiar with online ordering - from old days of Quelle catalogues - households moved easily onto the internet, said a second analyst. France is surprisingly less happy with online. The key question is what is going to stick after the resumption.
Managing perfection
While most investors and analysts were onboard with the move towards online, there was less praise for the pro forma EBITDA assumptions on which the planned refinancing is based, with one saying ‘it is priced for perfection.’
To get the LTM Management Adjusted EBITDA of €394.5m, we must begin with “Further Adjusted EBITDA for the twelve months ended December 31, 2019” of €347.3m and apply a series of adjustments and add backs to reach this figure. Douglas used June to October 2020 - the period where lockdowns were lifted - as a basis for a 100.2% ‘recovery rate’ as its multiplier. There are further adjustments for channel mix, adding in the €99.6m of benefits from the SOP plan and €18.9m of savings from its #Forward Organisation plan.
But LTM adjusted EBITDA of €250.2m is already heavy with add-backs. It consists of LTM Pre-IFRS 16 reported EBITDA of €111.9m, plus management adjustments of €138.3m (of which: +€21.4m consulting fees, +€13.3m restructuring costs and severance payments, +€8.3m PPA, -€2.5m inventory write downs, +€74.9m Covid-19 effects, and +€7.8m other adjustments).
The company has lost a lot of goodwill from investors with its accounting treatment, said the second analyst. “They didn’t need to do this.”
The €250m adjusted EBITDA figure is meaningless as a comparison, countered the source close to CVC. “We have taken the 2019 figure, adjusted it down to €275m for the negative changes in mix and added in the €120m of EBITDA from the transformation plan. This was the basis for our equity investment and our estimates were conservative.”
Ratings agencies were comfortable enough to improve the rating to single-B from CCC+ and investors which were pre-marketed to, were happy to work off these figures, he continued.
But some of those polled by 9fin, thought that there should be some haircuts applied to the assumptions. Our best case scenario is that cash EBITDA will not reach €395m until 2024, said the potential investor. “This is going to be challenging - it is not a done deal.”
Clicks not Bricks
Douglas’ transformation programme seeks to unlock €118-120m of potential EBITDA.
Under its store optimisation plan (SOP) Douglas has announced that it would close 500 of its 2400 stores, including 43 of its 500 German stores. In addition, they are in negotiations with landlords over switching to turnover rent, with 67% of leases subject to break clauses. This would be implemented in 2021 and would involve a €94m one-off cash cost and would improve EBITDA by €100m (€43m store closures, €35m personnel, €22m rent reductions).
According to management the stores being closed generated €373m of revenue, but just €12m of EBITDA. They expect many customers to shop at other Douglas stores, as 50% of their catchment is within 5km of another store. The plan assumes transfer rates below historical levels, with around one-third to transition online.
Management have already closed 12% of the stores with another 31% already terminated. The average cost saving has been 18% versus 10% targeted, but this is mainly due to low-hanging fruit, said management on a call for investors.
But problems in negotiations with Spanish unions over store closures, highlights execution risk for the plan, said the potential investor. Workers went on strike on March 12, over 110 store closures and the loss of 600 jobs. This has since been reduced to 97 and 500 job losses in total, according to the Spanish Press.
There was confusion on the translation of the article, said the source close to the sponsor. “We are keeping another 15 stores open, but the starting point for negotiations was at a higher point than assumed under the SOP - so it is roughly the same number as planned.”
The bricks and mortar stores have been generating negative like-for-likes (in most quarters, with the odd positive quarter) for a while now, said the potential investor. There is a lot of capex needed for the transformation plan. The store portfolio is too large, they are under pressure to rightsize - most notably in France and Italy. We think that they might need to adjust the business plan [if they cannot execute fully on closures] and spend more on Opex.”
Store density is much higher in Spain and Italy. These were acquired businesses, not grown organically, so there was a need to optimise the stores, said the source close to the sponsor. “Most customers will transition to nearby stores.”
Germany used to generate margins of over 20%, which hid losses elsewhere in the group, but their margins are now below 10%, said a second analyst. Faced with competitive pressure, it reduced its price points in 2017. “The company maintains this is a one-off.”
The Store optimisation programme makes a lot of sense, said Felix. It will release working capital over time, as they rotate out of the physical supply chain. “Douglas is a pure trader - so it doesn’t really add value to the products - it creates the show in its stores, but there is more breadth of selection online.”
Putting itself in the marketplace
Douglas' business plan is as much about attracting higher multiples and boosting its attractiveness as an IPO candidate, said the two analysts and the potential investor.
The valuation of this business is all about online, said the second analyst. It is over 20x online compared to just 7-8x offline - if they can raise the online percentage to over 50% - it will be able to cover the debt, he added.
It’s Marketplace offering is interesting and offers potential upside, continued Felix. “It is tiny, but if they could get revenues to over €100m - they could attract a high multiple - the HUT Group has shown the way here.
Douglas’ Marketplace generated just €13m of revenues in the quarter to end-December. If this can be grown, US investors will pay handsomely, said the distressed analyst. “Look at what Shopify is trading at.”
The source close to CVC concurred, “Absolutely, Marketplace is another driver of value. This is why we have talked a lot about it despite it having just €50m of run-rate revenues. It drives a lot of traffic to the Douglas site.”
Douglas is pursuing an omnichannel approach and is streamlining its warehouses. Its share of customers shopping via the omnichannel model increased from 12.4% in FY 2016/2017 to 17.4% in FY 2019/2020.
Most pure online beauty players make little money, noted Felix. The sale of Flaconi by Proseiben will be an important yardstick as it will be seen as a better pure-play comp than the HUT group, he explained.
However, the source close to CVC, believed that there was little read across, given that the business is loss-making.
We previously sought an IPO and refi pre-covid without an injection, but the pandemic has helped to accelerate the online transition and provided impetus for the optimisation plan, said the source close to CVC. This should provide a route to IPO in two-to-three years and see a EV/EBITDA multiple re-rating into the mid-teens, he added.
Limited Coverage
In addition to the perceived lack of equity cushion, the guarantor coverage is another potential stumbling block for investors. This is just 37.3% consolidated total assets, 48.5% consolidated sales, and 50.0% consolidated Adjusted EBITDA. The soft security package consists of share pledges, intercompany receivables, material bank accounts, and the Proceeds Loan.
The company says that it cannot offer guarantees to bondholders due to local laws, and adds there are a number of minority holdings in the non-guarantor group.
The France/Italy coverage is a financial assistance point, explained the source close to CVC. Therefore we cannot get the benefit of guarantees for the bonds, but can with the loans, as we are refinancing those with existing guarantees from the local operating companies. There is an intercreditor loss-sharing provision upon enforcement to protect the bonds, he said.
In common with other recent HY deals there is some slippage on covenant protections. These include generous starter amounts for Restricted Payments (RP) and ability to repay subordinated indebtedness via RP. Portability is less than one turn from day one leverage and could be round tripped, with flexibility to pay dividends via transfers to unrestricted subs.
The expectation is that they would want to take out the PIK as soon as possible, before it starts to really accrue, said the distressed analyst. I can see why they wanted to include the ability to use restricted payments towards subs in their docs, he added.
Call protection on the bonds makes this expensive, said the source close to the sponsor. Therefore, any deleveraging prior to the IPO is likely to come via repayment of the TLB.
For more detail on the covenant package please see our Legal Quick Take
Up to the nines
Roadshows for the refinancing end tomorrow (Wednesday 24, March). The €1.08bn five-year cov-lite term loan B is guided at E+ 500bps with a 99 OID and a 0% floor. Bookrunners are Goldman Sachs, Deutsche, Unicredit and UBS.
Ratings agencies have been kind to the proposed refinancing, avoiding triple-hook CCC ratings which would have limited its appeal to CLOs.
S&P has preliminary assigned a B- rating to the new €1bn five-year senior-secured notes. But most of its report reads as if for a CCC-rated business and the agency admits: “we see very limited headroom under the likely 'B-' rating upon completion of the transaction,” It goes on to say: “The execution risk associated with the group's transformation plan, coupled with the uncertain macroeconomic environment and the very high leverage post transaction, would likely translate into a negative outlook upon closing of the transaction.”
Moody’s says that the projected “improvement remains subject to execution risk and the initial leverage remains high at around 8.0x, which leaves the company weakly positioned in the rating category,"
Pricing wise, I tend to think that these levered rescue refinancings give you a second chance to buy cheaper, said the existing holder. “I agree that the ratings agencies have been generous - this is super-levered.”
The €300m HoldCo PIK is arguably the most interesting component of the deal, given that it is not fully pre-placed and doesn’t offer equity upside via warrants. The aim is to price below 10%, said the two analysts, investor and existing holder.
“Having a nine-handle is punchy,” said the first analyst. I think it offers some juice for holders of the senior secured, said the second.
It will price in the high-9s, but I think that fair value is nearer 12%, said the existing holder.
The seniors will be at least 300bps inside, said the potential investor. Thom Europe is being used as a comparator - the leads are looking for mid-5’s to 6%.
The PIK is oversubscribed at better than 10%, said the source close to CVC. The feedback on the SSNs is mid-5’s which is inline with the loans. He agreed that some buyers of the SSNs will also place orders for the PIK.