糖心视频

Introduction

This is the 46th of a series of weekly notes analysing the state of the UK retail market in the light of the COVID-19 pandemic. This note focusses on two key themes:

- GAP鈥檚 withdrawal from the UK market
- Further developments in the battle for Morrison鈥檚

Please do not hesitate to contact myself or any of my retail colleagues if you require any further information.

Key Messages

• GAP to close all remaining 81 UK and Ireland stores
• Has traded in the UK since 1987
• Initially a major internationalization success story
• But has been loss-making for a number of years
• Brand has lost relevance, constantly undermined by discounting
• GAP will continue as an online-only business in the UK
• Unlikely to prosper without a full brand overhaul
• Fortress launches £6.3bn bid for Morrison鈥檚
• Bid accepted by Morrison鈥檚
• Fortress deemed less 鈥榟ands on鈥�/intrusive than other PE bidders
• Assurances given that there won鈥檛 be significant sales and leasebacks
• Question marks as to whether this represents full value
• Stores in isolation may be valued at £8bn+
• Significant other real estate assets (logistics/HO/food processing)
• Plus intrinsic value of the business itself as a going concern
• Further bids likely.

1. GAP鈥檚 withdrawal from the UK market

An extremely long time coming, GAP鈥檚 withdrawal from the UK market was formally confirmed last week. All of its 81 stores in the UK and Ireland will close by the end of 2021. GAP will instead move the company online in a 鈥減hased manner鈥� from the end of August through to September.

GAP鈥檚 retreat from the UK high street comes as no surprise, but it is still significant. The withdrawal had been so well telegraphed previously that it was scarcely news when it was confirmed. The business announced a 鈥渟trategic review鈥� back in October 2020 and explicitly stated that it was exploring the possibility of closing the UK and Ireland stores. Many high profile stores (e.g. King鈥檚 Rd, Guildford etc) had already closed prior to the latest announcement, so a complete withdrawal was largely a foregone conclusion.

The fate of GAP in the UK marks the end of a significant chapter in the evolution of retail internationalization. Retail internationalization was all the rage from the 1990s onwards, with US retailers in particular targeting the UK as a bridgehead for wider expansion into Continental Europe and a launchpad for supposed global domination thereafter.

Only it hardly ever worked out that way. Many an international retailer has entered the UK with a bold-as-brass fanfare, only to beat a much more humble retreat a few years later. And it is by no means a one way street 鈥� the list of UK retailers getting their fingers badly burned through ill-fated forays overseas is just as long. The simple fact is that internationalization in retail is far harder to execute than most appreciate. Some have succeeded, many more have failed.

The most common shortcoming of retailer internationalization projects is a failure (or unwillingness) to understand and adapt to the nuances of the local market. What works domestically may not necessarily translate well in an overseas market and any retailer must be prepared to tailor its business model to the dictates of the local market. Many have been guilty of a far too one-size-fits-all gung-ho approach.

The irony is that GAP made a better fist of internationalization than many of its peers. The longevity of its UK presence bears this out 鈥� it first opened on these shores way back in 1987. There were a few initial wobbles, not least the somewhat random locations of its first two stores (Regent Street and Liverpool). But it did establish itself to become a significant force on the UK high street throughout the 1990s.

It may seem hard to believe now, but in its heyday GAP was in fact a breath of fresh air on the UK high street. Its denim and smart casualwear proposition set it apart from most other retailers at the time, as did the quality of its store fit and visual merchandising generally. Bright stores with wooden floors and chrome fittings certainly weren鈥檛 the norm before GAP came along. The products weren鈥檛 cheap by any means, but the strength of the brand was such that consumers were prepared to pay a premium.

So, where did it go wrong for GAP in the UK? In very simple terms, the brand failed to evolve significantly and retain its initial relevance. Other fashion retailers made a more concerted play in the denimwear market and expanded their ranges with new more relevant fits and sizes. Similarly, GAP鈥檚 fabled ability to downsize adult fashions into the childrenswear market was replicated across the board and what it was offering was no longer unique.

And GAP failed to respond effectively to these competitive challenges. It lurched between what it knew and did best (smart casualwear) and tried to become more fashionable. Only to revert to type when that didn鈥檛 work out. It struggled to achieve the right balance between the two, at the same time becoming trapped in a vortex of constant discounting.

Constant discounting is one of the key factors being wider brand devaluation. And it becomes a vicious circle that is almost impossible to break. Customers come to expect discounts and won鈥檛 shop there at full price. At the same time, it is difficult to justify heavy investment in a brand that is increasingly underperforming. Dismiss any notion that GAP is a victim of COVID, the UK business has been loss-making for a number of years. COVID has only bought matters to a head.

Likewise, the lazy media nonsense of GAP falling victim to online retailers. GAP is a multi-channel operator, it is already in the online space. Being active in the online channel is no defence against general brand weakness. In simple terms, if customers aren鈥檛 buying your product because they don鈥檛 see value or kudos in your brand, they are not going to suddenly start buying your product online. Consumers shop brands, not channels (stop me if you鈥檝e heard that one before鈥�)

Which is why GAP鈥檚 official statement carries little weight. 鈥淚n the UK and Europe, we are going to maintain our Gap online business. The e-commerce business continues to grow and we want to meet our customers where they are shopping. We鈥檙e becoming a digital first business and we鈥檙e looking for a partner to help drive our online business.鈥� A digital-first business that will be materially smaller than its current multi-channel incarnation and one that will require significant restoration of the brand if it is to prosper in any way at all.

Were there any alternatives to a complete withdrawal from the physical estate? Possibly investing in fewer, stand out stores, rather than seeking nationwide coverage. Or teaming up with a third party such as M&S, Next or John Lewis, as part of the growing trend towards multi-brand offerings. But initiatives that would only work as part of fundamental brand refresh. Everything comes back to the strength (or otherwise) of the brand.

The demise of GAP in the UK is less a cautionary tale of the perils and pitfalls of retailer internationalization and much more a case study of something far more fundamental 鈥� only those brands that offer something unique, continue to evolve, receive the required the level of investment and remain relevant. will survive.

2. Further developments in the battle for Morrison鈥檚

Another week, another bid for Morrison鈥檚. US investment firm Bidco has offered £6.3bn, trumping an earlier bid of £5.5bn from private equity group CD&R. Bidco is a new entity put together by Fortress (which previously bought out Majestic Wine), CCP Investments and Koch Real Estate Investments The key difference is that this new offer has been accepted by Morrison鈥檚.

Morrison鈥檚 chair Andy Higginson said: 鈥�The Morrison鈥檚 directors believe that the offer represents a fair and recommendable price for shareholders which recognises Morrison鈥檚 future prospects. Morrison鈥檚 is an outstanding business and our performance through the pandemic has further improved our standing and enabled us to enter the discussions with Fortress from a hard-won position of strength.鈥�

Morrison鈥檚 share price has obviously responded substantially, but does this higher offer represent fair value? Without full access to anything like a due diligence process, even back-of-envelope calculations suggest that Fortress would be securing an absolute bargain. Average store sizes of 60k sq ft @ an average of £17.50/sq ft, capitalized at 5% would give a very rough average value of ca. £20m per store. Multiply this out across a portfolio of ca. 400 sites gives an indicative value of ca. £8bn.

The crudest valuation ever, but it does raise the question as to whether the supermarket assets alone (ca. £8bn) are worth more than the current bid that has been tabled (£6.3bn). Factor in Morrison鈥檚 distribution sites as well (bearing in mind Asda鈥檚 just changed hands for £1.7bn), its head office in Bradford, plus all its processing plants, it seems highly probable that the value of Morrison鈥檚 entire real estate portfolio is significantly higher than any bid received to date.

And, of course, there is so much more to Morrison鈥檚 that its real estate. I won鈥檛 attempt an equally crude equity analysis, but there has got to be huge value in a proven, highly cash-generative FTSE100 business that turns over £18bn+ a year and is well-run and strategically sound (as discussed in last week鈥檚 Retail Note).

So why have Morrison鈥檚 accepted Fortress鈥� bid? Largely because current management believe it will be less disruptive to the current status quo than other potential private equity bids. The existing management team would be retained and seem to have assurance that external intervention from the new owner would be limited. And, crucially, it would not embark on an aggressive asset strip.

Certainly this is the message from David Potts, Morrison;s CEO: 鈥淔ortress is backing the management, backing the strategy and backing our people. Fortress does not anticipate engaging in any material sales and leaseback transactions. Our company owns 87% of the freeholds, so it鈥檚 important part of our assets. We would always keep it under consideration going forward so that we keep competitive鈥�.

CD&R may well return with a higher bid, while Apollo Global Management are also weighing up an offer, as reportedly are Lone Star. Another week, another bid for Morrison鈥檚. It is unlikely to be the last.