A dubious deal for Mothercare
Britain’s new parents may shop elsewhere these days, but the nation’s biggest babywear retailer is not desperate enough to accept a tax-driven US bid
Thursday 03 July 2014
Mothercare has become the latest British company forced to defend itself from the advances of a US suitor keen to take advantage of lower UK tax rates, shifting the focus on similar moves away from the pharmaceuticals sector and towards retail.
Destination Maternity, a US retailer similar in size to Mothercare, approached its rival’s chairman Sir Alan Parker at the end of May with the hope of a quick deal to buy the struggling retailer. This was rebuffed and was followed by a second, more lucrative, offer a few days later.
At 300p a share, split between 230p cash and 70p in Destination Maternity shares, the approach values Mothercare at £266m – a 90 per cent premium on the pre-offer share price.
On paper it would appear to be the deal of the decade for shareholders, who have seen their shares tank by 44 per cent in the past six months to 10- year lows at a time when the rudderless company has no chief executive and continues haemorrhaging money from its UK operation after a Christmas profit warning.
But several questions remain unanswered over yesterday’s approach, including whether Mothercare would disappear from the UK high street all together; whether Destination Maternity made the offer purely for tax purposes; and if the US chain can even afford such a bid.
Sir Alan rejected the offer immediately but did not completely rule out a takeover. He said: “The board has given these proposals full and thorough consideration. We do not believe they reflect the inherent value of Mothercare to our shareholders or its prospects for recovery and growth.
“In addition, we have significant concerns about the deliverability of these proposals.”
He was supported by major shareholders, with Matthew Tillett, a portfolio manager at top-10 shareholder Allianz Global Investors, saying Mothercare was undervalued because the market focus is on its loss-making UK business, not its strong international operations.
He asked: “How many UK retail businesses have successfully exported their brand overseas? Over the past six years, Mothercare’s international network sales have risen from £286m to £729m [and] international profits have risen even faster – from £9.6m to £45m over the past six years.”
Analysts have suggested that the fact Sir Alan has concerns about whether the deal could even go ahead shows that Destination Maternity may not have sufficient funding in place and the merged company would become overloaded with debt.
With 575 stores trading as Motherhood Maternity, A Pea in the Pod and Destination Maternity, the business would end up with a debt pile in the region of £350m, having already grown primarily through US acquisitions.
Nick Bubb, an independent retail analyst, said: “Mothercare may well be wary of the strength of DM’s balance sheet, having seen it grow by acquisition in the US.”
And Liberum’s retail analyst Sanjay Vidyarthi added: “A brief look at Destination’s financials suggests that its ability to execute the deal is not clear-cut.”
Destination Maternity has itself been suffering recently, with the shares down 30 per cent so far this year, along with a profit warning in April.
The company insists the deal is part of a bigger strategy to break into the UK, and it would want to keep and rebrand some of the stores Mothercare currently plans to close. But with Mothercare’s UK business losing £21m a year, there are fundamental issues that need fixing.
Mike Dennis, a retail analyst at Cantor Fitzgerald, warned: “We doubt a deal like this could fix the high UK store costs. Not only would this deal create £365m of goodwill, it would probably require the closure of more high street stores and mean a further loss of sales.
“The exit multiples could be a lot worse than those already indicated, which in our view are already very high.”
He suggests there could be another motive behind the approach – the UK’s low corporation tax rate. Destination Maternity has said it would want to re-domicile the business to the UK and remain listed on the Nasdaq stock exchange in the US.
Mr Dennis said: “There is a benefit there if you are paying 38 per cent corporation tax in the US and could pay 20 per cent in the UK.
“They can also offset their US profits, if they re-domicile to the UK, with the losses from Mothercare and Early Learning Centre.
“The problem with these deals is you can’t make a deal around the balance and structure of the balance sheet when the sector is in structural decline. You should not create a deal around a tax benefit – it’s not good for the shareholders.”
However, these kinds of deals are becoming ever more popular, with AstraZeneca’s suitor Pfizer keen to move to the UK and, more recently, AbbVie’s approach for Shire.
AbbVie’s boss even admitted to investors and analysts that part of Shire’s attraction was the low tax rates in the UK. Shire itself is already based in Ireland for lower taxes.
A shift towards retail take-overs could gather pace, most notably with internal wrangling at Alliance Boots. The high street chain’s recent link-up with Walgreens has seen senior managers looking at transferring the US pharmacy giant to the UK, again in search of lower taxes.
However, before Destination Maternity weighs up whether to launch an improved bid for Mothercare – which looks unlikely as shares closed up 8 per cent at 252p, well off the 300p offer price – there are serious issues that need to be addressed at the UK retailer.
Heavy discounting last Christmas led to a shock profit warning, and although the international division continues to prop up the group, UK stores continue closing and a return to profit here remains just a twinkle in the Mothercare board’s collective eye.
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