HMV turnaround plans fail to impress

HMV markets itself as "Top Dog" for entertainment products on the high street but a fresh profit warning yesterday left it looking more like a lame duck and completely overshadowed the company's announcement of a three-year turnaround plan.

Simon Fox, the ex-Kesa executive who took over at HMV six months ago, unveiled his strategy to whip the retailer into shape, but the dire performance over the key Christmas trading period spooked investors. Shares in the music and books retailer crashed nearly 16 per cent to 128.5p after it warned sales had deteriorated since the start of 2007.

HMV's revenue, excluding new stores, declined 3 per cent in the nine weeks to 10 March which only represented a slight improvement on the 3.5 per cent fall recorded in the first 36 weeks of its financial year. Sales at the company's HMV music stores in the UK and Ireland slowed while revenue at its Waterstone's chain declined more than 6 per cent. It also suffered a downturn at its Canadian unit to add salt to the wound.

The latest disappointment follows a profit warning in December when HMV said its full-year pretax profit would be no higher than £69m, compared to £98m the year before. It has now reduced that forecast to around £50m.

The grim trading performance reflects the company's lack of progress adapting to structural changes within the industry. Sales of CDs, DVDs and books have been declining sharply as consumer's buying patterns have changed. Youngsters who traditionally spent their pocket money on the latest CDs now download music online. Even those customers who do not have iPods have turned to web sites like eBay and Amazon, and perhaps more significantly supermarkets like Tesco, to buy CDs and books at much cheaper prices.

Mr Fox, who joined the company last September, admitted that it has been too slow to adapt its pricing structure and product range to reflect the structural change in the market. "Waterstone's and HMV are great brands but have not adapted quickly enough to the way customers are now buying consumer media. Our performance has suffered as a consequence," he said.

Mr Fox has unveiled his vision to resurrect the ailing retailer's prospects through a series of cost cuts and new product lines across its 421 HMV outlets and 329 Waterstone's stores. "The three-year transformation plan is exciting, radical and far-reaching," he argued. Mr Fox has already shaken up the management structure at the company after admitting he had been "disappointed" with the group'sperformance since he joined.

The first step in getting HMV into shape will be slicing £40m of annual costs from the company's business by 2010 by merging back-office systems and improving logistics. In a swipe at the company's previous management, Mr Fox said he was "frankly amazed" that there was no centralised group buying function at HMV. It will also close up to 30 of its book stores after its acquisition of Ottakar's last year, and around four of its loss-making HMV stores could also be sold. A disposal of its Japanese business also looks likely.

Whilst the cost cuts will go down well in the City, Mr Fox's growth plans will prove more significant in the long term. He plans to derive 20 per cent of HMV's sales through its online channel compared to 6 per cent at this stage while refocusing its high-street stores to better utilise space.

The most radical plan is for the transformation of its music retail business into an "interactive" store aimed at restoring HMV's image as a fashionable place to hang out. "Record shops used to be places that people would hang around and spend time and money. We don't give them the space to do that any more," Mr Fox said. He added that physical music sales are expected to decline to around a quarter of its sales by 2010 from 35 per cent in 2006.

HMV will install "refreshment hubs" in its music stores where customers can play computer games, log on to internet sites and make music compilations that can be burnt on to CDs while sipping coffee and juices. It will also launch its own social networking site which aims to blend the user-generated content model of YouTube and MySpace with access to copyright material that can be purchased via the site. It has already signed up Universal Music and 20th Century Fox to provide material for the site.

Mr Fox said the site would put HMV at the centre of behavioural changes among its customers so it does not get left on the sidelines of structural shifts within the industry again. HMV will also launch a loyalty-card scheme.

In a move to target the rapidly growing mobile-phone music market, HMV has teamed up with 3 to install concessions within its stores that sell music-centric handsets. It will also look to sell more MP3 players from the likes of Apple and Sony, further reducing its dependence on sales of CDs and DVDs.

Mr Fox denied the plan could overcrowd its stores and annoy its core customers who want to buy CDs, not a carrot juice and a mobile phone. "We are not going to undermine our specialist entertainment credentials. We don't want to become a Woolworths - that would be a disaster," Mr Fox said.

Its plans to revive Waterstone's include a new focus on children's books and up-market stationery products. The group plans to drive more sales through its website, particularly academic books.

However, analysts were unconvinced Mr Fox's plans were that radical. Some described the review as "underwhelming" and were disappointed the "store of the future" concept would not be tested until the autumn.

Philip Dorgan, an analyst with Panmure Gordon, said: "The strategic review looks good on paper, but in practice could be overwhelmed by the swiftness of structural change in HMV's markets. The suspicion is that it will be a case of rearranging the deck chairs on the Titanic." Jose Marco-Tobares, an analyst with Numis Securities, said: "We remain very sceptical about the group's future prospects as we do not see how these initiatives will save HMV from the structural problems it faces."

With shares at a four-year nadir and analysts unimpressed with the company's growth strategy, attention will turn to whether it is vulnerable to private equity bidders. A year ago, HMV's former chief executive Alan Giles rejected a 210p-a-share bid from Permira, the second time it had bid for the retailer, arguing that the offer undervalued HMV.

Mr Fox said he remains confident his plan to revive HMV is the right one. But given the amount of private equity activity on the high street, it is more than likely potential bidders will test his resolve unless the share price recovers soon.