HMV warns on profits again as troubles mount

Owner of entertainment chain may have to sell Waterstone's within two weeks

HMV, the troubled retail group, laid bare its deepening crisis yesterday by issuing its third profit warning in three months, as analysts said they expected its dire trading performance to add to its debt burden.

While HMV, which owns the eponymous entertainment chain and the bookseller Waterstone's, was yesterday able to announce that its lenders had extended its annual covenant tests from 30 April to 2 July, the profit warning spooked investors and its shares tumbled 3p, or 20 per cent, to 12.3p.

It has also emerged that HMV could have just two weeks to agree a deal to sell Waterstone's to the Russian billionaire Alexander Mamut as it looks for ways to cut its bank debt and put itself on a firmer financial footing.

In addition to saying its trading conditions "remained difficult", HMV now expects pre-tax profits to be about £30m for the 12 months to 30 April. As recently as 1 March, the group warned profits would be "moderately below" market expectations of £45m.

While HMV appears to have suffered more than most from a downturn in consumer spending this year, it is not alone. Dixons Retail, the owner of Currys and PC World, also warned on profits last week.

Furthermore, Marks & Spencer is expected to add to the darkening clouds over the high street by reporting a 6.2 per cent fall in general merchandise sales today, although the City expects the high street bellwether to deliver profits of £709m in 2010-11. At the more grisly end of the market, four retailers, including Officers Club, Oddbins, Easy Living and Alworths, have collapsed in the past week.

HMV's latest grim trading update led analysts to raise their debt expectations. Back in March, HMV said that its net debt at the year end would not be less than £130m – which itself was nearly double previous City forecasts.

The group provided no further details on its debt position yesterday but said its banking facilities remain "fully available" and its lenders continue to be supportive. HMV also described its dialogue with banks as "constructive". But Sanjay Vidyarthi, an analyst with Execution Noble, said: "Clearly, given the sales trend, we expect the position to have worsened."

At the time of its first 2011 profit warning on 5 January, the company said it would offload 40 of its 285 HMV stores and 20 of its 300 Waterstone's shops to trim its underlying earnings-to-rent-bill covenant. But more severe measures are now being considered. HMV said on 25 March it was exploring its options for Waterstone's and HMV Canada, which could both be sold.

As part of its presentation to its lenders last month, HMV has vowed to improve its performance by focusing more heavily on selling technology products and beefing up its online operations. Its acquisition of Mama, the music venues operator, for £46m in January 2010 is also key to its strategy. With the banks applying pressure, HMV could have just two weeks to reach a deal over Waterstone's with Mr Mamut, who has a 6 per cent stake in the company. The Russian, who has teamed up to bid with the book store's founder Tim Waterstone, is understood to have entered exclusive talks with HMV. If a sale cannot be agreed, HMV is unlikely to find many private equity suitors for Waterstone's, which made an operating profit of just £2.8m for the year to 24 April 2010. The group may then have to consider an emergency rights issue.

Matt Walton, a retail analyst at Verdict, expects the "going to remain tough for HMV. Disposable income will continue to be squeezed throughout the year and the market is continuing to move away from physical products towards downloads".