Positive thinking – Market gloom can offer a ‘free option’ on recovering share prices
Comet's collapse at the start of November has been making headlines but the events leading up to the electrical retailer calling in the administrators are worth a brief history lesson. Back in 2003, after deciding to focus on its DIY operations, B&Q's owner Kingfisher demerged its electricals arm into a new Anglo-French business called Kesa Electricals…
After a poor run in the UK, Kesa eventually decided to concentrate on its French business and, in February 2012, sold Comet to a private equity firm called OpCapita – although that does not perhaps convey the full flavour of the deal. OpCapita actually paid Kesa £2 and, in addition to Comet, received a 'dowry' of £50m in cash to compensate for pension and property liabilities.
Quite literally, Kesa could not give Comet away – and for good reason. Whatever OpCapita's aspirations were about moving into electrical retailing, it did not take the company long to conclude it was not for them. Successful financial engineering and the successful management of retail businesses both take some skill but clearly OpCapita is better suited to one area than the other.
Although OpCapita has now called in the administrators, we probably should not feel too sorry for the private equity firm. One part of Comet that will not go into administration is its separate extended-warranty business, which happens to contains excess capital. So, as the warranties eventually expire, OpCapita could – a year or so after buying a business that ended up in administration – walk away with around £20m.
With the cashed-up warranty business, the £50m 'dowry' and having only paid £2 in the first place, OpCapita effectively had a free option on trying to make a success of Comet but the firm knew that, even in a worse-case scenario, it would still make a lot of money. That is a pretty comfortable place to be as an investor but somewhat less so as an employee of a company ending up in administration.
For their part, when they take a stake in a business, value investors are also on the look-out for similar asymmetric situations – though hopefully in a more positive way. When, for example, we were looking at Dixons six months ago or Home Retail Group more recently, the valuations were so low that we essentially received a free option on economic growth – or indeed any other positive event.
While, at the time, it was difficult to foresee what such an event might be, the removal of Comet from the market – which in itself followed the withdrawal of Best Buy, another competitor, and a pull-back by the supermarket retailers – has fundamentally changed the landscape of electrical retailing in the UK.
As ever, when the wider market takes the view that a sector can only ever decline or at best just carry on in a very depressed place, we become interested because, as we discussed in Struggling Sectors, even for very challenged companies, positive developments can – and do – happen.
Fund Manager, Equity Value
I joined Schroders in 2000 as an equity analyst with a focus on construction and building materials. In 2006, Nick Kirrage and I took over management of a fund that seeks to identify and exploit deeply out of favour investment opportunities. In 2010, Nick and I also took over management of the team's flagship UK value fund seeking to offer income and capital growth.
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