Estates Gazette

15/11/08

When Iceland sneezes does the UK catch a cold? With a great deal of the UK’s high street owned or part-owned by Icelandic investment company Baugur, David Quinn reports on turbulent times

As a so-called nation of shopkeepers, the extent to which Britain’s high streets are exposed to the economy of another much smaller, more northerly European island state is surprising.

The reverberations from the collapse last month of several Icelandic banks were widespread. As a result of the dominance of one privately owned, highly leveraged Icelandic investment company, Baugur, the outlook for an array of British retail names was suddenly thrown into doubt.

Baugur’s ongoing troubles have been caused by the failure and nationalisation of Icelandic banks Glitnir, Landsbanki and Kaupthing in early October. Its debts tied up in these institutions are estimated to total anywhere between £1bn and £2bn. As the debts are frozen, analysts believe the company needs a huge and immediate cash injection to stay afloat, although Baugur says it is not calling in administrators.

The list of UK retailers owned or part-owned by Baugur makes for dizzying reading (see table, p17 ) and their disappearance from the British high street would lead to hundreds of vacant shop units across the country. Luckily for landlords, Baugur says the turmoil in Iceland will not affect its UK businesses.

The company declined to answer specific questions but claims its “operational assets are strong”.

A company spokeswoman says: “In response to developments in the Icelandic banking sector, we would like to make clear that this will have no impact on Baugur’s operations or its portfolio companies. In the individual cases where Icelandic banks may have to sell shareholdings in our portfolio companies, we would like to emphasise that these are all minority shareholdings.

Baugur maintains there is no threat to its portfolio of retailers in the UK, since pre-emption clauses offer the option for other existing investors to acquire equivalent shareholdings when a stake in a particular retailer is sold.

“Should an Icelandic bank sell all or part of their minority shareholding, there would be no impact on the successful day-to-day operations and performance of these companies. [This] would only change the ownership structure,” says the spokeswoman.

By its own highly acquisitive standards, Baugur has been having an unusual year. Even before the Icelandic banking crisis took hold, the company was looking increasingly bearish.

In September, it off-loaded the345-strong healthfood store chain Julian Graves to competitor Holland & Barrett for an undisclosed amount. It had already sold its entire 31.4% stake in cash-and-carry operator Booker for around £100m in June and, in May, had sold loss-making fashion retailer MK One to restructuring specialist Hilco.

MK One did not fit with Baugur’s strategy of investment in well-known fashion retailers that are ripe for international expansion. This strategy has been pursued with the names under its Mosaic Fashions banner, which include Oasis, Principles and Warehouse. Karen Millen, another Mosaic brand, opened a 10th Russian store in September.

Others among Baugur’s retail portfolio, including toy shop Hamleys, are also being expanded internationally. It has opened stores in India, Dubai and Jordan this year.

But such expansions, as well as recent sales growth at Mosaic, the Aurum jewellery group and House of Fraser, have not been enough to offset the impact on Baugur of the catastrophic failure of Iceland’s banking system.

As a result of that turmoil, predictions about the company’s long-term strategy have become impossible, since the future control of key retailers within its portfolio looks almost certain to change.

Jón Ásgeir Jóhannesson, executive chairman of Baugur, has admitted that “the person that owns the debt controls the company”. With no shortage of bidders for that debt, the ownership of up to 20 UK retail names could be about to change hands.

Arcadia owner Sir Philip Green was considered a frontrunner to sew up a deal, having flown out to Iceland early in October in the hope of pulling off an audacious coup. His main interest lies in assuming control of Mosaic, which competes with his Top Shop, Miss Selfridge, Wallis and Dorothy Perkins brands.

Green is expected to face off with private equity groups Permira, TPG and Alchemy, which are also circling. Any such deal would likely be concluded at fire-sale prices.

Management buyouts at Baugur’s various portfolio retailers are also considered possible by analysts. The Iceland frozen food chain, which has been trading strongly, is a prime contender after CEO Malcolm Walker withdrew his interest in taking over Woolworths.

Nick Bubb, an analyst at stockbroker Pani Capital, describes the situation at Baugur as “amazing” and believes its UK retail portfolio is likely to be broken up.

“Philip Green probably wants the whole of Mosaic to merge with Arcadia, but it’s not clear to me whether Mosaic has ever really achieved any synergies from being such a big fashion grouping,” he says.

“I think it could be broken up, with the best chains, like Karen Millen and Coast, going to private equity.”

The future of House of Fraser, which was taken private through a Baugur-led takeover in 2006, and the listed Debenhams, in which it has a 7% stake, has raised eyebrows.

Analysts speculate HoF could even be merged with Debenhams, which has suffered a profits slump in recent months.

However, the pre-emptive rights clause among shareholders means HoF looks increasingly likely to move into the control of its management. Chairman Don McCarthy owns 20%.

The timing of any such deals remains a moot point. While some analysts have speculated that a fire sale needs to – and will – be sewn up quickly, others point out that the Icelandic banking freeze means a swoop totalling billions of pounds for Baugur’s debt simply cannot be pushed through in any hurry. Some reports have even suggested the Icelandic government could retain the debt indefinitely.

While the company’s UK retail portfolio is not in any immediate danger, its break-up in some form or other seems almost certain, with widespread repercussions that have yet to be fully felt.

Baugur: Company History and Strategy

The roots of Baugur can be traced to 1989 when Jóhannes Jónsson and his son, the current Baugur UK CEO Jón Ásgeir Jóhannesson, formed discount food chain Bónus in Reykjavik.

Bónus merged with the Hagkaup supermarket chain in 1998 to create Baugur and by 2001 had begun its strategy of investment in the UK market.

Baugur was delisted from the Icelandic stock exchange in 2003 and was taken private by Jónsson, Jóhannesson and others. It acquired Hamleys, Julian Graves and a majority stake in Oasis, followed by Big Food Group, owner of the Iceland frozen food chain.

In 2005, Baugur oversaw the flotation of Mosaic Fashions on the Icelandic stock exchange, but delisted it in 2007.

In 2006, it acquired a 35% stake in House of Fraser. It also took on a minority stake in fashion brand All Saints, rapidly expanding the portfolio of stores.

Each deal has been concluded with significant amounts of debt, meaning Baugur is now estimated to owe up to £2bn to Iceland’s banks, several of which were part-nationalised in October in order to avoid collapse.

Meanwhile, Stodir, an investment company controlled by Jóhannesson, owns 32% of banking group Glitnir, which is now 75% owned by the Icelandic government. Stodir announced its intention in July to acquire a 39% stake in Baugur but called the deal off after filing for bankruptcy protection in October.

Baugur declined to answer questions about its UK property holdings but analysts believe they are minimal. In some cases significant freehold assets have been stripped out.

They include House of Fraser’s headquarters at1 Howick Place in London’s Victoria, which was sold for £60m in 2006.