Quarterly retail review Q4 2020

Boosted by a rise in home shopping during lockdown, online retailers outperformed all expectations from April through December. We expect demand for online stores to continue once normality returns and that the sector will maintain a strong performance.

With this surge in online sales being noticed, there was an uptick in M&A activity in the retail sector during the last quarter of 2020. Owners and management teams were keen to capitalise on their hard work by selling equity. These partial exits cleared space for new investors to sit beside existing management, merging new ideas with experienced leadership.

High performance also attracted private equity to take a fresh look at the retail sector and identify strong strategic growth opportunities. An uncertain economy makes valuations challenging, as underlying earnings are subject to outside influence, but there's no doubt the sector is drawing interest.

The three deals that drove Q4

Private equity looks again at retail

Private equity houses' keen interest in direct-to-consumer businesses is focused on the online retail sector as consumer demand continues to be altered by world events. This demand for resilient, high-performing businesses will make for a competitive market, and retailers with proven models will command strong valuations.

Recent retail sector M&A activity is showing several common features among acquired firms:

• A track record of steady growth before lockdown
• An active customer base with high retention and repeat ordering cycles
• Strong market-share acquisition or the creation of a new market
• The infrastructure, processes and people to manage operational risk and support rapid growth

Given the high levels of private equity interest in the space and the increasing volume of transactions, pre-process preparation is more important than ever. This includes financial model preparation.

Timing is everything

We believe the volume of retail sector M&A transactions will continue to increase through 2021.

In November 2020, the chancellor announced a review of capital gains tax, which was thought would be reflected in the March budget. This has created a sense of urgency in transactions during the first quarter of 2021.

Although a rise in capital gains tax is now considered less likely, given ongoing lockdown restrictions, this has already driven strong valuations. And while the increase will likely be pushed back to the long term, it will remain a looming driver for the market.

Given the strong performance of the sector and the boost offered by recent events, we feel the retail market will remain active for a long time to come.

If you'd like to discuss M&A opportunities in the retail and ecommerce sector, get in touch with Nicola Sartori.

Online retailers swoop in

ASOS’s £265 million acquisition of four Arcadia brands, which includes Topshop, and Boohoo’s double swoop to buy Debenhams’ intellectual property for £55 million, and three Arcadia brands – Dorothy Perkins, Wallis and Burton – for £25 million have made contentious headlines. The deals will leave the new owners with the brands, but not the hundreds of stores that once formed the bedrock of these high street businesses. Many say this sounds like the death knell of the UK high street.

ASOS and Boohoo are each following different strategies with their acquisitions

Read the full story behind their acquisitions and strategy here >>

High street retailers fight back

But could the pure players be missing a trick? The future of high street retail is changing but reports of its death may be greatly exaggerated.

Bricks-and-mortar businesses that can are starting to reshape their offer to meet the challenges of online competition. Meanwhile, commercial rents are falling resulting in lower costs. And while online sales are a rising trend, many shoppers will still prefer to visit a physical store with a brand name they know above the door. There is still everything to play for.

Next king of the high street?

Ironically, I think one of the biggest winners from this buying spree could be the business that walked away from the Arcadia deal.

Next plc chose to drop out of the bidding for Topshop and Topman and allow ASOS to claim the spoils. It also has a beautifully balanced omnichannel business, with just about half its sales in a normal year coming from online retail, and half from its well invested store estate.

The complete loss of the Debenhams' store estate from the UK high street, and the £1.8 billion sales it generated, represents an enticing opportunity for Next, the value of whose UK store sales are remarkably similar in value to Debenhams’. Most former Debenhams store shoppers will not migrate online and, when shops reopen in a few months’ time, Next will undoubtedly gain sales as a result of Debenhams’ and Arcadia’s demise.

If Next can rapidly develop its beauty business, launched in 2018, it could become a legitimate competitor to Frasers Group and the John Lewis Partnership in this lucrative category. It has already acquired five former Debenhams sites in which to do so.

Prime locations and falling rents

Next will also be a winner in that most of its stores are in prime locations, and it has already agreed deals with many landlords to ensure that it profits from any general rental reductions afforded to its competitors. With multiple vacancies on the high street and in shopping centres, I expect rental levels may fall sharply in the next 12 months and beyond. 

Of course, the loss of the better part of 18 million square feet of occupied retail space from the closure of the Debenhams and Arcadia retail stores is a huge challenge. And it won’t be the first or last of the closures.

But retailers like Next, JD Sports and even M&S are likely to benefit from the reduced competition and costs – once shoppers return, as they inevitably will.