Is South African Clothing Retailer Edcon Too Big to Fail?

(Bloomberg) -- South Africa’s national power utility’s woes have threatened to shut down industries, while the flagship airline has received repeated bailouts to keep it afloat. Now, a scramble to help a retailer that sells school shoes and fast fashion suggests it, too, may be seen as too big to fail.

Edcon Holdings Ltd. has about 30,000 employees, a supply chain that includes 750 companies and floor space that accounts for a 10th of the occupancy in the country’s biggest shopping malls, the most of any company. A potential collapse of could exacerbate an unemployment crisis and cause income from commercial property rentals to slide.

The Johannesburg-based company is in talks with South Africa’s biggest lenders and landlords to get more cash and to reduce rentals as it struggles with a debt burden that’s a legacy of the way its 2007 takeover by Boston-based Bain Capital Private Equity LP was financed.

“If Edcon were to fail, it would be a big challenge for South Africa and it’s in everyone’s interests to get a deal signed,” said Wynand Smit, a property analyst at Anchor Stockbrokers. “Even just closing a lot of stores would be negative for the property sector as the market is very sensitive to vacant space.”

Is South African Clothing Retailer Edcon Too Big to Fail?

Among potential rescuers is the Public Investment Corp., which oversees the pensions of government workers. It’s leading talks to provide 3 billion rand ($220 million) in funding to the company, along with landlords and banks, according to people familiar with the matter.

Even so, some have questioned whether helping a struggling retailer whose troubles are due to a private equity deal, sets a dangerous precedent.

It would need to be considered “whether a bailout sets a precedent which incentivizes reckless levels of indebtedness among private and listed retailers as they compete for market share,” said Daniel King, a Cape-Town based analyst at Avior Capital.

Bain handed ownership of Edcon to creditors including Franklin Templeton, Sanford C. Bernstein & Co. LLC and Harvard University Pension Fund in 2016.

In July, Edcon’s new Chief Executive Officer Grant Pattison, who replaced Bernie Brookes a year ago, said they would be closing some shops in an attempt to lure their customers to its flagship Edgars clothing chain. Under Pattison’s strategy, Edcon has been reducing its footprint from more than 1,300 stores, cutting floor space by 17 percent over five years to restore profitability.

The owners, which took control in a debt-for-equity swap after Bain walked away, have offered landlords a 5 percent equity stake in Edcon in exchange for a two-year rental reduction, the Johannesburg-based Sunday Times reported in December, citing a letter to landlords.

Sensitive Stage

Talks are at a sensitive stage with the retailer asking for a 41 percent rental reduction and “it’s hard to know at this stage whether it will go through or not,” said Smit.

The demise of department stores is not solely a South African problem. London-based Debenhams Plc said earlier this month it’s in talks with lenders as it faces at least 300 million pounds ($394 million) of debt coming due starting next year. It’s also not a first in South Africa. Stuttafords was put into business rescue in October 2017 after the 159 year-old retailer became a casualty of a slump in local consumer confidence. Woolworths Holdings Ltd. last year posted its first full-year loss since at least 2002.

“Edcon has been running a tightrope between improving sales and running out of money,” said Syd Vianello, an independent retail analyst in Johannesburg. “The existing shareholders are there by default, not because they wanted to be there and the banks are reluctant to add more cash because of Edcon’s history. So it’s come down to the landlords, who have a lot at stake, and then also looking for a new investor, which appears to be the PIC.”

Pattison said in December that the company is close to announcing a “complete recapitalization of the business that should endure for the next few years.” Edcon didn’t comment further.

Unfair Competition

“If government did move to help, one option that could be considered is tax breaks,” Smit said. Edcon could also try for so-called rental holidays, he said.

Company voluntary arrangements, or CVAs, are a means used by financially distressed businesses to come to an agreement under U.K. law with unsecured creditors, often by getting more favorable property rental agreements and allowing some outlets to close before their leases expire. CVAs are becoming more frequent in the U.K.’s shopping districts, with Homebase becoming another in a list of retailers using the process to shutter outlets.

While rent holidays are unprecedented in South Africa, and property companies could possibly withstand granting Edcon a rental break, it could mean that “competing retailers may become more emboldened to bargain for fair treatment,” King said. “Edcon’s competitors may even view the agreement as somewhat anti-competitive, especially if landlords take an equity stake in Edcon and proceed to give preferential treatment to the tenant.”

Rising costs have already resulted in South African mining companies cutting tens of thousands of jobs and so “a move to help Edcon would leave the question of what about other struggling companies?” Smit said.

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