debenhams - richard parry

DEBENHAMS: A CASE STUDY

by

Mr. Richard H. Parry MEng (Hons.) Oxon.

A thesis submitted in partial fulfillment of the requirements for the degree of

Sloan Fellowship MSc.

London Business School

2006

Approved by ___________________________________________________Supervisor

__________________________________________________

__________________________________________________

__________________________________________________

Program Authorized to Offer Degree _________________________________________________

Date __________________________________________________________

LONDON BUSINESS SCHOOL

ABSTRACT

Debenhams: A Case Study

by Mr. Richard H. Parry MEng (Hons.) Oxon.

Supervisory: Professor Eli Talmor Department of Accounting

A thesis presented on the case study of a private equity investment in

Debenhams by the Baroness Retail Consortium: a consortium that includes the

private-equity groups CVC Capital, Texas Pacific and Merrill Lynch PE

Figure 1: Debenhams: Britain’s Favorite Department Store

i

TABLE OF CONTENTS

List of Figures ..................................................................................................................... iii List of Tables....................................................................................................................... iv Acknowledgments............................................................................................................... v Executive Summary ...........................................................................................................vi

Chapter I: The History of Debenhams.................................................................... 1 Chapter II: The Private Equity Firms ...................................................................... 8 Chapter III: The Leveraged Buyout Model ..........................................................12 Chapter IV: The Transaction Timeline,,.................................................................21 Chapter V: How Baroness Won the Bid ...............................................................27 Chapter VI: Baronesses Investment in Debenhams ...........................................49 Chapter VII: The Debenhams IPO and The Performance of the Buyout.....58 Chapter VIII: Conclusion.........................................................................................76

Glossary...............................................................................................................................78 Appendix A: Pre-2003 Acquisition Stock Price ..................................................... 1 Appendix B: Abridged Profit and Loss Accounts – UK GAAP........................ 2 Appendix C: Abridged Balance Sheets – UK GAAP........................................... 3 Appendix D: Funding Debt – UK GAAP.............................................................. 3 Appendix E: Effective Interest Rates....................................................................... 4 Appendix F: Abridged Cash Flow Statements – UK GAAP.............................. 5 Appendix G: Director and Non-Executive Directors .......................................... 7 Appendix H: Source of Deal Value Creation .......................................................12 Appendix I: Debenhams Estimated ROCE Analysis ........................................13

ii

LIST OF FIGURES

Number Page Figure 1: Debenhams: Britain’s Favorite Department Store ......................................i Figure 2: Debenhams: UK Department Store Sales (Source: Company data) .......3Figure 3: Debenhams: FY 2005 Sales Mix (Source: Company data)........................4 Figure 4: Debenhams: Designers at Debenhams Sales (Source: Company data) ..4Figure 5: Debenhams: Own bought versus Concessions Mix (Source: Company

data) ........................................................................................................................5 Figure 6: ROCE Analysis of a fictional company; Flexible Connections..............17 Figure 7: Reaching New Heights...................................................................................26 Figure 8: Laragrove Offers Capital Structure..............................................................28 Figure 9: Relative Performance of UK Mixed Goods Retailers by Size (UK

Office of National Statistics) ...........................................................................34 Figure 10: Baroness Bids Senior Management Team................................................35 Figure 11: Baroness Capital Structure for the 455p bid............................................38 Figure 12: Baroness Capital Structure for the 477p bid............................................44 Figure 13: Nectar Rewards Partner...............................................................................48 Figure 14: Capital Structure at the 28th August .........................................................52 Figure 15: Capital Structure at the 3rd September 2005...........................................55 Figure 16: Debenhams: UK Department Store Sales (Source: Company data)...58Figure 17: Debenhams: Designers at Debenhams Sales (Source: Company data)

...............................................................................................................................59Figure 18: Debenhams: Bought versus Concessions Mix (Source: Company data)

...............................................................................................................................59Figure 19: Debenhams 2006 Brand Mix (Source: Company data) .........................60 Figure 20: Debenhams Brands Appeal versus the competition..............................60 Figure 21: Debenhams Supply Chain Improvements ...............................................62 Figure 22: Debenhams use of sourcing from low cost countries ..........................63 Figure 25: Designers at Debenhams.............................................................................64 Figure 23: Debenhams EBITDAR performance.......................................................69 Figure 24: Estimated ROCE analysis ...........................................................................73

iii

LIST OF TABLES

Number Page Table 1: Key Debenhams Facts.......................................................................................7 Table 2: Laragrove Offer: Transaction Sources and Uses (£m)..............................30 Table 3: Debenhams scheme of arrangement, expected timetable of principal

events, 3rd November 2003.............................................................................42 Table 4: 2003 Acquisition: Transaction Sources and Uses (£m).............................45 Table 5: Interviews with Philippe Costeletos, lead buyout partner from the Texas

Pacific Group......................................................................................................71 Table 6: Interviews with Philippe Costeletos, lead buyout partner from the Texas

Pacific Group......................................................................................................71

iv

ACKNOWLEDGMENTS

I would like to thank Professor Eli Talmor and Philippe Costeletos for their

assistance in the preparation of this thesis. I found Eli’s course, Venture Finance

and Private Equity, at the London Business School to be a fantastic grounding

for this case study. Philippe, the partner who conducted the buyout for the Texas

Pacific Group, provided useful information and a first hand insight into the case.

In addition, I would like to thank my wife, Comfort and my children, Oliver and

Violet for their patience and support during this undertaking.

v

EXECUTIVE SUMMARY

The three-year private equity investment by the Baroness Retail Consortium has

returned CVC, Texas Pacific Group, and Merrill Lynch Private Equity a

handsome profit. The deal, awarded European Buyout of the Year, is a two and a

half year story of individual courage, opportunism, great timing, and good

management.

Ultimately, Baroness beat Laragrove to take Debenhams private, because they

took a differential view about how to create additional value at Debenhams, and

because they took a more optimistic view of the UK retail sector. By backing an

experienced turnaround management team, Baroness was able to convince key

stakeholders that they could create additional value. This, in combination with

having a more optimistic view of the UK retail sector, allowed Baroness to justify

paying a higher price for Debenhams.

The bidding strategy and implementation by Baroness were innovative and

impressive. The lead buyout partner, Philippe Costeletos, was new to his job at

Texas Pacific and yet was able to convince key stakeholders to pursue a bid.

Baroness managed to convince Debenhams to pay £1m per week to catch up

with Laragrove’s due-diligence, and prevented others from bidding. The second

winning bid by Baroness exposed divisions within Laragrove that, along with a

shortened bid timeline allowed Baroness to win. The use of a scheme of

arrangement saved money on taxes and more easily facilitated fund raising.

Once in place, the new management team embarked on a new growth strategy.

They created value by transforming Debenhams’ business model from a cost

heavy ‘high-CAPEX, low-growth’ model to a more cost-efficient ‘high-growth,

vi

low-CAPEX’ model by (1) improving operational effectiveness, (2) driving core

sales and margin growth and transforming the supply chain, and (3) identifying

new growth sources and areas for geographical expansion.

The result was a 3.3x return on equity to investors at the IPO. An impressive 2.5x

returns were achieved through operational improvements to the Debenhams

business. These returns were 4.7x greater than if this transaction had been one

hundred percent equity financed which would have only returned 0.7x1 the

original equity. However, the impact of the British Land transaction on ROCE

needs to be investigated further. Without an accurate measure of the capital

employed in the business over the period of private ownership it is difficult to

conclude that ROCE has increased during private ownership.

The higher equity return enjoyed by Baroness did not come without additional

risk. In addition to the structural problems of department stores competing with

lower cost outlets and the cyclical risk of the UK retail market, there was

considerable interest rate risk in this transaction. Baroness chose to mitigate

business risks by conducting extensive due diligence and imposing a highly

experienced management team to transform the business. Baroness mitigated

interest rate risk through the use of hedging instruments. Baroness also mitigated

its investment risk by choosing to invest equity in other businesses that are in

other sectors and countries and by having a realistic exit strategy.

1 Company data and the following calculation: Return/(EV+Costs)=(2021-608)/(1868+40)

vii

C h a p t e r I : T h e H i s t o r y o f D e b e n h a m s

DEBENHAMS HISTORY2, ,3 4

Debenhams dates back as far as 1778. However, the name Debenhams did not

appear until 1813 when Clark and William Debenhams began retail operations, in

partnership, on Wigmore Street in central London.

The Debenhams name was first used in 1813 when Thomas Clark and William

Debenhams began retail operations as the Clark and Debenhams partnership on

Wigmore Street in central London. The business grew to include a number of

retail outlets across the UK and in 1905 Debenhams opened its first department

store and became and incorporated company.

In 1919, Debenhams acquired Harvey Nichols and, in 1928, Debenhams

acquired Drapery Trust, to gain control of several regional retailers. Subsequently,

Debenhams listed its shares on the London Stock Exchange and traded as an

independent company. In 1958, Debenhams had a failed bid for Harrods and in

1972 Debenhams was unsuccessfully bid for by UDS. By 1985 Debenhams had a

2 Debenhams website

3 Debenhams plc IPO Offer Prospectus (Citigroup, 4th May 2006), p22

4 Debenhams plc (DataMonitor), p6

1

2

portfolio of 65 department stores and owned a number of other companies,

including Hamleys, Harvey Nichols and Lotus.

In 1985 The Burton Group (now Arcadia) acquired Debenhams for £560m in a

hostile bid. The following business were subsequently disposed of:

Hamleys – 1985 to Harris Queensway

Lotus and HM Rayne (shoe retailers) – 1986 and 1987

Wellbeck Fiancé (credit cards) – 1990 to GE Capital

Harvey Nichols – 1991 to Dickson Concepts

In addition to these disposals, the late 1980s and early 1990s Debenhams

introduced exclusive ranges of own-bought merchandise in key product areas and

significantly increased its portfolio of stores. By 1997, Debenhams introduced its

first international franchise store in the Middle East.

In January 1998, Debenhams was demerged from The Burton Group and was

listed on the London Stock Exchange. Debenhams was an independent company

once again. In 1999, Debenhams launched an eCommerce website and continued

its international expansion with the launch of a store in Dubai. By December

2003, Debenhams had 104 stores in the UK and Ireland plus 10 franchises.

Debenhams delisted from the London Stock Exchange in December 2003,

following a trend set by its competitors BHS, Selfridges, and Arcadia. It was

acquired by Baroness Retail Limited, a company owned indirectly by a group of

funds managed or advised by CVC Capital Partners, Merrill Lynch Global Private

Equity and Texas Pacific Group, other institutional investors and the

management team. Baroness trumped an offer from Permira, through the use of

mezzanine financing, and paid £1.74bn in a leveraged buyout.

Since the 2003 acquisition the group has undergone a number of refinancing

rounds. In May 2005, the group underwent a major refinancing and restructuring

in which the company became the parent of the group.

In May 2006, Debenhams was IPO’ed .

DEBENHAMS TODAY5,6

Debenhams is a leading multi-category retailer and the second biggest department

store chain in the UK with approximately 18.6% of total in the United Kingdom

department store sales, having increased its market share from 15.3% in 2003.

11.812.9

12.3 12.1 12.112.8

13.4 13.8 13.7 13.3

12.2% 13.0%13.0%13.8%14.7%

18.6%15.2%16.4%

12.0%14.8%

1111121213131414

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

E

0%

5%

10%

15%

20%

Market Value (£Bn) Debenhams Market Share

Figure 2: Debenhams: UK Department Store Sales (Source: Company data)

5 Debenhams website


3

Debenhams has a strong presence in every key product category, including

women, men, childrenswear, cosmetics, and household goods. Along with its

range of women’s, men’s and childrenswear, Debenhams also offers a personal

shopping service, a wedding service, in-store catering, Debenhams Direct (home

shopping catalogue), financial services, and a fully transactional website.

Womenswear28.4%

Menswear17.4%

Childrenswear5.3%

Home & Gift16.9%

Health & Beauty13.6%

Accessories10.2%

Food Services2.8%

Lingerie5.4%

Figure 3: Debenhams: FY 2005 Sales Mix (Source: Company data)

Debenhams sells a number of international and designer brands, as well as its

own brands, including Designers at Debenhams. Sales from Designers at Debenhams

ranges’ sales have increased substantially in recent years.

2 4 8 13 83 143 208 266 324450

0100200300400500

1996

/97

1997

/98

1998

/99

1999

/00

2000

/01

2001

/02

2002

/03

2003

/04

2004

/05

Targ

et

Value (£M)

Figure 4: Debenhams: Designers at Debenhams Sales (Source: Company data)

4

Debenhams has a successful own brand portfolio of approximately 55 own

brands (such as Debut, Maine New England, Red Herring and Thomas Nash)

including 25 Designers at Debenhams brands. The Designers at Debenhams range offers

customers exclusive product lines at mainstream prices by designers such as

Jasper Conran, Julien Macdonald, John Rocha and Matthew Williamson. Third

party brands are either bought by Debenhams (such as Estée Lauder and Levi

Strauss) or available through in-store concessions (such as Oasis).

75 76 76 74 72 70 75

25 24 24 26 28 30 25

2000 2001 2002 2003 2004 2005 Target

Own Bought Concessions

Figure 5: Debenhams: Own bought versus Concessions Mix (Source: Company data)

Debenhams has 123 stores, including three Desire by Debenhams stores, across

the UK and Ireland, with approximately 9.3 million square feet of trading space

and around 20,000 employees. The stores are located in various locations,

including town centres, high streets and shopping centers and cover a wide

geographic and size range.

5

In addition, Debenhams has successfully expanded into international markets by

partnering with a small number of dedicated, regional franchise partners.

Debenhams currently has 29 international franchise stores in 15 countries outside

the UK and Ireland, with a further 15 franchises scheduled to open by the end of

the 2008 financial year. Debenhams is able to offer a unique value proposition to

its international clients through the use of the Debenhams brand, its portfolio of

over 100 successful designer and own brands, and Debenhams ability to adapt

their stores to local consumer preferences or cultural requirements.

Currently, Debenhams operates franchise stores in Bahrain, Czech Republic,

Cyprus, Denmark, Hungary - Budapest, Iceland - Reykjavic, Indonesia, Kuwait

Qatar - Doha, Saudi Arabia – Jeddah and Riyadh, Malaysia, Philippines, Sweden -

Stockholm, UAE - Dubai and Sharjah, and Turkey.

6

KEY FACTS

Head Office Debenhams Retail plc 1 Welbeck Street London W1G 0AA

Phone 084 4561 6161

Fax 020 7408 3366

Web Address www.debenhams.com

Gross Transaction Value (£M) £1810.2m (GAAP 2003) £2,224.7m (IFRS 2006E)

EBITDA (£M) £218.1m (GAAP 2003) £331.7m (IFRS 2006E)

% of GTV 12.0% (GAAP 2003) 14.9% (IFRS 2006E)

Financial Year End August

Employees 21,194 (August 2003) 20,262 (March 2006)

SIC Codes SIC 5311 Department Stores

NAICS Code 45211

Company Registration Number: 83395

VAT Registration Number: 698 7979 22

Table 1: Key Debenhams Facts

7

http://www.debenhams.com/

C h a p t e r I I : T h e P r i v a t e E q u i t y F i r m s

LARAGROVE7

Laragrove was a private equity consortium led by Permira that consisted of

Permira, Blackstone, Goldman Sachs PLA, and the Directors of Debenhams.

Permira

At the time of the transaction, Permira was one of Europe’s leading private equity

firms advising funds of nearly €9 billion. Permira was an independent business

with offices in London, Frankfurt, Milan, Paris, Stockholm, and New York and

focused on European buy-out transactions. Since 1985, funds advised by Permira

had invested in more than 250 transactions.

The Blackstone Group

The Blackstone Group is a private investment firm that was founded in 1985. At

the time of the transaction, The Blackstone Group, had offices in New York and

London and had raised over $14 billion for private equity investment. It had

approximately $6.5 billion in committed capital through its primary investment

vehicle, Blackstone Capital Partners IV. In addition to private equity, The

Blackstone Group also consists of private retail investing, corporate debt

investing, marketable alternative asset management, mergers and acquisitions

advisory, and restructuring and reorganisation advisory.

7 Recommended Cash Offer by Laragrove Limited for Debenhams (UBS Investment Bank, 04/08/2003),

p10-11

8

Goldman Sachs PLA

Goldman Sachs is a leading global investment banking, securities and investment

management firm that provides a wide range of services worldwide to a

substantial and diversified client base. This client base includes corporations,

financial institutions, governments and high net worth individuals. Founded in

1869, Goldman Sachs is one of the oldest and largest investment banking firms.

The firm is headquartered in New York and maintains offices in London,

Frankfurt, Tokyo, Hong Kong, and other major financial centres.

At the time of the acquisition, Goldman Sachs Capital Partners and investment

partnerships affiliated with Goldman Sachs had committed capital of

approximately $5.25 billion. GSCP 2000 was the primary investment vehicle of

Goldman Sachs for long term investments in equity, equity related securities in

privately negotiated transactions, leveraged buyouts and acquisitions. Goldman

Sachs and its partners had made global and diversified investments of

approximately £11 billion in around five hundred companies since 1986. Notable

investments included Yankees Entertainment and Sports Network, LLC and

R.H. Donnelley Corporation. Major European investments included Cognis,

Messer Griesheim, Legrand, and the cable television operations of Deutsche

Telekom.

BARONESS RETAIL CONSORTIUM8

Baroness Retail Consortium was a private equity consortium led by CVC that

consisted of CVC, Texas Pacific Group, Merrill Lynch Global Private Equity, and

the Independent Directors of Debenhams.

8 Recommended Cash Acquisition by Baroness Retail Limited for Debenhams by means of a Scheme of

Arrangement (Baroness Retail Limited, 12/09/2003), p12-13

9

CVC

At the time of the acquisitions, CVC Capital Partners was a leading independent

pan European private equity group with a strong, local European network of 11

offices focused on medium to large management buy-outs. Since 1993, CVC

Capital Partners had raised over US$8 billion that was to be invested in European

buy-outs. CVC Capital Partners’ current portfolio included 65 companies with a

combined turnover of €33 billion, which operated in 25 countries and employed

over 200,000 people.

Texas Pacific Group (TPG)

David Bonderman, James G. Coulter and William S. Price, III founded the TPG

GROUP in 1993 to pursue public and private investment opportunities through a

variety of methods, including leveraged buyouts, recapitalisations, joint ventures

and strategic public securities investments. TPG Partners III, L.P., (together with

certain parallel investment entities) is a US$4 billion private equity fund formed in

1999 to make investments in corporate acquisitions, and will be the principal

TPG Fund investing in Debenhams. The TPG Funds and their predecessor

funds currently manage over US$8 billion of committed capital. Over the past

decade, the TPG Funds, their predecessor funds and their principals have

invested over US$6 billion of equity capital in over 50 transactions.

Merrill Lynch Global Private Equity (MLGPE)

Merrill Lynch is one of the world’s leading financial management and advisory

companies, with offices in 36 countries and total client assets of approximately

US$1.4 trillion. As an investment bank, it is a leading global underwriter of debt

and equity securities and strategic advisor to corporations, governments,

institutions and individuals worldwide. Through Merrill Lynch Investment

Managers, the company is one of the world’s largest managers of financial assets.

MLGPE is the private equity arm of Merrill Lynch, and manages the MLGPE

10

Vehicles. The MLGPE Vehicles carry out long-term equity and equity-linked

investments in securities in private transactions, buyouts, and acquisitions.

11

C h a p t e r I I I : T h e L e v e r a g e d B u y o u t M o d e l

The Debenhams acquisition by Baroness Retail Consortium is a classic example

of a leveraged buyout. At the time of the leveraged buyout a small group of

investors purchased all of the equity of Debenhams. Baroness Retail Consortium

finances this acquisition with debt that was secured against Debenhams’ assets.

After the leveraged buyout the debt was restructured and assets were acquired

and divested. Debt restructuring allowed Debenhams to achieve lower rates of

interest on their debt and enabled Debenhams to achieve a greater distance of

their debt from their assets. This reduced interest costs and prepared Debenhams

for an eventual IPO. Real estate assets were divested to British Land to reduce

expensive borrowing, allow the business to focus on core activities, and to reduce

the amount of capital employed in the business. New store locations were

acquired to enable expansion of the business. Over the course of Baroness Retails

investment in Debenhams, cash was swept out of the business to pay down the

debt used to acquire Debenhams. These activities increased the enterprise value

of Debenhams and the percentage of equity in the investment. I believe that

Baronesses most likely exit was always going to be an IPO on the London Stock

Exchange. However, the consortium could have chosen to conduct a new

leveraged buyout of Debenhams or to have exited the investment through a trade

sale to another retail company.

THE EFFECT OF LEVERAGE ON AN INVESTMENT

Most young house buyers in the UK would surely appreciate the effect of

leverage on an investment. Low interest rates and an increasingly sophisticated

financial market for debt have allowed young house buyers to borrow increasing

12

13

multiples of their incomes to purchase property. These factors along with

demographic factors (increased immigration and more single households) have

boosted the demand for housing whilst tight planning regulations and a lack of

investment in travel infrastructure has restricted the supply of housing.

The corporate world has seen a similar phenomenon. Historically low interest

rates and an increasingly sophisticated financial market have allowed acquirers to

leverage their transactions at much higher levels and with lower cost debt. This

has caused a resurgence in the popularity of leveraged buyouts. How does

leverage increase the return to equity? Let us consider two examples:

Example One: One hundred percent of equity

ULeveraged Buyout (year 0)U EBITDA: 5 EV/EBITDA

multiple: 10x E = 50

UExit (year 3)U EBITDA: 7.5 EV/EBITDA


Cash multiple: 90/50 = 1.8x

IRR = 1.8P

1/3P –1 = 22%

50

90

0

20

40

60

80

100

LBO Exit

Equity

1.8x

14

Example Two: Thirty percent of equity

ULeveraged Buyout (year 0)U EV = 50 D = 35 E = 15

UExit (year 3)U EV = 90 D = 20 E = 70

Cash multiple: 70/15 = 4.7x

IRR = 4.7P

1/3P –1 = 68%

1570

3520

0

20

40

60

80

100

LBO Exit

EquityDebt

Clearly, a leveraged buyout has a higher internal rate of return than a pure equity

investment. However, this is misleading. If the enterprise value of the company

was reduced substantially the leveraged buyout financing could potentially have

their equity investment wiped out. In comparison, a one hundred percent equity

investment would not suffer as large a loss. Let us examine two further examples

where the value of the firm halves.

Example Three: One hundred percent of equity

ULeveraged Buyout (year 0)U EBITDA: 5 EV/EBITDA


UExit (year 3)U EBITDA: 7.5 EV/EBITDA


Cash multiple: 25/50 = 1/2x

IRR = 0.5P

1/3P –1 = (21)%

50

25

0

20

40

60

LBO Exit

Equity

1/2x

4.7x

15

Example Four: Thirty percent of equity

ULeveraged Buyout (year 0)U EV = 50 D = 35 E = 15

UExit (year 3)U EV = 25 D = 20 E = 5

Cash multiple: 5/15 = 1/3x

IRR = (1/3)P

1/3P –1 = (31)%

15

535

20

0

20

40

60

LBO Exit

EquityDebt

In the examples above the reduction in the equity value of the company was

more heavily felt by equity investors in the leveraged transaction. Indeed, the

higher potential return (and risk of loss) of a leveraged buyout is reflected in a

higher market cost of equity that is expected for a leveraged transaction.

Profits from leveraged buyouts have fuelled interest in Private Equity, a

previously much ignored form of ownership. This has increased the multiples at

which acquirers are now required to pay to acquire targets. Indeed in many

industries, trade buyers who were thought to have been able to bid more for

companies through achieving synergies with their existing business(es) are being

outbid by purely financial buyers. Financial buyers traditionally were able to pay

more because low interest rates have allowed these investors to achieve higher

financial returns through increased leverage than trade buyers can achieve

through creating value through releasing synergies. As mainly public companies,

trade buyers have not been able to match this degree of leverage due to pension

and other responsibilities of public ownership.

1/3x

16

SOURCES OF VALUE CREATION IN A LEVERAGED BUYOUT

A leveraged buyout can earn a return to equity in one of three ways. UValue

creationU ( V∆ ) occurs by improving the operating, investment, and / or capital

efficiency of the company. UValue arbitrageU ( P∆ ) exploits mispricing and is

essentially a transfer of value from the existing shareholders to new shareholders.

Value transfer ( O∆ ) transfers value from other stakeholders to the shareholders.

These three sources of value creation will be examined in turn.

Value Creation ( V∆ )

Value is created by improving the operating, investment, and capital efficiency of

the company. Many people use EBITDA and EBITDA/ Sales to gauge value

creation. This has the advantage of being a number that is ‘close to cash’ that can

be used with a multiple to see the impact on the value of the company. How this

measure neglects to include capital that is employed in the business. Additional

capital can destroy value but increase EBITDA and EBITDA. A ROCE analysis

provides an alternative viewpoint that can be used in conjunction with EBITDA

and EBITDA/Sales growth. The diagram below shows a ROCE analysis of a

fictional company, Flexible Connections.

The x-axis (Sales/CE) is a measure of capital efficiency. The y-axis

(NOPAT/Sales) is a measure of operating or profitability of the company.

Together they show the ROCE of the company, the curved lines of constant

value. By increasing ROCE, shareholder value should be increased. So, any

additional investment (the addition of capital employed in the business) needs to

generate sufficiently profitable sales in order to maintain or enhance ROCE and

therefore shareholder value.

17

Sources: Flexible Connections Case & My Analysis

FLEXIBLE CONNECTIONS LIMITED ROCE ANALYSIS

2004

2005

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

0.000 0.500 1.000 1.500 2.000

NOPAT / Sales

Sales / CE= £20M Revenue

13.3% ROCE is attractive, however NOPAT/Sales declined from 9.7% in 2004 to 8.6% in 2005. This was despite FCL focusing on the more profitable ‘Direct Order’ segment.

ROCE(%)

20

10

13.3%

14.8%

12141618

8642

Figure 6: ROCE Analysis of a fictional company; Flexible Connections

Sources of value creation include portfolio company, product, and asset

adjustments that enhance profitability and / or capital efficiency and efficiency

gains through cutting unnecessary costs, better control of inventories and

accounts receivables.

Value Arbitrage ( P∆ )

The ‘buy low’ and ‘sell high’ view of leveraged buyouts seek to source deal that

exploit mispricing in equity markets. Firms may take a contrarian view about the

market and / or buy in an industry down cycle. A private equity firms longer

investment horizon allows them to be able to ride the cycle to its peak before

exiting at a profit.

18

Value Transfer ( O∆ )

Tax Savings: very high leverage generates substantial tax savings for a leveraged

company. Indeed, many companies do not pay any taxes during their period of

high leverage. Due to the increasingly competitive nature of the bidding process

for leveraged buyout transactions these gains are being priced into the premium

paid to conduct the leveraged buyout.

Transfers from new creditors: new creditors may overvalue the leveraged

buyouts financial claims. During the 1990’s the junk bond overheated and

creditors lost out. Many people have similar concerns over the current market.

Risk shifting to existing creditors and preferred stock holders: existing

covenants may not sufficiently protect existing creditors. This depends on the

covenants that have been agreed between the creditor and the company.

Employees: the new owners may be tougher in pay negotiations because of the

need to finance their increased debt load.

What makes a good deal for shareholders?

A good deal for acquiring shareholders requires that:

CPOV +∆+∆>∆

So, the value created in the transaction must be greater than the value transferred

to other stakeholders, the premium paid to the old shareholders, and the costs of

the transaction.

What makes a good leveraged buyout candidate?

A good leveraged buyout candidate has the ability to sustain a huge debt load and

has the potential for efficiency gains.

To sustain a large debt load high and stable cash flows are required. Examples are

found in market leading companies that are in mature and recession proof

industries and who do not require large amounts of capital expenditure. Larger

amounts of debt can be achieved at lower rates if this company has a relatively

liquid balance sheet (collaterisable assets and excess cash/liquid investments),

separable non-core assets and a low current leverage.

Efficiency gains can be achieved by running the company more efficiently to

achieve cost reductions and / or top-line sales growth that improve profitability.

For example, a store refurbishment program that uses less capital but that

achieves the same results would be an example. So would reducing the value of

inventory whilst obtaining the same gross margins and sales. This is a very large

area that will be examined in more detail later in this paper for the Debenhams

transaction.

What are the key risks of a leveraged buyout and what remedial action can

be taken to address these risks?

Interest rates could rise: The western world currently enjoys historically low

interest rates. This combination of a low interest rate environment and more

sophisticated, liquid, and more relaxed lending policies by banks have, I believe,

been instrumental in causing asset prices to rise across the economy. Leveraged

buyouts should automatically do well in a low interest rate environment with

rising asset prices. Many people in the private equity and financial markets fear

the impending reversal of this trend. A rising interest rate environment would

cause a fall in asset prices and an increase in variable interest rates. Leveraged

buyout firms can and have protested themselves from these risks by taking out

fixed rate debt and / or by using hedging instruments to protect cash flows from

rising interest rates.

19

The private equity company might overpay due to adverse information

asymmetry: Information asymmetry between the buyer, the private equity

company, and the vendor: UK takeover regulations require all company

information to be shared with a potential buyer. Sufficient due-diligence enables

this gap to be reduced. Indeed, the private equity buyer may indeed have an

informational advantage because they seek to obtain a differential and more

valuable view of the company that allows the private equity company to pay more

for a winning bid.

The firm might not be able to afford it’s interest payments: Reduction in the

firms cash flows: Appropriate investment selection allows the selection of

investments that have robust cash flows during a downturn and a portfolio of

investments allows a fund to spread non-systemic risk between investments.

20

C h a p t e r I V : T h e T r a n s a c t i o n T i m e l i n e 9, ,10 11

The events of this deal can be broken down into two periods: (1) How Baroness

won the bid and (2) Baronesses investment in Debenhams. The remainder of this

chapter will present the key events during these two periods before discussing

further the events in these two time periods in the next two chapters.

HOW BARONESS WON THE BID

1998

Debenhams completes their London IPO and demerges from the Burton Group

May 12th 2003

Debenhams receives a proposal from Permira to acquire all of the share capital of

Debenhams. A committee of Independent Directors is appointed to consider the

proposal by the management team and Permira.

May 19th 2003

Philippe Costeletos starts his new job with responsibility for retail at the Texas

Pacific Group.

June 5th 2003

CVC and Texas Pacific Group meet their proposed new management team.

9 Debenhams plc IPO Offer Prospectus (Citigroup, 4th May 2006)

10 Interviews with Philippe Costeletos, lead buyout partner from the Texas Pacific Group

11 Recommended Cash Offer by Laragrove Limited for Debenhams (UBS Investment Bank, 04/08/2003)

21

Mid June 2003

CVC and Texas Pacific Group partner, together with Merrill Lynch Private

Equity and the new management team to form Baroness Retail.

June 29th 2003

Debenhams reveals that it has had an approach from Baroness and agrees to pay

Baroness £1m a week for 6 weeks diligence.

July - August 2003

Baroness conducts team diligence and site visits at Debenhams.

July 23rd 2003

The board of Laragrove (a consortium led by Permira, Blackstone, and Goldman

Sachs PIA) announce that they had agreed the terms of a recommended cash

offer of £4.25 per share for Debenhams. This values Debenhams at ~£1.5bn and

was recommended to shareholders.

August - September 2003

Baroness runs a dual track financing process.

August 4th 2003

The Laragrove offer was made to Debenhams shareholders.

September 5th 2003

The Baroness team change their financing to a senior and high yield structure.

These documents are produced over one weekend.

September 12th 2003

Baroness Retail Consortium, consisting of CVC, Texas Pacific Group, and Merrill

Lynch Private Equity, and the Independent Directors announced a £4.55 per

22

share cash offer for Debenhams to be completed under a scheme of

arrangement.

On the same day Laragrove stated that it was considering its position.

Debenhams stock trades at above £4.55 for the next month.

September 29th 2003

Baroness Retail Ltd. publishes a scheme of arrangement for the proposed

acquisition of Debenhams.

October 23rd 2003

Baroness Retail increased its cash offer to £4.70 per share.

October 24th 2003

Laragrove confirmed that it would not be increasing its offer or participate in a

bidding process that was scheduled to start on October 31st 2003.

November 1st 2003

Baroness Retail Ltd. publishes a revised scheme of arrangement for the proposed

acquisition of Debenhams.

November 5th 2003

European Commission grants unconditional clearance under the EC Merger

Regulation for Baroness Retails proposed acquisition of Debenhams.

December 5th 2003

Debenhams shares are de-listed from the London Stock Exchange.

23

BARONESSES INVESTMENT IN DEBENHAMS

December 4th 2003: The Acquisition of Debenhams by Baroness

Baroness Retail Consortium acquire Debenhams in a £1.9bn public to private

transaction. The deal is financed by £608m equity, £335m Property Bridge

financing, and £956m term debt.

April 23rd 2004: Refinance of bridge with a mortgage facility

£375m mortgage facility was raised to refinance the more expensive property

bridge financing.

2004: Refinance of Mezzanine Facility with a High Yield Bond

The original acquisition mezzanine facility of £325m is refinanced with a high

yield bond of a similar amount.

February 22nd 2005: The British Land Sale-and-Leaseback Transaction

Debenhams completes a sale-and-lease-back with British Land of 23 freehold and

long leasehold Debenhams stores. Debenhams receives a £490m consideration

from British Land.

May 16th 2005: The 2005 Acquisition

The capital structure of Baroness is changed to deliver a £1.3Bn dividend to

investors. This dividend was funded by cash generation within Debenhams,

proceeds from the sale and leaseback of properties and through the refinancing

of acquisition debt.

May 26th to June 23rd 2005: Senior Credit Agreement

Debenhams completes £2.05bn refinancing with Credit Suisse, Merrill Lynch,

Morgan Stanley and Citigroup.

24

19th April 2006

Debenhams completes a ‘New Credit Agreement’ with The Royal Bank of

Scotland, The Governor and Company of the Bank of Scotland, Lloyds TSB

Bank, and Barclays Capital.

April 2006

Debenhams announces its £1.74bn flotation

5th May 2006

Debenhams returns to the London Stock Exchange

25

Figure 7: Reaching New Heights

26

C h a p t e r V : H o w B a r o n e s s W o n t h e B i d

PERMIRA’S FAILED BID

The retail sector in 2003 was expected to perform badly 2003. The Debenhams

LBO, at the price ultimately paid by Debenhams, went against market sentiment

at the time and was a gutsy move by the leader of the buyout Philippe Costeletos.

Philippe joined the Texas Pacific Group on the 19th May 2003 to head up the

retail practice and organized the Baroness Retail Consortium bid. This bid

included a number of innovative features and took a different and more valuable

view of Debenhams and the sector than that of Permira.

The Permira Offer

In mid-May 2003, Debenhams received a cash offer of 425p per share from

private equity firm Permira Ltd.12 Permira was given until the end of June to

complete due diligence and finalise funding arrangements. New bidders were

prevented from launching a bid because (1) Permira was months ahead in their

due diligence, (2) the existing management team supported the Permira bid, (3)

there was a breakup fee that would compensate Permira should another higher

winning bid arise (4) The bid arguably represented a fair price with the existing

management in place and reflected the prevailing financial market sentiment of

the sector.

12 Mintel, Department and Variety Store Retailing – UK (Retail Intelligence, June 2003), p85

27

Funds advisedby Permira

(37.5%)

Funds advisedby Balckstone

(20.8%)

Funds advisedby GSCP(20.8%)

Co-Investors(10.9%)

Baron LP

Baron Guernsey 3 Ltd(C&D shares)

Laraway

Debenhams Ltd.

OtherSubsidiaries

DebenhamsCard Handling

Services

DebenhamsGift

Vouchers Ltd.

DebenhamsProperty Ltd.

DebenhamsRetail plc

SeniorFacility

Management(10%)

Laraplace

Wheehurst

Laragrove

Baron Guernsey 2 Ltd(B shares)

Secured BridgeFacility

MezzanineFacility

DeepDiscounted

Bonds

Baron Guernsey 1 Ltd(A shares)

Equity of £528,404,647

Funds advisedby Permira

(37.5%)

Funds advisedby Balckstone

(20.8%)

Funds advisedby GSCP(20.8%)

Co-Investors(10.9%)

Baron LP

Baron Guernsey 3 Ltd(C&D shares)

Laraway

Debenhams Ltd.

OtherSubsidiaries


Services

DebenhamsGift

Vouchers Ltd.


DebenhamsRetail plc

SeniorFacility

Management(10%)

Laraplace

Wheehurst

Laragrove

Baron Guernsey 2 Ltd(B shares)

Secured BridgeFacility

MezzanineFacility

DeepDiscounted

Bonds

Baron Guernsey 1 Ltd(A shares)

Equity of £528,404,647

Figure 8: Laragrove Offers Capital Structure

28

The Financing of Laragrove’s Bid For Debenhams

The capital structure of the holding companies that formed the Laragrove

bidding consortium was organized in a tax efficient manner. The proposed capital

structure of the transaction is shown in Figure 8: Laragrove Offers Capital

Structure.

This capital structure was used to enable Laragrove Consortium members to be

able to recoup money from the transaction in a tax efficient way. The consortium

provided an equity injection of £528,404,647 in a limited partnership Baron LP.

This limited partnership owned four classes of shares in three limited companies

in Guernsey. The equity investment was protected from possible dilution in

further rounds of investment by using deep discounted bonds that were held by

another company owned by the Guernsey limited companies, Laraway. Laraway

owned Laraplace, Whelhurst, and the bidding vehicle, Laragrove. Debt used to

finance the transaction along with the proceeds from the aforementioned equity

injection would have been used to buy Debenhams.

The debt used to finance the transaction, unlike the deep discounted bonds, were

placed close to the assets Debenhams and its collaterisable property. Three types

of debt were used. A senior facility of variable rates at different premiums to

LIBOR and of varying terms constituted the bulk of the money that would be

used to finance the transaction. This facility also included a multi-currency

revolver to enable efficient running of the business. A bridge facility secured

against the freehold and long leasehold properties of Debenhams provided a

cheaper source of interim finance. Finally, there was a high yield component on a

short-term basis that provided that remainder of the finance.

29

Transaction Sources and Uses

Laragrove committed £528 million of equity to the purchase of Debenhams. The

transaction had an enterprise value of £1669 million with additional costs of £55

million incurred. This represented a leverage ratio of 68%.

Sources Uses Term loan - A 280 Purchased equity1 1541Term loan - B 120 Debt refinanced2 128Term loan - C 120 Other3 55Deep discount bonds 506 Bridge facility 325

Mezzanine facility 350 Ordinary equity 22 Total 1723 1723

Table 2: Laragrove Offer: Transaction Sources and Uses (£m)

Notes

1. Baroness Retail Consortium paid £4.25 per share. The offer document,

4th August 2003, used 362,543,038 issued shares to calculate the

Laragrove offer. This represents a purchased equity value of £1.541bn.

2. On the 30th August 2003, Debenhams had £127.8m of net debt

outstanding. This figure represents an estimate of the net debt

outstanding at the time of the transaction.

3. The remainder is expected to consist primarily of transaction fees relating

to the transaction and variation in the amount of the net debt

outstanding.

30

Immediate Refinancing Post Acquisition

The Laragrove offer document contained agreements to setup a mortgage facility

for £160 million secured on Debenhams stores and sale and leaseback

agreements to Legal and General of £144 million, to Ravenscroft £22.4 million,

and RBS (if no other offer was received) of £145 million. Together these

transactions amounted to £471.4 million.

Interest Rate Risk Mitigation Plan

Hedging contracts were entered into that would protect two thirds of the interest

costs of the debt used to finance the acquisition. It was the intention of Permira

to refinance most (if not all) of the acquisition debt within a short timeframe after

the acquisition. So variable rate debt and hedging contracts were used to mitigate

exchange rate risk rather than the use of fixed interest rate debt.

BARONESS ENTERS THE RACE

Shareholder objections and the entry of Baroness

Permira’s offer at this stage looked like it was a done deal. However, there were

objections from Debenhams shareholders about the price that Permira was going

to pay. Some shareholders regarded the lack of a competitive process and the fact

that private equity companies had had a recent history of making large amounts

of money from the retail sector as sufficient reasons to correctly conclude that

Permira was going to buy Debenhams at too low a price.

“Before we entered the process, there was little incentive for Permira to revise is

price, even though some institutional shareholders were expressing concerns”13


31

Philippe Costeletos starts his new job at the Texas Pacific Group

Philippe Costeletos started his new job at the Texas Pacific Group on the 19th

May 2003. He had responsibility for leading the retail industry sector at the Texas

Pacific Group in their London office. Philippe seized the opportunity to put

together a competing bid for Debenhams. He had a differential view of both the

company and sector in mind that would allow him to create additional value in a

take-private of Debenhams. Crucially, he also had in mind a plan to catch up on

the months of due-diligence that Permira had already completed. Ultimately,

Philippe Costeletos would be the lead partner for the transaction and would earn

himself and his company European Buyout of the year for this transaction.

Baroness Persuades Debenhams to Pay for Due-diligence

Philippe’s decision to ask for due diligence to be paid was a crucial one. He was

new in his job at the Texas Pacific Group and had to establish the credibility to

persuade his investment committee that his differential view was worth exploring

and Debenhams that this was worth paying for.

“… Given how far ahead the competitors were in the process, we couldn’t justify

going out of pocket with the diligence costs, so we asked to be compensated for

it. This wasn’t something that had been done before, but we felt it was the only

way to move forward. As a result, the advisors were able to add some competitive

tension to the sales process and ultimately a much higher price for

shareholders.”14

Philippe’s ability to persuade his investment committee that he would be able to

catch up due diligence work was aided by UK competition law which, as long as

his team asked for same questions as the Permira team, meant that he would

receive the same information as Permira. Nonetheless to persuade the investment


32

committee that this could be done was brilliant and only matched by his ability to

deliver on his promise to catch up with Permira.

In order to add competitive tension to the bidding process, Debenhams agreed to

pay £1.06m per week to Baroness to conduct due-diligence on Philippe’s

differential view of Debenhams future potential and prospects. Details of this

inducement fee15 are contained in the Laragrove offer prospectus. The

inducement fee of £8.5m would compensate Laragrove and Baroness should a

higher bid be accepted. This feature also provided up to £6m for CVC and TPG

to conduct due diligence on Debenhams over a period of five weeks. This fee,

limited to 1% of any offer for Debenhams, also provided an additional

disincentive of up to £23m for any other bidder to enter the bidding race for

Debenhams.

BARONESSES DIFFERENTIAL AND MORE VALUABLE VIEW OF THE BUSINESS

Baroness ultimately had a differential view to Permira that resulted in a higher

valuation and bid for Debenhams. This differential view was based on a more

optimistic view than the market of the UK retail sector and that the Debenhams

business could be more effectively managed under a new set of managers. This

differential view was crucial to Philippe and Baroness pursuing a bid for

Debenhams:

“We were working on a different plan [than Permira]. If we didn’t have our own

strong management team and investment thesis, we wouldn’t have bid.”

15 Recommended Cash Offer by Laragrove Limited for Debenhams (UBS Investment Bank, 04/08/2003),

p12

33

A Different View of the Sector

A financials markets at the time had concluded correctly that at best that the

department store retail market in the UK was flat. The large-mixed goods retail

sector, although the fastest growing segment, was only growing at a compounded

annual growth rate of 3.7% between 2000 and 200316. Analysts were worried that

consumer spending was going to hit the wall in the UK. Baroness took a different

view by looking to the USA, which was ahead of the UK in the economic cycle.

From this they concluded that the UK consumer would get used to living with

higher levels of debt. At worst a slow down was predicted but not a sudden fall in

consumer expenditure and therefore in the prospects of Debenhams. Indeed,

Debenhams had a better track record and stronger growth prospects than its

competitors.

100103

109

116121 123

127

100

110

120

130

1998 1999 2000 2001 2002 2003 2004

All Retail Sales Mixed Goods Retailers Large Mixed Small Mixed

Figure 9: Relative Performance of UK Mixed Goods Retailers by Size (UK Office of National Statistics)

A Better Management Team

Baroness also believed that they had a management team that would be better

than the incumbent managers at Debenhams. The senior management team that

16 Office of National Statistics

34

Baroness proposed is shown in Figure 12: Baroness Bids Senior Management

Team below. Rob Templeman, Michael Sharp, and John Lovering - who turned

around Homebase and Halfords were employed to turn around Debenhams.

John Lovering, assumed the part time role of Chairman of Debenhams in

addition to his duties as a Director of Baroness Retail. Ordinarily one would

question the validity of this argument as the existing management were skilled,

experienced, and knowledgeable about the Debenhams business. This should

have given the Laragrove bid an edge.

John LoveringChairman

Rob TemplemanCEO

Chris Woodhouse FD

Michael SharpCOO

Nigel PalmerRetail Ops Dir.

Nikki ZambleraHR Director

Figure 10: Baroness Bids Senior Management Team

However, the three senior members of the executive management team that were

brought onboard were very strong indeed. They had over seventy years of retail

experience between them at the time of the 2003 Acquisition (see Appendix G:

Directors Details). Both Rob Templeman (CEO) and Chris Woodhouse (CFO)

had worked together during the turnarounds of Homebase and Halfords. They

both have a reputation for being able to grasp the details of the business,

resulting in a deeper understanding of the business. Michael Sharp (COO) was

the effective number two to CEO Terry Green when Debenhams demerged

from Burton in early 1998. At the Burton Group, Michael was regarded as one of

35

the strongest operators in the Burton Group. He is also the former Managing

Director of Principles.

Ultimately this gave the Baroness team the experience, credibility, and fresh

perspective that allowed them to demonstrate additional value from their

management team vis-à-vis the incumbent management team backed by Permira.

Indeed, the lead buyout partner from the Texas Pacific Group stated that “For us

to really gain conviction in this deal, we just referred back to the [management’s]

track record of success”17

THE FIRST BARONESS BID FOR DEBENHAMS

Debenhams decision to invest in due-diligence by Baroness was validated and

rewarded with a £4.55 conventional cash offer. This cash offer was made with

the option for Debenhams to convert this bid to a scheme of arrangement.

Ultimately, Debenhams exercised the option to use a scheme of arrangement.

Capital Structure of the Debenhams Transaction

The capital structure of the holding companies that formed the Baroness bidding

consortium was organized in a tax efficient manner. The proposed capital

structure of the transaction is shown in Figure 12: Baroness Capital Structure for

the 455p bid.

This capital structure was used to enable Baroness Consortium members to be

able to recoup money from the transaction in a tax efficient way. The consortium

provided an equity injection of £599,000,000 in a limited partnership Baroness

Group LP. This limited partnership owned Baroness Group Holdings. The


36

equity investment was protected from possible dilution in further rounds of

investment by using deep discounted bonds (called the senior credit facility) that

were held by Baroness Group Holdings. Baroness Holdings UK is a wholly

owned subsidiary of Baroness Group Holdings and owns a number of

intermediate companies. These intermediate companies own Baroness Retail Ltd.,

the bidding vehicle for the transaction. Debt used to finance the transaction along

with the proceeds from the aforementioned equity injection would be used to

buy Debenhams.

As with the Laragrove bid, the original financing package included a senior facility

with a mezzanine bridge funded by a high-yield bond. The bank consortium

consisted of Credit Suisse, Merrill Lynch, Morgan Stanley, and Citigroup. The

debt used to finance the transaction, unlike the deep discounted bonds, were

placed close to the assets Debenhams and its collaterisable property. Three types

of debt were used. A senior facility of variable rates at different premiums to

LIBOR and of varying terms constituted the bulk of the money that would be

used to finance the transaction. This facility also included a multi-currency

revolver to enable efficient running of the business. A bridge facility secured

against the freehold and long leasehold properties of Debenhams provided a

cheaper source of interim finance. Finally, there was a high yield component on a

short-term basis that provided the remainder of the finance. Most of the debt was

raised as a high yield debt because “The high-yield market was more liquid than the

market for mezzanine debt. It had a deeper investor pool, meaning you could raise more.”

[Brian Gray, Freshfields Partner18]

18 Cushnie, L. “Debenhams’ return to the LSE ensures saga ends well for all” The Lawyer, Vol. 20 Issue 18

(8th May, 2006), 13-13

37

Funds advisedby TPG(37.9%)

Funds advisedby CVC(37.9%)

Funds advisedby MLGPE

(15.4%)

Management

(8.8%)

Baroness Group LP

Baroness GroupHoldings

BF VI

Baroness Retail Ltd.

Debenhams Ltd.

Senior CreditFacility

Term £566mRevolver £125m

BaronessHoldings UK

BF I

BF II BF IV

BF III

BF V

MezzanineFacility£300m

BridgeFacility£354.7m

Deep DiscountedBonds

A = £289.4mB = £165.8mC = £165.8mTotal = 621m

Equity of £599,000,000




(15.4%)

Management

(8.8%)

Baroness Group LP


BF VI


Debenhams Ltd.



BaronessHoldings UK

BF I

BF II BF IV

BF III

BF V




A = £289.4mB = £165.8mC = £165.8mTotal = 621m

Equity of £599,000,000

Figure 11: Baroness Capital Structure for the 455p bid

38

BARONESSES USE OF A SCHEME OF ARRANGEMENT19

A scheme of arrangement (section 425 of the Companies Act 1985) is a court-

based procedure that is announced in the same way as a conventional offer.

However, instead of the target’s shareholders receiving an offer document the

shareholders receive a scheme document instead. This scheme document

contains notice of a shareholders’ meeting to approve the scheme and any other

resolutions that required for its implementation. For example, resolutions are

often required to approve the reduction in capital of the company.

Schemes of arrangement have traditionally been considered as being a

cumbersome and inflexible alternative to a conventional offer for companies that

are being taken private. They have both advantages and disadvantages that make

their use on balance make their use increasingly desirable in private equity

transactions.

Advantages

A lower acceptance threshold is required to acquire the company. Under a

conventional offer the bidder can only acquire the minority shares once the bid

has been accepted by 90% of the shares. A scheme of arrangement has a much

lower threshold of only 75% of the shares that vote at the meeting! It also less

likely that the bidder will be left with having to placate the interests of minority

shareholders.

Stamp duty savings (of 0.5% of the offer value) on the acquisition of the targets

shares can be made by adopting a cancellation scheme of arrangement. This

19 Compagnoli, M. and MacDougall, M. “UK switches on to schemes of arrangement: 2005 Guide to Private

Equity” International Financial Law Review, Vol. 24, p72-75

39

involves the cancellation of all shares in the target by a reduction in the targets

capital, followed by an issue of new shares to the bidder.

Share options are triggered with a conventional offer that allows minority

shareholders to exist post the transaction. If a scheme is used this problem can

be negated as these share options will be triggered at the moment the scheme

becomes effective.

Under a conventional offer, the bank has a higher degree of financial risk because

the bank can avoid any risk that the bidder will not wholly own the target and

that this situation will occur more quickly. Under a scheme of arrangement debt

can be secured on the assets of the target immediately after the scheme has

become effective.

Disadvantages

The scheme of arrangement is a court based procedure and is subject to the

timetable of the court. In contrast, a conventional offer requires only the majority

acceptance of shareholders to accept the deal in order for the bidder to obtain

control.

In order for the Baroness Retail Consortium to gain control of Debenhams they

needed to gain the approval of 70% of the voting stock of the company. On the

day of the approval of the scheme of arrangement the major shareholders were

Prudential (12.5% of the voting shares), Schroder Investment Management Ltd.

(11.51% of the voting shares), and CGNU plc. (4.79% of the voting shares).

Together, these companies represented 41% of the votes needed to pass the

scheme of arrangement if all shares were voted. Their acceptance of the deal was

critical to the scheme’s approval.

40

Market purchases prior to the shareholders meeting are excluded from the shares

that are able to vote on acceptance of the bid. Such purchases are often at a lower

price than the final bid price and allow the bidder to be more confident that their

bid will be accepted. However, should the bid fail the bidder will not be left with

shares in the company that would need to sell at a potential loss.

It is more difficult to obtain irrevocable undertakings from shareholders to accept

the bid prior to the shareholder meeting that accepts the scheme. There are

complex legal issues that arise regarding potentially different classes of shares.

Conclusion

It is now common for banks, when arranging finance, to provide loan

documentation with the transaction structured as a scheme of arrangement and as

a conventional bid. During hostile or competitive bids conventional offers

provide a higher degree of flexibility for the target to achieve a higher price. Once

the bid has been accepted or if the bid is friendly and uncompetitive the bid can

revert to a scheme of arrangement. Such a structuring of the deal has a number of

advantages for private equity transactions. This was evidential in the take-private

of Debenhams by the Baroness Retail Consortium.

Latest time for lodging blue forms of

proxy for the Court Meeting

11:00 am on 8 November 2003

Latest time to lodge pink forms for the

Debenhams EGM

11:15am on 8 November

Voting record time 6:00 pm on 8 November

Court Meeting 11:00 am on 10 November

Debenhams EGM 11:15 on 10 November

41

First Hearing Date (to sanction the

Scheme)

28 November

Hearing Record Time 6:00 pm on 1 December

Second Hearing Date (to sanction the

reduction of capital)

2 December

Last day of dealings in Debenhams

Shares

3 December

Scheme Record Time 6:00 pm on 3 December

Effective Date of the Scheme 4 December

Delisting of Debenhams Shares 7:30 pm on December 5th

Latest date for dispatch of cheques 18 December

Table 3: Debenhams scheme of arrangement, expected timetable of principal events, 3rd November 2003

PERMIRA’S CONSORTIUM STARTS TO DISSINTEGRATE

After Baroness had tabled the £4.55 bid for Debenhams there was disagreement

in the Laragrove consortium about how high they could go without overpaying.

Ultimately, Laragrove had a different (and lower value) view about Debenhams

prospects. This differential view arose from a different view about the

performance of the retail sector in the UK and the performance of the

management team.

42

Permira was relying on the existing management team, whereas Baroness was

relying on a new management team.

Goldman Sachs had the most conservative view of Debenhams prospects and

began to have cold feet. As the Laragrove team and bid began to waiver,

Baroness strengthened its team by recruiting Merrill Lynch Private Equity.

Baroness then took the unusual decision to up its bid to £4.75. Philippe explained

this rational as follows:

“We knew we had to move fast. We were starting to hear that Permira was trying

to get more banks on board to put in a higher offer. It’s not easy to submit a bid

over your own, but we felt their consortium was starting to waiver, and we went

in with the new bid when we felt we had the best advantage.”20

THE SECOND AND FINAL BARONESS WINNING BID

The Revised Baroness Bid

The revised bid of £4.77 was 4.8% higher than the previous high Baroness bid

and proved to be the difference between the consortiums bids and at a bid level

that provided the transaction with a very good expected return on expected risk21.



43




(15.4%)

Management

(8.8%)

Baroness Group LP


BF VI


Debenhams Ltd.



BaronessHoldings UK

BF I

BF II BF IV

BF III

BF V




A = £289.4mB = £165.8mC = £165.8mTotal = 621m

Equity of £607,534,661




(15.4%)

Management

(8.8%)

Baroness Group LP


BF VI


Debenhams Ltd.



BaronessHoldings UK

BF I

BF II BF IV

BF III

BF V




A = £289.4mB = £165.8mC = £165.8mTotal = 621m

Equity of £607,534,661

Figure 12: Baroness Capital Structure for the 477p bid

44

The Financing of the Debenhams Winning Bid

The financing structure of the winning £4.77 bid was nearly identical to the

previous £4.55 bid by Baroness. The new bid required an additional £7.5m of

equity from the consortium in order to maintain the same leverage ratio of

~67%. The remainder was financed through an increase of £25m in the

mezzanine facility and £5m in the term portion of the Senior Credit Facility.

Transaction Sources and Uses

Baroness committed £608 million of equity to the purchase of Debenhams. The

transaction had an enterprise value of £1868 million with additional costs of £40

million incurred. This represents a leverage ratio of 67%.

Sources Uses Term loan - A 289.4 Purchased equity1 1740Term loan - B 165.8 Debt refinanced2 128Term loan - C 165.8 Other3 40Deep discount bonds 606.3 Bridge facility 354.7

Mezzanine facility 325.0 Ordinary equity 1.0 Total 1908 1908

Table 4: 2003 Acquisition: Transaction Sources and Uses (£m)

Notes

1. Baroness Retail Consortium paid £4.7 per share. At 11:15am on the 10th

November, 2003 the scheme of arrangement was approved. At this time

there were 370,180,593 issued shares. This represents a purchased equity

value of £1.74bn.

45

46

2. On the 30P

thP August 2003, Debenhams had £127.8m of net debt

outstanding. This figure represents an estimate of the net debt

outstanding at the time of the transaction.

3. The remainder is expected to consist primarily of transaction fees relating

to the transaction and variation in the amount of the net debt

outstanding.

Interest Rate Risk Mitigation Plan

Hedging contracts were entered into that would protect a substantial portion of

the interest costs of the debt used to finance the acquisition. It was the intention

of Baroness to refinance most (if not all) of the acquisition debt within a short

timeframe after the acquisition. So variable rate debt and hedging contracts were

used to mitigate exchange rate risk rather than the use of fixed interest rate debt.

THE TRANSACTION PREMIUM PAID BY BARONESS

The 2003 Acquisition price paid by Baroness was far in excess of the net asset

value of Debenhams and represented a substantial premium to the NAV and the

pre-offer and alternative offer prices for Debenhams. The stock price for

Debenhams is charted in HTUAppendix A: Pre-2003 Acquisition Stock PriceUTH from the

9P

thP May 2003, which was the last closing price before the announcement of a bid

by Laragrove, too the 4P

thP December, which was the last closing price before

Debenhams shares were delisted from the London Stock Exchange. Baroness

Retail was required to pay the following premiums to acquire Debenhams:

The final Laragrove bid price: U10.6 percent higherU than the £4.25 price

per share announced by Laragrove on the 29P

thP July 2003.

47

The pre-bid speculation price: U83.6 percent higherU than the £2.56

closing price per share on the 8P

thP April 2003. This was the last closing

price prior to the announcement of a possible offer for Selfridges plc.

This announcement started speculation that Debenhams would also be

made an offer.

The last business day before Laragrove’s first offer on the 12P

thP May:

U42.0 percent higherU that the May 9P

thP 2003 closing price of £3.31 per share.

The six-month average closing price prior to bid speculation: U66.6

percent higherU than the average six-month closing price prior to May 9P

thP,

2003 of £2.82 per share.

The lowest closing price in the six-month period prior to bid

speculation: U87.3 percent higherU than the lowest price paid per share of

£2.51 in the six-month period prior to bid speculation.

Figure 13: Nectar Rewards Partner

48

C h a p t e r V I : B a r o n e s s e s I n v e s t m e n t i n D e b e n h a m s

FINANCING ACTIVITIES DURING PRIVATE OWNERSHIP

Summary

The financing activities during public ownership where designed to accomplish

several aims. The first was to release quasi dividends to Baroness in the form of

cash. The second aim was to replace expensive debt with less expensive debt

(Appendix E: Effective Interest Rates). Finally, the debt structure of the business

was altered to move debt away from assets, as was the case at acquisition, to the

group level in order to prepare the company for an eventual IPO (Appendix D:

Funding Debt – UK GAAP). This would allow Baroness to achieve an exit on

their investment. These financing activities are described below.

Pre-Take Private

Pre take-private, Debenhams debt included only bank overdrafts and lease

obligations. These totaled only £146m at the 30th August 2003.

4th December 2003: Acquisition Financing

Please see section on financing the winning bid Chapter V: How Baroness Won

The Bid: The Second and Final Baroness Winning Bid: The Financing of the

Debenhams Winning Bid)

Immediate Post Acquisition Financing

Post acquisition financing was concerned chiefly with refinancing higher interest

rate bridge and mezzanine facilities with mortgage and high yield facilities

respectively. In total over half of the acquisition debt, ~£700m, was refinanced

out of a total acquisition debt of ~£1.3bn. These actions marginally reduced the

49

effective interest rate of the debt used to acquire Debenhams and moved debt

further away from Debenhams Ltd.

April 23rd 2004: Refinance of Bridge with a Mortgage Facility

The bridge facility, at an interest rate of 6.5%, was an interim facility and was

refinanced by a mortgage on properties held by BF Properties (No. 3) Ltd. The

facility was due in 2011 and has an effective interest rate based on LIBOR of

6.5%

2004: Refinance of Mezzanine Facility with a High Yield Facility

The £325m mezzanine facility at an interest rate of 10.5% was an expensive

facility that constituted one of the principal components of the 2003 acquisition

financing. This was refinanced by a high yield term facility of £209m at an

interest rate of 10.5% due in 2012 and a 172 million euro facility at 9.5% also due

in 2012. The costs of this refinance were also expensed immediately.

Balance Sheet at the 28th August 2004

Both the mortgage facility, although secured against freehold and long leasehold

assets, and the high yield senior note facility ensured that debt was moved away

from the core Debenhams business and towards Baroness Holding UK Ltd. See

(Figure 15: Capital Structure at the 28th August 2004). This prepared Debenhams

for an eventual IPO and made it easier for Baroness to receive a dividend in a tax

efficient manner from Debenhams. Because the senior note debt was moved

further away from the cash generation of Debenhams Ltd. The banks were taking

on additional risk in issuing this debt. Baroness was able to achieve the

mezzanine refinancing due an improvement in the cash generation capacity of the

Debenhams business. This was the result of the first stage in the Baroness plan to

improve the financial and operational performance of the Debenhams business.

50

Debenhams managed its exchange rate risk by holding a number of interest rate

swaps at between 4.9% and 6.0% interest to a total value of £939m.

51

Funds advisedby TPG

Funds advisedby CVC

Funds advisedby MLGPE Management

Baroness HoldingsUK Ltd.

Intermediate ParentCompanies

BF III

Issuer (DebenhamsFinance Holdings plc)


Senior Notes

Debenhams Ltd.

OtherSubsidiaries


Services

DebenhamsGift

Vouchers Ltd.


DebenhamsRetail plc


Mortgage Facility

Baroness Group LP

DeepDiscounted

Bonds

Funds advisedby TPG

Funds advisedby CVC

Funds advisedby MLGPE Management

Baroness HoldingsUK Ltd.

Intermediate ParentCompanies

BF III

Issuer (DebenhamsFinance Holdings plc)


Senior Notes

Debenhams Ltd.

OtherSubsidiaries


Services

DebenhamsGift

Vouchers Ltd.


DebenhamsRetail plc


Mortgage Facility

Baroness Group LP

DeepDiscounted

Bonds

Figure 14: Capital Structure at the 28th August

52

The Dividend Payment and Preparing for an IPO

February 22nd 2005: The British Land Sale-and-Leaseback Transaction

Debenhams management had already separated the real estate assets from the

operating company. In February 2005, Baroness completed a sale-and-leaseback

of 23 freehold and long-leasehold Debenhams stores to British Land. Profits

from the £495m deal were used to pay down debt (the mortgage facility), formed

part of a dividend that was paid to Baroness alter in the year, and provided cash

for Debenhams to expand.

May 16th – June 23rd2005: The 2005 Acquisition and Refinancing

The 2005 Acquisition and refinancing was a vehicle for Baroness to recover a

£1.3bn dividend payment from Debenhams. £1,196m was paid to the sponsor

consortium and £84m was paid to management and employees. Effectively a new

leveraged buyout occurred whereby the old company, Baroness Group Limited

Partnership was dissolved and replaced by a new company Debenhams Retail

Holdings Limited. £589.2m of equity was invested in the same proportions as

before by the consortium and £1.82bn of senior term loan debt was raised. This

debt was held further away from the cash flows generated by Debenhams Ltd. By

Debenhams Retail holdings Limited, which refinanced new loan, notes held

Baroness Group Holdings. These loan notes were no longer needed as this

refinancing not only delivered a £1.3bn dividend payment but also gave the

group the necessary capital structure to prepare for an eventual IPO.

Freshfields Bruckhaus Deringer advised Debenhams on the £2.05 billion

refinancing of its third-party and shareholder debt and on the related corporate

restructuring22. CSFB, Citigroup, Merrill Lynch and Morgan Stanley acted as lead

22 “Banking and Restructuring” International Financial Law Review, Vol. 24 Issue 7 (July 2005), 13-13

53

arrangers for the syndicated loan facilities23. Shearman and Sterling advised the

lead arrangers24.

The market had some concerns about the amount of cash that Baroness was

taking out of Debenhams. Their concerns regarding the leverage and pricing of

the refinancing are detailed below in a European Venture Capital Journal article

of the time.

“Leverage is aggressive for a company operating in the notoriously difficult UK retail market and

some lenders have expressed concern that second lien pricing is too fine, especially as the

recapitalisation will see £800m of equity removed from the company.”25

The Balance Sheet at the 3rd September 2005is shown in Figure 24: Capital

Structure at the 3rd September 2005.



25 M. Brizard, “REFINANCINGS” European Venture Capital Journal, 123 (June 2005), p25-26

54




(15.4%)

Management

(8.8%)

Debenhams RetailHoldings Limited


IntermediateCompanies


Debenhams Ltd.

BaronessHoldings UK

Loan NotesB = £50.1m

C = £22.3m (BELP)Total = 589.2m

Equity of £589.2m

Senior TermLoan

£1.82bn




(15.4%)

Management

(8.8%)

Debenhams RetailHoldings Limited


IntermediateCompanies


Debenhams Ltd.

BaronessHoldings UK

Loan NotesB = £50.1m

C = £22.3m (BELP)Total = 589.2m

Equity of £589.2m

Senior TermLoan

£1.82bn

Figure 15: Capital Structure at the 3rd September 2005

Final Preparations for an IPO

April 19th 2006: The ‘New Credit Agreement’

Once IPO’ed Debenhams would become a FTSE250 company. FTSE250

companies reach a different investor base and so Debenhams was able to secure

better funding levels from the banks prior to its IPO. The New Credit

Agreement provided senior facilities up to £1,350m. This consisted of a £1,050m

55

term loan and a £300m multi-currency revolving facility. “They hit the market with

perfect timing to get as much from the debt as they could” [Brian Gray, Freshfields Partner26]

The proceeds were intended to refinance the existing package of debt and

included the early repayment of a second lien. The new credit agreement was

entered into with The Royal Bank of Scotland, the Governor and Company of

the Bank of Scotland, Lloyds TSB Bank, and Barclays Capital. The refinancing

prepared Debenhams for a near term IPO by making sure that the loan

documentation included sophisticated qualified public offering provisions.

PERFORMANCE IMPROVEMENT

The Baroness strategy is fundamentally a relatively simple and classic strategy:

Baroness bought an underperforming business whose industry and business

prospects were undervalued by the financial markets. Baroness immediately

improved the operational effectiveness of the business and adjusted the portfolio

of what was being sold to higher margin and higher growth segments whilst

taking cost out of the business by reducing non-core activities, investments, and

negotiation. These improvements then create new growth opportunities that were

exploited through the use of cash flow generated from improvements. The result

is a more profitable business that is valued at a higher multiple because of its

improved prospects. By leveraging the equity investment higher returns were

achieved than through the use of all equity financing.

26 Cushnie, L. “Debenhams’ return to the LSE ensures saga ends well for all” The Lawyer, Vol. 20 Issue 18

(8th May, 2006), 13-13

56

Baroness essentially set about transforming the operations of Debenhams. They

did this by transforming Debenhams business model from a cost heavy ‘high-

CAPEX, low-growth’ model to a more cost-efficient ‘high-growth, low-CAPEX’

model. This released cash to invest in growing the business.

The next chapter will seek to expand on and quantify the sources of value that

the Debenhams management team and Baroness created at Debenhams.

57

C h a p t e r V I I : T h e D e b e n h a m s I P O a n d T h e P e r f o r m a n c e o f t h e B u y o u t

OPERATIONAL EQUITY RETURNS

Sales Growth (£213m equity gain)

Although the market declined between 2003 and 2005, from £13.8bn to

£13.3bn27 (see figure below), a 3.6% reduction. Debenhams was able to increase

its market share of the UK department store market from 15.3% to 18.6% during

the same period28. Market share gains accounted for a £213m increase in the

equity value of Debenhams over the period of the transaction (see Appendix H:

Source of Deal Value Creation) and produced a 35% return on equity for the

sponsor consortium. A number of initiatives were pursued in order to achieve

these impressive gains.

11.812.912.312.112.112.813.413.813.713.3

1111121213131414

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

E

0%5%10%15%20%

Market Value (£Bn) Debenhams Market Share

Figure 16: Debenhams: UK Department Store Sales (Source: Company data)



58

2 4 8 13 83 143 208 266 324450

0

100

200

300

400

500

1996

/97

1997

/98

1998

/99

1999

/00

2000

/01

2001

/02

2002

/03

2003

/04

2004

/05

Targ

et

Value (£M)

Figure 17: Debenhams: Designers at Debenhams Sales (Source: Company data)

75 76 76 74 72 70 75

25 24 24 26 28 30 25

2000 2001 2002 2003 2004 2005 Target

Own Bought Concessions

Figure 18: Debenhams: Bought versus Concessions Mix (Source: Company data)

59

Figure 19: Debenhams 2006 Brand Mix (Source: Company data)

Figure 20: Debenhams Brands Appeal versus the competition

60

Other Initiatives – Beating the sector average

Debenhams has actively promoted and enhanced the position of its own brands

and has increased its customer differentiation versus its competitors (Figure 20:

Debenhams Brands Appeal versus the competition). This along with a logical

extension of product sold through its designer range (and additional designers)

has enabled and increase in sales performance.

International Expansion

The opportunity to expand internationally was first presented to Debenhams by

the long-established, Kuwait-based Alshaya Group. The Alshaya Group is a

company with a wealth of experience in the retail sector of the Middle East and

an understanding of western retailing.29 In 2001, the Alshaya Group was

operating four hundred franchise outlets in seven Middle Eastern countries and

was a leading operator of international brands. They had franchise agreements

with Mothercare, Liz Claiborne, Next, River Island, Etam and Clarie’s

Accessories.30 Continued partnership with companies such as the Alshaya group

drives top-line growth and moves the business down the experience curve

through creating an increased bargaining power vis-à-vis suppliers.

Margin Improvement (£439m equity gain)

Reduction in Overhead and Increased Store Efficiency

Head office overhead reduced is likely to have been reduced as a proportion of

sales. Head office headcount has remained constant despite an increase in gross

transaction value31.

29 J. Glynis, “Taking Debenhams International,” European Retail Digest, Issue 36 (Dec2002), p22-25

30 “Exploring the Middle East as a Region of Retail Excellence conference proceedings,” World Class Retailing, 30-31 (October 2001)

31 Company data.

61

Store efficiency was increased through the achievement of improved lead times,

flexing space to be responsive to changing customer fashions and by ensuring

that high traffic floor space is used to sell higher margin product. Historically

Debenhams was part of the Burton group and much of its floor space was

devoted to selling those products, which was lower margin concession product.

Selling a more profitable mix of products

During private ownership, gross merchandise margin improved seventy basis

points from 42.2% to 42.9%. This was achieved through improved space

management in the stores, creating a differentiated and premium offering to the

customer (Figure 20: Debenhams brand appeal versus the competition), by

increasing the proportion of higher margin own brand rather than concession

products32 (Figure 18: Debenhams: Bought versus Concessions Mix), and by

increasing the mix of more profitable Designers at Debenhams sales (Figure 17:

Debenhams: Designers at Debenhams Sales).

Supply Chain Improvements

44.0%47.7% 49.0% 49.3% 50.0%

671579

434 380

260

40%42%44%46%48%50%52%

2001/02 2002/03 2003/04 2004/05 Target0

200

400

600

800

Mix of Top 30 Number of Suppliers

Figure 21: Debenhams Supply Chain Improvements

32 See Figure 18: Debenhams 2006 Brand Mix for a description of Debenhams major brands

62

The number of suppliers has fallen dramatically from 679 in 2002/03 to 380 in

2004/05. This has likely resulted in volume, transaction cost, distribution cost,

and payment term savings. However, the mix of the top thirty suppliers has only

increased from 47.7% to 49.3% during the same period. A consolidation of the

supplier base imposes additional risk to the business. Reducing the number of

smaller suppliers rather than increasing the concentration of the largest suppliers

has mitigated supplier concentration risk on the business.

A new distribution center has replaced several other smaller centers and can

provide additional capacity for future growth.

Sourcing from Low Cost Countries

Debnhams sources most of its merchandise by value from low cost countries. It

has adopted a sourcing strategy run on a country rather than supplier basis to

protect itself from political and macro-economic risks. This strategy has kept its

sourcing costs low.

Far East56%Europe

23%

Turkey10%

Indian Region

6%

Rest of World

5%

Figure 22: Debenhams use of sourcing from low cost countries

63

Figure 23: Designers at Debenhams

64

Improved Targeting of Customers

In October 2002, Debenhams joined a new loyalty card venture with non-

competing brands Sainsbury’s, BP, and Barclaycard. An independent company,

Loyalty Management UK, manages the venture. The take up of the scheme

exceeded all expectations and by Spring 2003 there were 11mn33 active cards in

use. Shared access to the customer database has provided Debenhams with more

accurate customer information. This has enabled Debenhams to more effectively

market itself and attract new customers. Consequently this has improved

mix/pricing and has helped to drive Lfl sales increases.

Cash Flow and Working Capital Improvements (£282m equity gain)

Cash Flow and Working Capital improvements generated a £282m equity gain

for the deal. Baroness was very effective in this area and acted very quickly to

achieve these gains.

When Baroness took Debenhams private, the new management team found that

7.2%34 of stock was terminal (Terminal stock is stock that has reached the end of

its selling season). Indeed, stock was lying around in non-shop floor areas of

stores gathering dust. The new management managed to achieve a five hundred

basis point reduction in terminal stock to only 2.2%35 at the end of the 2005

financial year. This was achieved through an immediate fire sale that cleared this

stock and generated some immediate cash for the business36.

33 Mintel, Department and Variety Store Retailing – UK (Retail Intelligence, June 2003), p84

34 Management Accounts



65

Management also took action to increase average creditor days. During the same

period average creditor days were more than doubled from 27 days to 60 days37

and had the effect of freeing both cash and working capital for the business.

Initiatives such as those described had the effect of freeing up a substantial

amount of working capital. Indeed before the take-private average working

capital was £25m38. At the end of the 2005 financial year average working capital

was reduced by £145m to £(120)m39.

NON-OPERATIONAL EQUITY RETURNS

The following presents a discussion of the non-operational equity returns for the

Debenhams deal. It is worth considering that multiple expansion will contain an

unknown proportion of gains that are caused by improved prospects in the

Debenhams business. These gains are the result of operational improvement

made by the Debenhams management team.

British Land Transaction ($315m equity gain)

This transaction provided a £315m (51% ROE) gain in the value of the

transaction on £600m+ of property transferred to British Land40. Any sale of

property assets that are necessary to conduct business should be reflected in

higher lease payments in future years. This should, all things being equal, reduce

future expected cash flows and cancel out the money made on this gain. See

limitations of value analysis later in this chapter.





66

Expenses (£421m equity gain)

Expenses were incurred to incentivise management. At £221m these are much

smaller than the operational value created in the business. Fees and expenses paid

to lawyers, bankers, and consultants totaled £200m are cost of conducting a

leveraged buyout. It would be easy to regard these as destroying value in a

business. However, I regard them as cost in facilitating a step-level change in the

performance of the Debenhams business. Whether, this could have been

achieved under public ownership with appropriately designed incentives is

questionable and is the subject of much debate in management literature.

Multiple Expansion (£595m equity gain)

Multiple expansion accounted for a £595m increase (97% ROE) in the equity

value of Debenhams. It is unclear the extent to which the multiple expanded as a

consequence of a rising market for buyouts. However, the Debenhams

management team was successful at demonstrating improved growth prospects

for the business. This has been achieved by creating new business sales growth

opportunities by improving the economics of new Debenhams stores so that they

can now be sited in smaller markets. These markets could not previously justify

the capital expense of a new store. In addition, the Desire by Debenhams new

store concept provides an exciting small store format that can tap new smaller

markets.

Reduced New Store CAPEX

New store CAPEX has been a major success story for the Baroness team. Capital

spending per square foot for new stores has decreased by 39.3% from £178 per

sq ft to £108 per sq ft. This has been achieved by reengineering the process of

investing in new stores. Debenhams states that this has allowed them to justify

expansion into smaller markets that would have otherwise have been

uneconomic. However, the difficulty of some of its major competitors such have

67

Alders, have allowed a large amount of store space to come onto the market at a

lower cost than in the past. Whether this is included in the calculation of new

store CAPEX is not clear and also makes comparisons across stores to

benchmark performance all the more challenging.

Desire by Debenhams

Desire by Debenhams operates on a smaller 20,000 sq ft footprint and sells

higher margin Debenhams products such as the Designers range, accessories, and

cosmetics. The store is aimed squarely at women who want to purchase

Debenhams products in their smaller local town. Such a concept, if successful,

promises to increase sales per square foot and lower the cost base of the entire

company through improved company buying power. However, with only three

stores in operation at the time of the IPO, this new store concept is still in its

early stages of proving its long-term viability.

The case for multiple expansion has largely convinced the financial markets.

However, in my mind the case is not so clear. I think that time will tell if new

stores that have undergone the new CAPEX program require refurbishment

earlier than before, if lease acquisition payments are included in new store

CAPEX and if Desire is a hit.

VALUE CREATED

The result of the Debenhams management team and Baronesses strategy was an

improvement in EBITDAR (EBITDA adjusted to include rent escalators from

the British Land transaction) during the period of private ownership from

68

£218.1m to £378.8m41 (see Figure 19: Debenhams EBITDAR performance).

This is a CAGR of 20.2%42.

218.1 254.2318.0

378.8

12.0%13.4%

15.2%16.7%

0

50

100

150

200

250

300

350

400

2003 2004 2005 2006e0%2%4%6%8%10%12%14%16%18%

Adjusted EBITDA % of GTV

Figure 24: Debenhams EBITDAR performance

The operational improvements achieved in the business are impressive. £934m of

value was created through improving the operational performance of the

Debenhams business. £479m of value was created in non-operational

performance improvements. This deal achieved a total increase in value of

£1,413m.

41 Company data

42 Company data

69

THE IPO TRANSACTION AT £1.95

On the 4th May 2006, Debenhams returned to the London Stock Exchange. This

partial exit (Baroness, management, and employees still held thirty eight percent

of the equity in Debenhams post IPO) allowed Baroness to release a further

£1.045bn in cash. Debenhams was very consistent in its financial outlook leading

up to the IPO and stated a few weeks before the IPO that “The prospects for

Debenhams' trading for the financial year ending August 2006 remain in line with

management expectations.”43 Citigroup and Merrill Lynch were the joint global

co-coordinators of the offer, while Citigroup, Merrill Lynch, Credit Suisse and

Morgan Stanley were the joint book runners for the offer.

P/E 12.8x

2006E analyst forecast of NI £131.2m

Implied equity value £1,675m

Analyst forecast of post IPO Net debt £1,200m

Enterprise value £2,875m

Primary issuance (includes fees) £700m

Selldown at IPO £345m

Total equity issuance at IPO £1,045m

Free float post IPO 62%

Implied value of initial investors equity

at IPO price

£975m

Less Selldown at IPO (gross) £345m

43 Debenhams press release.

70

Holding post IPO £630m

% Holding 38%Table 5: Interviews with Philippe Costeletos, lead buyout partner from the Texas Pacific Group

DEAL ECONOMICS

Sponsor

Consort um (4) i

Management

and Employees

(2)

Initial Investment (5th December 2003) £602m £6m

% Of company 86% 14%

Dividends at Recap (16th May 2005) £1,196m £84m (3)

Share of Selldown at IPO (5th May

2006)

£306m

Value of equity still invested (5th May

2006)

£529m

% Of company 32%

Fees (5th May 2006) £19m

Total Value from Investment (1) £2,012m

Multiple of Initial Investment 3.3x

Internal Rate of Return on Investment

(5)

98.0%

Table 6: Interviews with Philippe Costeletos, lead buyout partner from the Texas Pacific Group

Notes

71

1. This figure is net of IPO fees and includes the value of remaining stock.

2. Includes senior management and the Debenhams Retail Employee Trust.

3. Includes cash and Debenhams loan notes.

4. There were press reports of an immediate £130m dividend paid to

Baroness post take-private. However, this amount is not included in the

figures provided by the Texas Pacific Group.

5. Calculated using the XIRR function in Microsoft Excel. This function

discounts the cash flows on the exact date that they occurred.

The Baroness Retail buyout of Debenhams returned the sponsor consortium a

3.3x return on equity to investors at the IPO. However, at the time of the IPO,

twenty six percent of the total value from the investment was not in cash and was

in the form of Debenhams stock. This left this return vulnerable to fluctuations

in the stock price and was not as liquid a return as cash. Management and

employees total value from their investment of £6m was £221m. The internal

rate of return of 98.0% is much higher than a private equity firm’s normal

requirement of at least 35%. 2.5x returns were achieved through operational

improvements to the Debenhams business. The sources of these gains are

presented in Appendix H: Source of Deal Value Creation.

LIMITATION OF VALUE ANALYSIS

General

Such an analysis is dependent upon the information that is available to analyze

decisions taken by management and their results. No attempts has been made to

72

separate the results of actions taken by past management and either been enjoyed

or regretted by the buyout management team. In addition, short-term measures

that are presented as savings from long-term trends (and therefore value

enhancing) could prove to be false economies. And projections of future

performance based on one or two years of running may prove to be too

optimistic. These risks are inherent in such an analysis.

Return on Capital Employed is a better measure of value creation

The value analysis does not consider the return on capital employed in the

business. Over the course of private ownership by Baroness, considerable capital

was released from the business on a sale and leaseback basis. In order to get a

true measure of the capital employed in the business, the present value of future

lease payments needs to be recognized as a fixed asset in order to arrive at a true

and comparable value of the capital employed in the business.

Capitalizing Leases to arrive at ROCE

2003 2004 2005

Capitalised leases (IFRS) na na 3789.5

Operating leases (GAAP) 55.3 64.8 107.2

Scaling factor 52% 60% 100%

Estimated Capitalized Leases 1954.8 2290.7 3789.5

Capital Employed excluding goodwill 852.1 1015.8 536.5

CE excl. GW and incl. Est. Cap. Leases 2807 3306 4326

Gross Sales 1810 1903 2087

EBITDA/GS 12.0% 13.3% 14.7%

GS/CE 0.64 0.58 0.48

ROCE 7.8% 7.7% 7.1%Figure 25: Estimated ROCE analysis

73

The information needed to conduct this analysis is not included in sufficient

detail for me to be able to conduct a thorough analysis. For example, note 29 in

the IFRS statements details future lease commitments for 2005. However, figures

for 2003 and 2004 are not available under IFRS. The GAAP statements in note

27 provide summary operating lease commitments for 2003, 2004, and 2005.

However, using the GAAP figures as a scaling factor to arrive at a rough figure

for capitalized lease costs for other years could be misleading because of the size

and long-term nature of the deal vis-à-vis the other leases. In addition, freehold

properties would need to be removed from tangible fixed assets to arrive at a

better figure for capital employed in the business. Taking a rough figure using a

scaling factor for leases and not including goodwill, ignoring property price rises,

or removing freehold fixed assets, capital employed in the business increased

from £2,807m in 2003 to £4,326m in 2005.

Value would have been destroyed, as ROCE would have declined over the period

from 7.8% to 7.1%. In effect, the gains from operational improvements would

have been negated by the increase in the capital employed in the transaction from

the British Land transaction (see Appendix I: Debenhams Estimated ROCE

Analysis). The results from this analysis however are not conclusive and more

information is required to obtain a more accurate figure for capitalized lease

costs.

Ignoring the British Land Transaction

Ignoring the impact of the British Land transaction, I can proceed as follows.

Asset Turnover: Excluding property transaction, I believe that through working

capital reduction and reductions in the CAPEX required for new and refurbished

stores and ignoring goodwill, that asset turnover should have increased over the

period of private ownership.

74

EBITDA Margin: During the period of private ownership, adjusted EBITDA

margin increased from 12.0% by three hundred and eighty basis points to

15.8%44.

From this analysis, I conclude that (excluding the property transaction) return on

capital employed in the Debenhams business has risen during the period of

private ownership.


75

C h a p t e r V I I I : C o n c l u s i o n

The Debenhams case is an important case to analyze. The deal won European

Buyout of the year and was the Texas Pacific Groups fourth largest ever

investment45. It is also an interesting case because of the contrarian view that

Philippe Costeletos took in the first few weeks in his new job at the Texas Pacific

Group. The innovative tactics used at key decision points during the bid process,

performance improvement of the business, and exit have made this a fascinating

case to explore as a case study. I believe that from this case that I have learnt

more about how it is possible to take an original view on a business and to have

the courage, commitment, and integrity to get others to back that idea.

Ultimately, this has allowed tremendous value to be created in the business that

has benefited not only the private equity firm but also Debenhams customers. My

only regret is that I could not continue to answer some of the following

questions:

SUGGESTIONS FOR FURTHER ANALYSIS

Quantify the impact of the British Land Transaction on ROCE

It is clear that Baroness has made a healthy return from their investment. In

addition management operational improvements to the business have

demonstrably created operational value in the Debenhams business. However,

before I can conclude that value has been created in the Debenhams business I

would like to know more about the long-term financial impact of the British

Land transaction. Additional information is needed to allow for lease costs to be

capitalized on a common basis. This would be an interesting further piece of


76

work and would validate the incredible achievement that the Baroness group and

Debenhams management made in creating value in the Debenhams business.

Sources of Multiple Expansion

Multiple expansion was responsible for £595m of equity gain in the deal. This is

one third of the total equity gain in the deal. To what extent is this multiple

expansion due to improved growth prospects in the business due to the new low

CAPEX high margin strategy and the new Desire by Debenhams sotres? And to

what extent is this multiple expansion caused by the rising tide of equity prices

and appetite for private equity deals during this period?

Bid Dynamics

What were the bid dynamics and strategies employed by Baroness and Laragrove

and what was the thought process behind critical decisions that were made during

the key decision points during the deal?

How did Philippe Costeletos persuade key stakeholders to back the bid?

How did Philippe Costeletos persuade the investment committee, the banks, and

the new management team to join the bid? What was it that made him more

effective than his counterpart at Laragrove? What were the special challenges that

Philippe had to overcome as a new joiner at the Texas Pacific Group.

77

GLOSSARY

Acquisition. The acquisition in 2003 of Debenhams by a group of funds managed or advised by CVC, MLGPE and TPG, other institutional investors and by management and the related delisting from the London Stock Exchange

Adjusted EBITDA. Adjusted EBITDA is calculated as operating profit before deemed disposal of subsidiary and before exceptional items (which includes amortization of landlord and developer contributions received) plus depreciation of tangible fixed assets and amortization of intangible assets and profits or losses on the disposal of fixed assets where these are included in operating profit and includes an adjustment for a rent expense that would have been incurred if the British Land Transaction had been complete for the full duration of the reporting period

Admission. The admission of the ordinary share capital of the Company, issued and to be issued pursuant to the Offer, to the Official List becoming effective

APR. Annual percentage rate

Baroness Senior Credit Agreement. The Credit agreement dated 25 April 2005 among inter alia Baroness Retail Limited, Debenhams Limited, Debenhams Retail plc, Debenhams Properties Limited, Debenhams Card Handling Services Limited and Debenhams Gift Vouchers Limited as guarantors

Baroness Senior Credit Facilities. The aggregate principal amounts provided pursuant to the Senior Credit Agreement

Board. The board of directors of the company

bps. Basis points

British Land. The British Land Company PLC

British Land Transaction. The February 2005 transaction with British Land (indirectly through its wholly owned subsidiary Delta Retail Properties Limited) acquired an interest in the companies owning 23 Debenhams freehold and long leasehold department store buildings that were freehold or subject to leases to Debenhams

78

Citigroup. Citigroup Global Markets Limited

Combined Code. The corporate governance code issued by the Financial Reporting Council

Company. Debenhams plc

Competition Commission. The UK Competition Commission

CVC. CVC Capital Partners Group Sarl and its subsidiaries and affiliates

CVC Shareholder Group. Capital Investors 2002 Limited, Citi Europe co Invest LP, Citigroup Capital Investors Europe Limited, CVC Europe Enterprise (Cayman) LP, CVC Europe Enterprise (Domestic) LP, CVC European Equity Partners III LP, CVC European Equity Partners III Parallel Fund A LP and CVC European Equity Partners III Parallel Fund B LP

Debenhams. The Company and its consolidated subsidiaries and subsidiary undertakings from time to time

Demurrage. The period of detention of stock beyond its scheduled item of departure from the dock

Department Stores. Department stores typically trade from a minimum of 1,000m2 and stock at least half a dozen different product categories, with one category unlikely to account for more than two thirds of turnover, and usually significantly less than this.

Directors. The board of directors of the company

Disclosure Rules. The rules relating to the disclosure of information made in accordance with section 73A of FSMA

EBITDA. EBITDA is calculated as Group operating profit before exceptional items under UK GAAP or operating profit before deemed disposal of subsidiary and before exceptional items under IFRS (both of which include amortization of landlord and developer contributions received) plus depreciation of tangible fixed assets, amortization of goodwill (for the purposes of UK GAAP) and other intangible assets and profits or losses on the disposal of fixed assets where these are included in operating profit

79

EBITDAR. EBITDAR is calculated as Group operating profit before exceptional items under UK GAAP or operating profit before deemed disposal of subsidiary and before exceptional items under IFRS (both of which include amortization of landlord and developer contributions received) plus depreciation of tangible fixed assets, amortization of goodwill (for the purposes of UK GAAP) and other intangible assets and profits or losses on the disposal of fixed assets where these are included in operating profit, plus property lease rental costs

EEA. European Economic Area

Employee Option Plan. The Debenhams Employee Option Plan approved by the remuneration committee of Baroness Holdings UK Limited on 2 September 2004

EU. The European Union

Exchange Act. United States Securities Exchange Act of 1934, as amended

Executive Directors. The Executive Directors of the Company

GE Consumer Finance. GE Capital Global Consumer Finance Limited

Global Coordinators. Citigroup Global Markets UK Equity Limited and Merrill Lynch International

Gross Transaction Value. Turnover or revenue on a gross basis, including the sales (excluding VAT) of concessions, rather than just the commission received from them

IASB. The International Accounting Standards Board

IFRS. International Financial Reporting Standards, as adopted for use in the EU

IRS. Inland Revenue Service

Joint Bookrunners. Citigroup, Credit Suisse, Merrill Lynch and Morgan Stanley

LIBOR. London Inter Bank Offered Rate

“Like for like sales growth” or “Lfl”. Growth in retail gross transaction value for stores that have been trading for 53 weeks of longer. Lfl is aggregated on a

80

weekly basis to the extent a store was trading throughout the same financial week during both years and is reported inclusive of value added tax

Listing Rules. The listing rules of the UK Listing Authority made under section 74(4) of the Financial Services Act and Markets act 2000 as amended from time to time

London Stock Exchange. London Stock Exchange plc

Merrill Lynch. Merrill Lynch International

Merrill Lynch Shareholders Group. Merrill Lynch Ventures LP 2001 and ML Global Private Equity Fund, LP

Mixed Goods Retailers. Mixed goods retailers are generally non-food generalist retailers. This is the smallest unit of analysis for which market information is readily available. There are three main types of business – department stores, variety stores, and catalogue showrooms. The last of these is very minor – Argos and Little woods are the only major players.

MLGPE. Merrill Lynch Global Private Equity or the Merrill Lynch Shareholder Group, as the context may require

Morgan Stanley. Morgan Stanley Securities Limited

New Shares. New Ordinary Shares in the capital of the Company of 0.01p each to be allotted and issued under the offer

Non-Executive Directors. The Non Executive Directors of the Company

Offer. The offer of New Shares and Existing Shares to institutional investors in the United Kingdom and elsewhere as described in Part 6 of the IPO prospectus.

Offer Price. The price at which each share is to be issued or sold under the Offer

Official List. The Official List of the UK Listing Authority

Over-allotment Arrangements. The arrangements pursuant to which the Stabilising manager may purchase from the Over-allotment Shareholders, or procure purchases for, the Over-allotment Shares

81

Over-allotment Option. The Option expected to be granted by certain of the Selling Shareholders to purchase, or procure purchasers for, additional Existing Shares as more described in Part 6 of the IPO prospectus

Over-allotment Shareholders. Those Selling Shareholders who, pursuant to the Underwriting Agreement, agree to sell Over-allotment Shares pursuant to the Over-allotment Arrangements

Over-allotment Shares. Shares, which may be purchased by the Stabilising Manager in relation to the Over-allotment Option

Own bought gross transaction value. Own bought gross transaction value means the gross transaction value of Debenhams’ own bought product offerings

Pension Plans. Debenhams’ defined benefit pension plans

Principle Shareholders. Members of the CVC Shareholder Group, the Merrill Lynch Shareholder Group and the TPG Shareholder Group

Refinancing. The refinancing carried out in May 2005

Restructuring. The restructuring carried out in May 2005

Retail gross transaction value. Retail gross transaction value means the gross transaction value produced from retail sales (which excludes Debenhams’ franchise and internet businesses)

RPI. Retail Price Index

ROIC. Return on invested capital

SDRT. Stamp duty reserve tax

SEC. The US Securities and Exchange Commission

Securities Act. The US Securities Act of 1933, as amended

Selling Shareholders. Existing Shareholders who sell Exiting Shares in the Offer

SFAS. Statement of Financial Accounting Standards

82

“Shares” or “Ordinary Shares”. Ordinary shares of 0.01p each in the capital of the company

Shareholders. The holders of Shares in the capital of the Company

Shareholder Agreement. Shareholders’ agreement between Debenhams Retail and its Principal Shareholders

Sponsor. Citigroup Global Markets Limited

Square to linear conversion. A measurement of space that converts the square footage of floor space to the linear space available on the fixture for displaying stock

SSAP. Statement of Standard Accounting Practice

Stabilising Manager. Citigroup Global markets UK Equity Limited

TCW. TCW/Crescent Crescent Mezzanine Partners II LP, TCW/Crescent Mezzanine Trust LP and TCW/Crescent Mezzanine Partners III Netherlands LP

Terminal stock. Stock that has reached the end of its selling season

TNS. TNS Media Intelligence

TPG. Texas Pacific Group

TPG Shareholder Group. TPG Delta Holdco II LLC, TPG Delta Holdco III and TPG Delta Holdco LLC

UK. The United Kingdom of Great Britain and Northern Ireland

UK GAAP. Accounting principles generally accepted in the UK

Underwriters. Citigroup, Credit Suisse, Merrill Lynch and Morgan Stanley

United States or USA. The United States of America, its territories and possessions, and State of the United States of America, and the District of Columbia

US GAAP. Accounting principles generally accepted in the United States

83

US GAAS. Auditing standards generally accepted in the United States

VAT. Means value added tax

Variety Stores. Variety stores started to emerge during the economic slump of the 1920’s and 1930’s. They are often perceived as being the poor man’s department store, trade on fewer floors, are less brand-orientated, have fewer concessions, and a narrower product offer. Their image and appeal is more mass market.

Verdict. Verdict Research Limited

84

A p p e n d i x A : P r e - 2 0 0 3 A c q u i s i t i o n S t o c k P r i c e

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1

A p p e n d i x B : A b r i d g e d P r o f i t a n d L o s s A c c o u n t s – U K G A A P

1998 1999 2000 2001 2002 2003 2004 2005£m £m £m £m £m £m £m £m

Source: 1998 AR 1999 AR 2000 AR 2001 AR 2002 AR IPO Prosp. IPO Prosp. IPO Prosp.

Turnover 1,678.1 1378.8 1397.2 1606.9 1688.5 1435.9 1491.8 1608.7Cost of Sales (1,428.4) (1,182.0) (1,198.3) (1,376.0) (1,448.1) (1,187.4) (1,235.4) (1,272.4)

Gross Profit 249.7 196.8 198.9 230.9 240.4 248.5 256.4 336.3 Distribution costs (29.7) (23.5) (25.3) (29.7) (33.1) (37.7) (41.1) (43.5) Administrative expenses (37.6) (28.1) (37.3) (44.4) (43.5) (61.7) (106.9) (109.6) Share of trading loss in jv - (0.2) (1.9) (2.5) (3.8) - - -

Trading profit 182.4 145.0 134.4 154.3 160.0 149.1 108.4 183.2

Profit on disposal of subsidiary 128.7 - - - - - - 117.7 Profit on sale of fixed assets - - - - - - 8.5 -

Profit on ordinary activitiesbefore interest 311.1 145.0 134.4 154.3 160.0 149.1 116.9 300.9

Net interest payable and (7.5) (6.2) (4.8) (8.2) (6.4) (7.4) (157.0) (252.4) similar charges - Net interest payable before - - - - - (7.4) (123.4) (159.5) exc. costs - - - - - - - - - Exceptional net interest costs - - - - - - (33.6) (92.9) Other finance income 2.5 2.5 2.8

Profit on ordinary activitiesbefore taxation 303.6 138.8 129.6 146.1 153.6 144.2 (37.6) 51.3 Taxation (55.7) (45.8) (41.5) (43.8) (44.6) (40.0) 9.3 13.0 - Taxation before exc. costs - - - - - (40.2) (9.6) (33.6) - Taxation on exc. costs - - - - - 0.2 18.9 46.6

Profit for the financial year 247.9 93.0 88.1 102.3 109.0 104.2 (28.3) 64.3 Total dividends payable (231.3) (39.3) (39.4) (43.0) (46.0) (48.5) - - - paid to Burton (194.3) - - - - - - - - payable to shareholders (37.0) (39.3) (39.4) (43.0) (46.0) (48.5) - -

Retained profit / (loss) 16.6 53.7 48.7 59.3 63.0 55.7 (28.3) 64.3

Earnings per share - Basic 65.8 24.7 23.6 27.9 29.8 20.8 (5.7) 12.9 - Diluted 65.7 24.6 23.6 27.4 29.2 20.8 (5.7) 12.9

Dividends per ordinary share - Paid to Burton 51.5 - - - - - - - - Payable to shareholders 9.8 10.4 10.6 11.7 12.6 na - -

Total Shares Outstanding (m) 377.5 378.5 373.7 372.8 372.7 500.0 500.0 500.0 - Basic 376.6 377.2 372.6 367.0 365.9 500.0 500.0 500.0 - Dilutive potential 0.9 1.3 1.1 5.8 6.8 - - -

2

A p p e n d i x C : A b r i d g e d B a l a n c e S h e e t s – U K G A A P

1998 1999 2000 2001 2002 2003 2004 2005£m £m £m £m £m £m £m £m


Fixed AssetsIntangible assets - - - 0.2 0.2 2.2 833.1 2,497.6 - Licenses and Tradem arks - - - nk nk 0.3 0.3 0.2 - Goodwill - - - nk nk 1.9 832.8 2,497.4 Tangible assets 705.0 753.4 819.9 865.4 920.2 969.8 1,038.9 668.0 - Cost 971.1 1,028.1 1,127.7 1,229.6 1,299.9 1,415.4 1,104.1 691.9 - Depreciation (266.1) (274.7) (307.8) (364.2) (379.7) (445.6) (65.2) (23.9) Total investm ents 0.8 1.2 6.3 9.9 18.8 - - 7.2 - Investm ents in joint ventures (0.2) (2.1) (4.8) - - - 7.2 - Loan to joint venture 0.2 4.2 5.1 - - - - - Investm ent in own shares 0.8 1.2 4.2 9.6 18.8 - - -

705.8 754.6 826.2 875.5 939.2 972.0 1,872.0 3,172.8

Current assetsStocks 173.0 177.2 195.3 211.1 203.5 198.2 167.4 197.2 Bebtors 28.5 34.9 42.0 45.8 58.2 57.7 49.5 61.8 Cash at bank and in hand 8.6 14.1 10.2 12.9 29.4 18.2 159.3 76.6

210.1 226.2 247.5 269.8 291.1 274.1 376.2 335.6

Creditors: am ounts falling duew ithin one yearFunding debt (35.0) (60.3) (92.0) (78.3) (97.0) (86.6) (43.1) (75.0) - Bank overdrafts (28.2) (53.2) (92.0) (74.9) (97.0) (86.6) (11.3) (12.1) - Debenture loans - - (3.4) - - - - - Bank loans (6.8) (7.1) - - - - - - - O ther (see funding debt) - - - - - (31.8) (62.9) Other creditors (277.7) (254.4) (270.6) (286.7) (286.9) (305.5) (356.5) (399.5) - Trade creditors (59.6) (59.4) (59.9) (60.3) (69.8) (66.8) (142.9) (189.7) - O ther creditors (79.5) (50.6) (66.6) (69.2) (83.5) (77.4) (79.5) (77.6) - Am ounts owed to subsidiary undertakings - - - - - - - - - O ther taxation and social security - (15.6) (14.9) (23.7) (21.2) (27.3) (28.1) (22.1) - Corporate taxation (54.9) (51.1) (44.4) (41.3) (21.1) (10.3) - - - Accruals and deferred incom e (61.4) (53.9) (60.9) (66.1) (63.5) (93.3) (106.0) (110.1) - Proposed dividend (22.3) (23.8) (23.9) (26.1) (27.8) (30.4) - -

(312.7) (314.7) (362.6) (365.0) (383.9) (392.1) (399.6) (474.5)

Net current liabiliities (102.6) (88.5) (115.1) (95.2) (92.8) (118.0) (23.4) (138.9)

Total assets less current liabilities 603.2 666.1 711.1 780.3 846.4 854.0 1,848.6 3,033.9

Creditors: am ounts falling dueafter m ore than one yearFunding debt (63.4) (61.1) (61.9) (59.2) (59.4) (59.4) (1,829.2) (1,839.1) - Property lease obligations (56.3) (57.7) (58.5) (59.2) (59.4) (59.4) (61.6) (61.9) - Debenture loans (3.4) (3.4) (3.4) - - - - - - Bank loans payable between 1 and 2 years (3.7) - - - - - - - - O ther (see funding debt) - - - - - (1,767.6) (1,777.2) Provisions for liabilities and charges (22.8) (34.2) (42.0) (52.5) (61.7) (66.5) (50.2) (31.4) Net assets / liabilities excl. pension schem e 517.0 570.8 607.2 668.6 725.3 728.1 (30.8) 1,163.4 Pension schem e (liabilities)/assets (41.5) (33.2) 0.1 Net assets / liabilities incl. pension schem e 686.6 (64.0) 1,163.5

Capital and reservesCalled up share capital 37.8 37.8 37.0 37.1 36.9 36.6 - - Share prem ium account - 0.1 0.1 2.4 3.3 19.7 1.0 - Capital redem ption reserve - - 0.8 0.8 1.0 1.8 - - O ther reserves 43.2 43.2 43.2 43.2 43.2 43.2 - 1,200.9 Profit and loss account 436.0 489.7 526.1 585.1 640.9 585.3 65.0 37.4 Shareholders' funds - Equity interests 517.0 570.8 607.2 668.6 725.3 686.6 66.0 1,238.3

Gearing 17.4% 18.8% 23.7% 18.6% 17.5% 18.6% 2595.5% 148.4%

3

A p p e n d i x D : F u n d i n g D e b t – U K G A A P

30-Aug-0304-Dec-03

Acquisition 23-Apr-04 28-Aug-04 22-Feb-05 16-May-05 26-May-05 23-Jun-05 03-Sep-05 04-Mar-06 19-Apr-06£m £m £m £m £m £m £m £m £m £m £m

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ok ok okBank Overdrafts 86.6 11.3 12.1 5.4 Lease Obligations 59.4 61.6 61.9 61.0

Term Loan Facility 1,050.0 Revolving Facility 300.0

Tranche A - 407.6 407.6 399.2 Tranche B 560.0 560.0 560.0 560.4 Tranche C 560.0 560.0 560.0 560.5 Tranche D 300.0 300.0 300.0 300.3 Multicurrency revolving credit - - - -

'A' Loan Notes 516.8 - - 'B' Loan Notes 50.1 50.1 49.6 'C' Loan Notes (Held by BELP) 22.3 BELP BELP BELP BELP

High Yield Facility High Yield Bonds 324.7 324.7 324.7 324.7 - - -

Mortgage Facility Mortgage Facility 369.2 369.2 369.2 -

Senior Facility - Term Loan A 289.4 289.4 289.4 289.4 289.4 289.4 - - Senior Facility - Term Loan B 165.8 165.8 165.8 165.8 165.8 165.8 - - Senior Facility - Term Loan C 165.8 165.8 165.8 165.8 165.8 165.8 - - Deep Discounted Bonds 606.3 606.3 606.3 514.3 514.3 514.3 - - - Bridge Facilities 354.7 - - - Mezzanine Facility 325.0 325.0 - -

Total Funding Debt minus Bank Overdrafts, Leases,and unamortised issue costs - 1,907.0 1,921.5 1,921.2 1,829.2 1,460.0 2,049.2 1,420.0 1,827.6 1,877.7 1,870.0 1,350.0

Total Funding Debt minus unamortised issue costs 146.0 1,902.1 1,951.7 1,936.4

Less: unamortised issue costs - - - - (29.8) - - - - (37.6) (34.6) -

Total Funding Debt 146.0 - - - 1,872.3 - - - - 1,914.1 1,901.8 -

Amortised costs (3.5) (1.5) Expensed costs - -

Total Issue Costs - - - - (33.3) - - - - (39.1) (34.6) -

DDBPS 29.4

Notes:* Excludes interest rate swaps held as part of groups interest rate management strategy

2003 Acquisition

Loan Notes

Senior Credit Agreement

New Credit Agreement

3

A p p e n d i x E : E f f e c t i v e I n t e r e s t R a t e s

30-Aug-03 Interim 28-Aug-04 26-Feb-05 Interim 03-Sep-05 04-Mar-06 Interim

Bank loans and overdrafts nk nk 5.75% 5.50% 5.50%'B' Loan Notes nk nk - 7.05% 7.05%

Term Loan Facility -Revolving Facility -

Senior Term Loan - Tranche A - -

LIBOR + 2.25% plus ratchet and

QPO 6.85% 6.84%

Senior Term Loan - Tranche B - -


QPO 7.35% 7.34%

Senior Term Loan - Tranche C - -


QPO 7.85% 7.84%

Senior Term Loan - Tranche D - -


QPO 9.10% 9.59%

Multicurrency revolving credit -

LIBOR + 2.25%plus ratchet and

QPO


QPO


QPO

'A' Loan Notes - - - nk - -'B Loan Notes - - - 4.80% - -'C' Loan Notes - - - 4.80% - -

High Yield Bonds High Yield Bonds -10.5% and 9.5%= 10.3% 10.30% - -

Mortgage Facility Mortgage Facility - 6.50% - - -

Senior Facility - nk 7.53% - -Deep Discounted Bonds - 12.50% 12.50% - -Bridge Facilities - 6.50% - - - -Mezzanine Facility - 10.50% - - - -Lease obligations nk nk 5.25% 5.25% 5.25%

Notes:* The effective interest rate on the 'B' Loan Notes includes the interest rate on the guarantee of the Tranche A of the Senior Term Loan which amounts to 2.25%

2003 Acquisition

Loan Notes

Senior Credit Agreement

New Credit Agreement

4

A p p e n d i x F : A b r i d g e d C a s h F l o w S t a t e m e n t s – U K G A A P

1998 1999 2000 2001 2002 2003 2004 2005£m £m £m £m £m £m £m £m


Trading profit 182.4 145.0 134.4 154.3 160.0 149.1 108.4 183.2 Depreciation charges 51.9 44.4 55.7 65.1 77.0 82.9 91.3 89.1 Goodwill amortisation - - - - - 0.2 31.8 64.5 Asset write-offs 6.6 2.9 0.6 0.8 1.1 - - - Profit on sale of fixed assets - - (0.7) (1.1) - (1.6) 0.9 3.0 Difference between pension charge andcontributions made - - - - - 5.9 1.9 (26.7) Amortisation of investment in own shares - - - - 1.2 - - - Shares of trading loss in joint ventures - 0.2 1.9 2.7 4.0 - - - Increase in stocks (77.5) (4.2) (18.1) (15.8) 9.2 5.3 30.8 (29.8) Increase in debtors (24.9) (4.1) (1.6) (9.5) (7.9) (1.6) (3.5) (7.2) Increase in creditors and provisions (159.4) (4.4) 21.1 29.6 1.9 23.3 28.4 105.8 Exceptional items (8.3) - - - - - - - Net cash (Outflow)/inflofrom operating activities (29.2) 179.8 193.3 226.1 246.5 263.5 290.0 381.9

Returns on investments and servicingof finance:Interest received 3.1 0.7 0.8 0.4 0.4 0.5 3.3 8.1 Interest paid (9.1) (2.8) (2.2) (5.0) (3.7) (5.1) (46.7) (294.5) Preference dividend paid (0.1) (3.2) (2.6) (3.1) (2.8) (3.1) (2.5) (3.4) Issue costs of funding facilities - - - - - - (66.9) (39.1) Net cash outflow form returns oninvestment and servicing financing (6.1) (5.3) (4.0) (7.7) (6.1) (7.7) (112.8) (328.9) Taxation paid (19.8) (48.4) (39.4) (35.3) (53.4) (44.7) (22.8) (10.4) Capital expenditure:Payments to acquire intangible fixed assets - - - - (0.1) (0.1) - - Payments to acquire tangible fixed assets (92.0) (105.2) (134.8) (0.2) (127.7) (134.5) (84.6) (148.2) Receipts from sales of tangible fixed assets 2.9 1.3 7.4 (133.8) - - - 48.1 Increase in loan to joint venture - - (3.4) 16.3 (5.1) 2.3 21.0 - Purchases of shares by ESOPs (net) (0.8) (0.4) (3.1) (6.9) (10.4) - - - Purchase of investment - - - - - - - (4.2) Net cash outflow form capital expenditure (89.9) (104.3) (133.9) (124.6) (143.3) (132.3) (63.6) (104.3) Disposal of subsidiary undertaking 919.2 - - - - - - 121.8 Purchase of business - - - - - (2.1) - - Investment in joint venture - (0.2) - - - - - - Acquisition of subsidiary - - - - 4.7 - (1,757.5) - Acquisitions and disposals 919.2 (0.2) - - 4.7 (2.1) (1,757.5) 121.8 Equity dividends paid (296.0) (37.8) (39.3) (40.8) (44.3) (46.0) - - Cash inflow/(outflow) before financing 478.2 (16.2) (23.3) 17.7 4.1 30.7 (1,666.7) 60.1

FinancingPurchase of own shares - - (12.3) - (7.0) (20.4) - - Purchase of own shares by ESOPs - - - - - (20.0) - - Sale of own shares by ESOPs - - - - - 1.6 38.7 - Capital contribution 197.2 - - - - - - - Parent company loans (681.9) - - - - - - - Issue of ordinary share capital - 0.1 - - 0.7 7.3 15.5 - Senior Term Loan - - - - - - - 1,827.6 Senior Facility - - - - - - 621.0 Repayment of Senior Facility - - - - - - - (621.0) Bridge Facilities - - - - - - 354.7 - Repayment of Bridge Facilities - - - - - - (354.7) - Mezzanine Facility - - - - - - 325.0 - Repayment of Mezzanine Facility - - - - - - (325.0) - Deep Discounted Bonds - - - - - - 606.6 - Repayment of Deep Discounted Bonds - - - - - - (92.3) (514.3) High Yield Bonds - - - - - - 324.4 - Repayment of High Yield Bonds - - - - - - - (326.7) Settlement of 'A' Loan Notes - - - - - - - (516.8) Restricted cash held in DRET 2004 - - - - - - - 13.3 Mortgage Facility - - - - - - 369.2 (5.7) Repayment of debenture loans due within a year (2.5) - - - (3.4) - - - Repayment of bank loans due within a year (16.8) (3.4) (7.1) 2.1 - - - - Repayment of capital element of property leases (47.5) - - - - - - - Net cash (outflow)/inflow (551.5) (3.3) (19.4) 2.1 (9.7) (31.5) 1,883.1 (143.6)

(Decrease)/increase in cash (73.3) (19.5) (42.7) 19.8 (5.6) (0.8) 216.4 (83.5)

4

1998 1999 2000 2001 2002 2003 2004 2005£m £m £m £m £m £m £m £m


Reconciliation of net debt:Opening net debt (81.8) (89.8) (107.3) (143.7) (124.6) (127.0) (127.8) (1,713.0) (Decrease)/increase in cash (73.3) (19.5) (42.7) 19.8 (5.6) (0.8) 216.4 (83.5) Analysed as: - - - - - - - - Capitalised issue costs of funding facilities - - - - - - 33.3 39.1 Mortgage Facility - - - - - - (369.2) 5.7 Senior Facility - - - - - - (621.0) 621.0 Deep Discounted Bonds - - - - - - (514.3) 514.3 High Yield Bonds - - - - - - (324.4) 326.7 Issue Loan Notes - - - - - - - (566.9) Settlement of Loan Notes - - - - - - - 516.8 Senior Term Loan - - - - - - - (1,827.6) Movements in borrowings and lease finance 66.8 3.4 7.1 - 3.4 - (1,795.6) (370.9) Other non-cash movements (1.5) (1.4) (0.8) (0.7) (0.2) - (6.0) 329.9 Closing net debt (89.8) (107.3) (143.7) (124.6) (127.0) (127.8) (1,713.0) (1,837.5)

4

A p p e n d i x G : D i r e c t o r a n d N o n - E x e c u t i v e D i r e c t o r s

Main Board:

John Lovering - Chairman

John Lovering was appointed Chairman of Debenhams in

December 2003. He is also Chairman of Somerfield Limited and

has led several consumer-focused private equity transactions,

including Homebase Group, Fitness First, The Laurel Pub

Company, Birthdays Group, Odeon Cinemas and Fired Earth.

He was previously Chief Operating Officer at Tarmac plc and

Finance Director at Sears plc.

Rob Templeman - Chief Executive

Rob Templeman was appointed Chief Executive of Debenhams

in December 2003. He was previously Chairman of Halfords

Group, Chief Executive of Homebase Group and before that

Chief Executive of Harveys Furnishing plc.

Chris Woodhouse - Finance Director

Chris Woodhouse was appointed Finance Director of

Debenhams in December 2003. He was previously Deputy

Chairman of Halfords Group and Commercial Director and

Deputy Chief Executive at Homebase Group. He is a former

finance director of Birthdays Group and Superdrug Stores. He is

4

a Fellow of the Institute of Chartered Accountants in England

and Wales and is an Associate of the Association of Corporate

Treasurers.

Michael Sharp - Chief Operating Officer

Michael Sharp became a director of Debenhams in 1999 and was

appointed Chief Operating Officer in January 2004. From 1997

to 2004 he was Trading Director of Debenhams and previously

served in various capacities within The Burton Group, including

as Managing Director of Principles and Racing Green and

Buying and Merchandising Director of Top Shop and Top Man.

4

Non-Executive Board:

Philippe Costeletos - Non-Executive Director

Philippe Costeletos was appointed a Non-Executive Director of

the company in April 2006 and is a Partner of Texas Pacific

Group, which he joined in 2003.

Adam Crozier - Non-Executive Director

Adam Crozier was appointed a Non-Executive Director of the

company in April 2006 and is Chief Executive of the Royal Mail.

He was formerly Chief Executive of the Football Association

and Joint Chief Executive of Saatchi and Saatchi.

Jonathan Feuer - Non-Executive Director

Jonathan Feuer was appointed a Non-Executive Director of the

company in April 2006 and is a managing partner of CVC

Capital Partners. He joined CVC in 1988.

4

Richard Gillingwater - Senior Non-Executive Director

Richard Gillingwater was appointed Senior Non-Executive

Director of the company in April 2006. He is Chief Executive of

the Shareholder Executive, the body responsible for the

Government’s shareholdings in major, publicly owned

businesses. He is currently a director of Faber Music Limited

and Rights Worldwide Limited. His previous directorships

include Homebase Limited, Kidde plc, P&O and Qinetiq.

Peter Long - Non-Executive Director

Peter Long was appointed a Non-Executive Director of the

company in April 2006. He is Chief Executive of First Choice

Holidays and was previously Chief Executive of Sunworld

Holidays. He is currently a Non-Executive Director of Rentokil

Initial plc.

Dennis Millard - Non-Executive Director

Dennis Millard was appointed a Non-Executive Director in

April 2006. He was Group Finance Director of Cookson Group

plc from 1996 to 2005 and is currently a non-executive director

Xchanging Limited. He is a member of the South African

Institute of Chartered Accountants.

Guido Padovano - Non-Executive Director

4

Guido Padovano was appointed a Non-Executive Director of

the company in April 2006. He is a Managing Director in the

Merrill Lynch Global Private Equity Division with a focus on

Europe (since 2003) and Latin America (since 1998).

Paul Pindar - Non-Executive Director

Paul Pindar was appointed a Non-Executive Director of the

company in April 2006.He has served as Chief Executive of the

Capita Group since 1999 and was previously a Managing

Director in 1991 and Finance Director in 1987.

4

A p p e n d i x H : S o u r c e o f D e a l V a l u e C r e a t i o n

4

Sources: Texas Pacific & My Analysis

At the IPO Price, The Deal Has Returned 3.3x ROE to I 2

.5x Returns Were A hi dThrough Operational

I

2,021

595(200)

315

1,542

110

150(80)

608

(221)

172

46293

243

Total (£M) 608 2,021

Initial Equity

Sales •Share •Market

MarginImproveme•Head

•Store •Mix /

Cash •Cashflo

•Working

EquityReturnFrom

Operation

PropertBritish Transactio

Expense•Manageme

Incentive•Fees/Expens

MultipleExpansio

TotalReturn

213 439 282 1,542 315 (421) 595Total (%) 100 33235 72 47 254 51 (70) 97

A p p e n d i x I : D e b e n h a m s E s t i m a t e d R O C E A n a l y s i s

4Sources: Company Information & My Analysis

Note:* More information is required to obtaining a more accurate picture of capitalized lease costs. Figures provided here are a best estimate.

DEBENHAMS ESTIMATED ROCE ANALYSIS*

2003

2004

2005

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

0.000 0.500 1.000 1.500 2.000

EBITDA / Gross Sales

Gross Sales / Estimated CE= £2bn Revenue

After Estimating Capitalized Lease Costs and Excluding Goodwill, ROCE falls from 7.8% at the beginning of private ownership to 7.1% at the end of private ownership. Extra capital

employed in the business has not compensated for increased sales and margins.ROCE (%)

20

10

7.8%

12141618

8642

7.1%

debenhams - richard parry

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