Posted: 09/06/2016
The adviser group 3 session took place on Wednesday 25 May comprising: Stephen Hermer, corporate partner for Retail Acquisitions (Olswang); Andrew Frangos, chief executive of Cornhill Capital, engaged by Swissrock (Retail Acquisitions) to source funding pre- and post-acquisition; and Mark Byers, engaged by Swissrock (Retail Acquisitions) to provide financial due diligence on BHS (Grant Thornton).
Initial questioning was round the "gig", as the chairman put it, and when advice commenced. Advice started in November 2014 and ended at acquisition for both Olswang and Grant Thornton, although Grant Thornton's main involvement really started in February 2015. Cornhill Capital was apparently involved from around December 2014 but had known about discussions for about ten months. It appears that Retail Acquisitions has disputed ever engaging them.
Olswang dealt with a number of people at Retail Acquisitions, Cornhill Capital dealt with Dominic Chapell, and Grant Thornton had no direct contact, although its financial due diligence was addressed to the Retail Acquisitions board.
When questioned about the level of due diligence that each undertook for their new client, Mark Byers confirmed that Grant Thornton undertook a formal take on process and followed what was their normal take on procedures. He was satisfied that it was a proper process.
Andrew Frangos explained that he personally carried out standard anti-money laundering checks and there were checks carried out on Swissrock (Retail Acquisitions).
Stephen Hermer said that Olswang's due diligence included searches against risk intelligence databases. He mentioned that, in high profile cases, the firm also undertakes further investigations. Its investigations did show that Dominic Chapell had two insolvency related incidents in his history. Asked if the name Paul Sutton ever came up during the due diligence, both Stephen and Mark said no. However, it does appear that Paul Sutton introduced Dominic Chapell to Cornhill Capital.
Turning to one of their favourite subjects, the committees asked about fees. Mark Byers confirmed that Grant Thornton had received a reasonably-sized meaningful fixed fee. It had 25 people working on the project for nearly four weeks. Andrew Frangos said that Cornhill Capital did not receive a transaction fee, it was all based on success and contingent on the sale happening. Andrew had, in advance, provided the committees with a copy of its engagement. It included the success fee plus 2% fee on all property sales. He confirmed that a potential route to access funds for the business was property sales so, yes, they would get 2% on each.
Focusing on this engagement, it appears that it also related to the "subsequent acquisition of Arcadia Group" and, when asked if this was a mistake or an intention, Andrew told the committees that the engagement was considered to be a bit of a catch all rather than a definition of what was intended. Dominic Chapell had indicated that Retail Acquisitions would go to do other deals, including other retail brands.
Stephen Hermer confirmed that Olswang received a meaningful fee which was fundamentally based on hours, with a small abort and small success arrangement.
The committees then asked why they thought that Retail Acquisitions and Dominic Chapell could turn BHS around when Sir Philip Green could not. Mark and Andrew's responses focused on the re-negotiation of leases (please see Paul Budge session) and that Retail Acquisitions consisted of a board of four primary people, it was not just Dominic Chapell. Stephen, on the other hand, confirmed that they would not be expected to make a judgment about the future viability of the business.
When discussing the extent of the due diligence undertaken by Grant Thornton on the BHS acquisition, Mark Byers indicated that it was given limited information in respect of the pension scheme and denied access to speak to the trustees. He felt constrained to be questioned much further about this but was prepared to say that Grant Thornton would probably have expected to receive more information. He also corrected a statement made in one of the earlier sessions about Grant Thornton's involvement. He was keen to ensure that the committees understood that the firm was not involved in formulating a business plan, but was involved in reviewing the turnaround plan that BHS's management had developed.
Questioned further on this, Mark was asked that, if the BHS management team had a plan, why could they not fulfil that while under the Arcadia group? Was it "basically to shaft the landlords? Was there anything else in that business plan?” Once again, client confidentiality prevented further answers but Mark did say that the properties would be one of the reasons.
Stephen Hermer confirmed that he was aware of the turnaround plan but it did not form part of Olswang's work. Andrew confirmed that most of the information that they received was related to property as funding discussions were predicated on securing against the properties. Asked how much money was assessed to be needed to secure the business under the owners, figures ranged from £30 million to £200 million. Although Cornhill Capital was requested at one point to source a £100 million working capital, it was then told that the money had been sourced elsewhere and this is where the relationship fell over.
Stephen Hermer could not say anything further with regard to funding due to client confidentiality, but he was prepared to confirm that, if there had been a financing arrangement, then Olswang would have been involved in documenting that. Pressed a little more on this, he was asked in what circumstances would there not be a financing arrangement for an acquisition by a special purpose vehicle such as Retail Acquisitions of a company that was losing £60 million and had a significant pensions liability.
Stephen confirmed that, as a matter of law, it is possible to buy the company for £1 without actually having financing in place but whether that would be a prudent thing to do would be a different matter although it would be possible. This is when it got interesting and, again being pressed, the committees wanted to be clear as to whether it is possible to take a company that the vendor is prepared to give you for £1, but that has annual losses in its operations of tens of millions of pounds and obligations to its pensioners of hundreds of millions of pounds. Is it possible for that sale to take place for the price of £1 and then, after the event, for the new owner to try to find out whether he or she can get the financing? Stephen confirmed again that yes it would technically be possible but there might be a question of breach of fiduciary duty but he could not comment on exactly what happened here.
Although Olswang's relationship with the transaction ended when the transaction completed, it appears that Olswang did carry on working for BHS after the transaction up to the point of the administration. Stephen was not prepared to comment on the work that was carried out after completion, including the so-called reports of possibly selling to Sports Direct.
Grant Thornton also had a post-acquisition note predominantly advising BHS and providing a range of consulting services aimed at assisting BHS's management to address some of the issues that were identified in the due diligence report.
The questioning then moved on to whether or not it is possible to be bankrupt and acquire another business while you were still bankrupted. Stephen Hermer confirmed that yes it is possible and, although there are some technicalities around how you would do it, in principle you can, as a bankrupt, make an acquisition. However, much later in the session he corrected this to a ‘discharged bankrupt’.
Stephen Hermer also said that there was clearly a question mark over Mr Chapell's business acumen raised by his bankruptcy history and, in the context of a rescue bid for a large retail chain, there was a judgment call that needed to be made on how much weight to put on that background.
The committees asked whether or not Mr Chapell is an internal optimist. Stephen Hermer was not prepared to make any judgment about his character. Olswang does not give references about clients’ probity or about their business competence but they do confirm - should they be asked - what due diligence checks have been done. He pointed out that this is an unusual occurrence but it did happen here. This backs up what Owen Clay of Linklaters had said in the advisor group 2 session on 23 May.
Stephen Hermer was asked if he thought that the regulations for mergers and acquisition transactions place too much reliance on caveat emptor and that the seller can essentially gift to anyone, without anyone checking, a very substantial set of assets in the hope that he will be a 'good chap'. Stephen said that he thought the principle of caveat emptor is generally qualified by the due diligence process which allows people on either side of the transaction to look at the risks that apply to try to assess those risks and to work out how much to mitigate them. He pointed out that they did not think that, at a process level, what happened was atypical.
With further probing, Mark Byers wanted to confirm that Grant Thornton’s involvement was a limited role in relation to the acquisition of BHS. It was undertaking financial due diligence and not considering the synergistic benefits of Retail Acquisitions as an acquirer. It would have made an assessment in relation to the business plan that BHS presented which would have included some re-positioning of the business and would have involved some rebranding and changes in marketing. In his view, the BHS management team had capability and a line of sight to get the business from losing £35 million a year on a cash basis to break even.
The questioning then turned to pensions. Mark Byers has asked whether or not Grant Thornton had done due diligence on businesses before with defined benefit schemes. He confirmed that it had. He also confirmed that it is quite critical that an acquirer understands what the position is with the pension scheme and understands what the options are in terms of being able to develop a funding solution for it.
In broad terms he was prepared to say that the strength of covenant on a business that is losing money is clearly very weak. As was indicated, the strength of the covenant was effectively zero, so the challenge was to see whether there was a funding solution to the pensions situation. Grant Thornton was made aware of Project Thor.
Mark Byers confirmed that they would normally expect to have access to the trustees and to the advisors of the scheme. In this case, they only met the advisers to Arcadia. Grant Thornton considered that there was a gap in its understanding which was reflected in its due diligence report because, as far as it was concerned, the firm did not think that dealing with the corporate provided a clear view of the pension scheme and its potential importance to any buyer of the business.
The due diligence report therefore only had some content on the pension scheme. Mark Byers was unable to give details due to client confidentiality. He was asked a series of questions which he was unable to answer as they were venturing into areas where any answers would be breaching confidentiality.
The questioning then turned back to Andrew Frangos and to the relationship that seemed to have broken down. The committees were interested to know what the timeline was for Cornhill Capital’s involvement and the subsequent breakdown. He confirmed that it was quite stop-start. It appears that, in the four weeks prior to the actual transaction going ahead, they were getting very little feedback or information and people were not turning up at meetings. He said they were arranging appointments with ultra high net worths who had an interest in either property or investment and they were just not being followed up. When asked if he knew where the money came from, he confirmed that he believed that £35 million came in from Allied Commercial.
Knowing that the relationship with Dominic Chapell was poor, the committees wanted to know more about his view of Mr Chapell. Andrew Frangos confirmed that he thought that the plans were hugely ambitious when they first started talking and they did wonder whether or not it was real. He wondered if they had any realistic chance of success. For Cornhill Capital, it was a bit of “a punt”.
Asked about whether other names had been suggested to become part of the empire, he did not want to be specific but a Swiss retailer and a small UK retailer were mentioned. Although the plans he maintained were ambitious, as time passed they seemed to be gaining credibility because they appeared to become more and more real. Many entrepreneurs have big ambitions and big egos and sometimes things that do not seem plausible on day one subsequently turn out to work. He also confirmed that, before he met Dominic Chapell, he was not aware that he was a bankrupt.
Again the committees moved on to Mark Byers, wanting to find out whether or not he was asked to consider what working capital was available to allow BHS to continue to trade. He said that they did not do any work to identify whether the working capital was available but they did look very carefully at the trading cash flow projections and identified the working capital requirement. (Readers will remember from the session with Paul Budge, the finance director of Arcadia, that it emerged that some guarantees were provided to Retail Acquisitions to BHS post sale). He confirmed that Grant Thornton was not involved with or aware of any of those discussions. When pressed again about the financing requirement, Mark Byers could not answer due to client confidentiality.
In closing, the committees asked Andrew Frangos more about Paul Sutton. They wanted to know if it was fair to say that this was really a Sutton deal. He confirmed that, when they first started discussing the transaction, it was being discussed with Paul Sutton. But during the course of the relationship Sutton stepped back and Dominic stepped forward. He could not say to what extent he may or may not have been involved thereafter but his involvement with him discontinued at that point.
Our readers should note that this is a very short and selective summary of the session.
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