Permira takes on a challenge with HMV

Retailer HMV received a preliminary takeover approach, sparking a surge in the company’s share price, and confusing Permira’s competitors about what the buyout house plans to do with the ailing book and music seller.

The private equity firm is understood to have appointed Merrill Lynch to advise on a bid, which would value HMV at about 200p a share or 6x Ebitda. According to one private equity source close to the deal, this price “is not very cheap for a retailer that has to run very hard just to stand still.”

With banks streamlining exposure to retailers and waiver requests ticking up, it will be challenging for Permira to achieve the height of leverage excess that has been available in the last few years. Like many of its peers, HMV struggled over Christmas. It was forced to sacrifice its margin and slash the price of thousands of DVDs, CDs and books.

Chief executive Alan Giles blamed the poor performance on intense competition from internet rivals and discounting from supermarkets and then announced his own shock resignation.

Confidence in the group was also shaken when its attempted £100m bid for rival bookseller Ottakar’s was referred to the Office of Fair Trading.

That followed intense lobbying from a consortium of pressure groups led by the Forum for Private Business and the Publishers’ Association.

Given all of this, and a fairly stagnant UK retail climate, commentators are struggling to see where Permira can make its return.

“I fundamentally fail to see any positive growth in either books or retail. On the music side, the market is moving toward downloads that can be completed at your desk at work or in a high-street kiosk. Book sales are moving to the internet and supermarkets can dominate the big launches that used to be relied upon to drive footfall,” said one investment professional.

It is also hard to see where costs can be taken out of the business. HMV has already had a lengthy stint in private equity hands, having been partially owned by Advent International in the four years up to its flotation in 2002.

Reports cite the presence of three head offices, which would present an opportunity for cost savings. However, unlike many recent private equity deals in the retail space, the company does not have an extensive freehold property portfolio to be sold or auctioned.

The third possible scenario for Permira involves an operational change of the kind that it executed with such success when it acquired Homebase and moved the DIY

store into soft furnishings. Potential acquisition targets like Game Group, the UK-listed retailer of computer software and video games, would build a strong high-street entertainment triple play.

The other option is to make a play for further consolidation of the UK book market, but, as the Ottackers’s experience shows, this too is fraught with danger.

What is known is that Martin Clark, the partner at Permira who is working on the deal alongside managing partner Damon Buffini, has faced this type of scenario before. He looked at Waterstone’s in his previous job at PPM Capital, and is credited as the brains behind the Homebase deal. Perhaps he sees something that eludes the rest of the market. HMV is being advised by its brokers, Citigroup and UBS.