Turning to retail

Everyone has heard of bathroom and kitchen retailer MFI and everyone who knows the private equity industry has heard of Merchant Equity Partners (MEP), which acquired MFI last year. But beyond the name little else is known of this relatively young firm.

Now, almost a year after the MFI deal, MEP is keen to speak out and get its business model understood – perfect timing perhaps in the midst of the ongoing private equity debate.

At a time when the potential takeover of Sainsbury by a private equity consortium is making headline news, against the backdrop of recurring cries of barbarians at the gate, predators and locusts, the MEP approach is enough to give the industry’s political adversaries food for thought.

The firm is focused on the acquisition and turnaround of underperforming businesses in the retail and consumer sectors. Although MFI has been its sole investment to date, its aim is typically to invest between €100m and €500m in each transaction across Europe.

It describes its targets as “strategically sound but operationally or financially challenged businesses in which we can employ capital and operational expertise to drive business recovery”.

Managing partner and chief executive Henry Jackson, is a former managing director of Deutsche Bank and head of its European consumer and retail group. Prior to this, he held senior positions at Credit Suisse First Boston (CSFB), Peter J Solomon Company (PJSC), and Donaldson Lufkin and Jenrette (DLJ).

It was at Credit Suisse where Jackson, under the tutelage of Bruce Wasserstein, one of the pioneers of the sector approach to investment banking, was assigned to the retail sector group, a pivotal point in his career. And it was while working with New Look at Deutsche Bank that the idea for MEP was formed.

Apax and Permira acquired New Look for £699m in March 2004 and subsequently acquired 34 stores from ailing chain Littlewoods.

“All businesses have natural life cycles, it happened to both Kmart in the US and Littlewoods in the UK,” says Jackson. “We reinvest and rejuvenate businesses once they have reached a natural phase in their life cycle. Other people are not doing that, the financial investors are just not there.”

Jackson will not disclose MEP’s financial backers, although he says: “They are the normal type of major investing institutions. We don’t have a dedicated fund but instead are backed by significant capital from these institutions.

“It is a very flexible model,” he says. “We are not limited by the constraints of a traditional fund. We can buy a controlling stake in a company or buy bank debt and get control that way. With an MFI type business, where the equity no longer has any value so we can buy the debt at a discount as a means of gaining operational control of the business.”

Jackson argues that at a time when private equity firms are coming in for a lot of criticism for bloated fees and uncalled for job losses, the MFI transaction is the perfect example of private equity doing the exact opposite.

“MFI was effectively facing liquidation when we acquired it, so potentially we saved over 3,000 jobs,” he says. “Our role is very much to make the business better and preserve jobs. We cannot cut to grow. We also work on a success fee only basis. This keeps us focused, either we create value or we don’t make any money.”

When MEP acquired it for £1, Jackson argues that MFI was still a strong 40-year old brand. But it got into the situation where the trade joinery and kitchen side of the business, Howdens, had become the main focus and in the words of Jackson began to “bleed MFI dry”.

“It basically became a grossly mismanaged business,” he says. “EBITDA fell from over £100m in 2003 to a loss of approximately £40m in 2006. Supply chain was the major problem, the stores were too big, virtually all the senior managers left, leaving predominately only daily contract managers, and the systems did not work, which meant among other things, distribution was dismal. All the focus was on Howdens and MFI was near to liquidating. But with 200 stores and over 3,350 staff it was still a great brand”, Jackson says.

The auction for MFI included the likes of Apax, Permira, Archie Norman and Sun Capital, but, says Jackson: “Most of the people involved were looking at it from a distressed or a retail perspective but in reality it was too difficult for them.

“There was too much turnaround involved for normal funds and for distressed funds it was not the right focus. They prefer multi-divisional companies were they can sell the bad ones and clean up the good ones. But it is perfect for what we want to do,” he says.

“We are very hands on with MFI. We can invest money to support the new model and fix the systems. This is not a short-term hold – we are still at the early stages of implementing many of the new systems; it will take 12 to 18 months to work out whether we have been successful or not,” he adds.

“So our business model is less about volume of investments, because the main work is done after the investments have been made, which is time consuming. We are, therefore, more likely to make one or two investments this year rather than two or three,” says Jackson.

That said, “although we are enmeshed with MFI at the moment there will be something in the first half of the year and something else in the second. There are four of five opportunities on the short list,” he says.

So perhaps the Sainsbury agitators should think again, especially as Jackson’s inspiration New Look is also back in the news. The high street fashion chain is expected to be one of the biggest success stories among UK buyout deals in recent history.

Since it was taken private led by founder Tom Singh three years ago, its workforce has grown from 12,000 to 15,000 and capital expenditure on expanding the business has risen from £99m in March 2004 to £230m at December 2006. Not much to criticise there.