CVAs have been thrust back into the limelight by the collapse of BHS and could provide some important reminders for landlords. Mark Simmons reports
The demise of BHS and Austin Reed has presented the property market with a timely reminder that retailers have company voluntary arrangements at their disposal and are not shy of attempting to use them.
CVAs have something of a bad rep with the property industry – and, conversely, are seen in a very positive light by retail bosses. Both sides tend to view the process as a ‘get out of jail free’ card for retailers which have at some stage signed up for leases they perhaps shouldn’t have (those in the know reckon BHS was paying up to 20% above market rents on many of its leases), and one in which landlords have little control.
Yet the reality is that many CVAs never achieve what they set out to and ultimately end up, as BHS and Austin Reed did, in the hands of an administrator. Lee Manning, restructuring services partner at Deloitte, says: “Most CVAs fail because there is too high a level of expectation of a turnaround, mainly by the company directors. They offer too quick a repayment schedule or expect a pick-up in trade, and do not make provision for lack of credit or harsher credit terms.”
Manning says that getting a management to stand back from its business can be a real challenge: “They often have rose-tinted spectacles and think they know their business better than anyone. To be fair, they may well do, but what they do not know is the whole recovery-from-insolvency process.”
One of the most common faults when CVAs are drawn up, say insolvency specialists, is the failure to prune the business back hard enough.
Manning recounts the case of Oddbins, which tried to agree a CVA in 2011. Advised to cut the store network from 149 to 60, management opted to attempt to preserve 80. In the end, the CVA was scuppered by HMRC. In the resulting administration, around 50 stores were sold on. Had the CVA been more realistic (and been approved), Manning believes it would likely have stood a much greater chance of survival.
However outlandish the prospects of success, landlords are remarkably acquiescent when it comes to voting for CVAs – very few have voted against. On paper, it is not hard to understand why: creditors stand to get a much better deal than if the business goes into administration. For example, the CVA agreed with Travelodge in 2012 (see case study) was reportedly based on creditors receiving a return of 23.4p to the £1 versus 0.2p to the £1 for the straight-to-administration option. But there are other reasons.
“From the landlord’s perspective, income is absolutely key, so they will hold on for as long as they can,” explains Damian Sumner, JLL’s head of retail agency. “And, depending on the portfolio, the capital cost of reconfiguring units may mean owners will be reluctant to take an aggressive stance.”
The recent recurrence of CVAs also flags up shortcomings on the landlord side, says Stephen Springham, head of retail research at Knight Frank: “Landlords could be accused of not managing their own portfolios very well – and not understanding how retailers occupy their spaces.”
The large landlords approached by EG were reluctant to comment on those points or the wider issue of insolvency, but Stephanie Pollitt, assistant director of real estate at the British Property Federation, responds: “We have worked with insolvency practitioners to ensure that the CVA process is as transparent as possible for landlords, and there has been definite progress in this area, which we hope will continue.”
While retail property experts agree that retailers are generally on a much firmer footing than they were in the last recession, inevitably there will be more CVAs to come. Although a CVA can be as short as three months, most are longer.
“They are generally at least three years, so all parties will need to have an appetite for that period of time,” says Neil Bennett, director at insolvency specialist Leonard Curtis.
The jury is out on whether the three-year CVA agreed with Beales department stores in March will be enough to keep the retailer afloat.
Will landlords be tempted to take a tougher stance and even vote down CVAs in future? Mike Jervis, restructuring and insolvency partner at PwC, suggests one reason they might: “They like the individual interaction they get on an administration. This is because the insolvent tenant has to deal with each site (surrender, assignment, continuation or subletting).
“As a result, landlords feel that they are less bamboozled into a deal where they have had very little dialogue and each site can be considered on its individual merits.”
Many property professionals suspect, though, that the status quo will continue. Sumner concludes: “The CVA has been around long enough to tell us it is not a great solution, but landlords accept that it may be the best of a bad job.”
CVA – in brief
A company voluntary arrangement aims to allow a company to avoid liquidation. At its most basic, a CVA involves an agreement between a company and its creditors to restructure or reduce its debts.
A CVA can keep a business going, with the directors staying in control, while giving it time to pay, although the support of creditors is crucial.
Source: Freeths
Case study – happy ending
Budget hotel chain Travelodge used a CVA in 2012 to check out of a £500m debt problem, equivalent to nearly £1m for each of its 505 hotels.
Approved by 97% of creditors, a three-year plan was agreed with backers Goldman Sachs, GoldenTree Asset Management and Avenue Capital that included the closure of 49 hotels, a 25% rent reduction on circa one-quarter of the remaining portfolio, and a significant debt write-off.
The rent cuts were balanced by lease extensions, target-related cash bonuses and opportunities to reset rents to market levels after three years.
Peter Gowers, a new chief executive who had a deep understanding of hospitality, came on board in 2013 from IHG to oversee a £100m refurbishment programme.
Helped by a recovering global economy and rocketing demand for budget hotel accommodation, Travelodge has bounced back, seeing underlying earnings break the £100m barrier for the first time last year. Occupancy rates have climbed to nearly 77%.
Earlier this year, the chain said it planned to invest a further £140m in new hotel openings across the UK – 19 are expected in 2016, following on from 12 that opened last year.
A mooted £1bn sale of the business or flotation has been shelved for the time being, though the current voracious investor appetite for hotels may mean it is back on the cards before too long.
Are leisure operators fitter for CVAs?
While Austin Reed and BHS are the latest in a string of retailers to hit the buffers after unsuccessful CVAs, their leisure sector counterparts seem to have had more success. They include: Travelodge (see box), Tragus Group (Café Rouge, Bella Italia, Strada), Intertain (Walkabout), Essenden (Tenpin), LA Fitness and Fitness First.
The reason leisure operators may be better placed to flourish under a CVA than retailers, suggest market experts, is that the underlying business is often stronger. “There are higher barriers to entry in leisure and the sector is less vulnerable than retailing and more resilient to the internet,” says Coffer Corporate Leisure managing director Mark Sheehan.
Although few leisure operators are currently showing signs of financial stress, there is a quiet awareness in the market that both restaurant groups and hotel operators that have recently expanded quickly may have signed up to leases that, in a couple of years’ time, may look much less attractive.
So to avoid issues with CVAs in the future, Sheehan advises leisure investors not to be bowled over by glitzy tenant names and focus on property fundamentals such as location and building quality.
He warns: “Covenants can be pretty worthless, as an equity player can take a company private, rack up debt and suddenly what was a strong covenant is now a weak one.”
Case Study: Unhappy ending
As well as having illustrious investors such as the Bill & Melinda Gates Foundation, JJB Sports is notable for unsuccessfully finding its way out of not one, but two CVAs. The first was agreed in 2009 when the UK’s former largest sports retailer stumbled during the recession.
Despite closing 140 stores, it remained in trouble and the CVA gave landlords of the closed stores a share in a £10m cash fund (payable in two instalments) in lieu of rental payment. The landlords of the remaining 250 stores agreed to monthly (rather than quarterly) rent payments for one year.
This was the first time a listed company had used a CVA to fight off administration, but at the nadir of a global recession, it wasn’t enough to put the business back in the black. So a second CVA, in 2011, tried to get JJB back in the game. This time landlords agreed to monthly rents for two years on a core portfolio of 147 stores. The remaining 89 were earmarked for possible closure over two years, with rents reduced by 50%.
Despite these concessions, JJB was still unable to meet the terms of the second CVA and the business went into administration in 2012.
