Debenhams share price: where to next as Sports Direct circles?

The transformation occurring on the British high street has claimed victims from all areas of the retail sector. The competition from leaner online rivals twinned with burgeoning labour, store and restructuring costs has had a crippling effect on long-established players, with BHS, Toys R’Us, Poundworld, Maplin, HMV and, in the last three months alone, LK Bennett and Patisserie Valerie, just some of the many brands to have collapsed. Even Bennetts Department Store in Derby – which claims to be the oldest department store in the world having been open since 1734 – has fallen into administration after failing to adapt to online rivals and succumbing to weaker consumer confidence that has plagued the industry for years.

The sector now faces losing a considerably larger department store as Debenhams, having become a staple of the high street and an iconic British brand over its 200-year history, fights for survival. Having been stuck in the doldrums and seen its performance deteriorate over recent years Debenhams is now scrambling to secure funding to keep itself afloat while trying to defend itself against Mike Ashley, the retail tycoon and founder of Sports Direct who is trying to fulfil a long-held ambition of taking control of the department store chain.

We have a look at what has happened at Debenhams, how the department store is trying to turn things around, and whether Ashley will get his way.

The fall of Debenhams: how did it come to this?

Despite its best efforts, Debenhams, which runs 165 stores in the UK with more in Ireland and Denmark and about 27,000 employees on its books, has failed to turnaround its fortunes after falling into a period of decline in 2016.

The firm, which has traditionally been strong in areas like clothing, gifts and beauty, has been slow to adapt to the growing amount of shopping being done online. Debenhams makes about 20% of its total sales through its online site, and growth in the six months to March 2 slowed to just 2% versus 10% the year before. Plus, while its digital rivals enjoy lower costs, Debenhams has been burdened by rising staff costs and higher business rates, and weighed down by long and pricey leases that sees Debenhams pay above market rates for two thirds of its estate.

The chain has issued several profit warnings over recent years – three alone in 2018 – as demand for its mid-market offering has faltered. Although its rivals have also faced trouble, rivals such as Savers, Bodycare and B&M have all stolen custom in the key areas of health and beauty while the likes of John Lewis has shown there is opportunity at the higher-end of the market, reporting an 11% sales surge in the final week of 2018 to report a relatively mild 0.5% dip for the full year. Meanwhile, Debenhams saw sales decline 3% over the Christmas period – which was the worst season for the industry as a whole since the financial crash of 2008. Debenhams says trading has improved but sales have continued to decline in 2019 and, in March, said the guidance for the current year – issued only in January – was no longer valid.

Read more on Debenhams saying profit guidance is ‘no longer valid’ as refinancing talks drag on.

In an effort to move Debenhams into the digital age, restructure its bloated store network and wean itself off relying on reducing prices in order to compete with the swathe of discounting rivals, the company launched a new strategy in April 2017 named ‘Redesigning Debenhams’. However, it has so far failed to yield tangible results, with Debenhams having sunk to an almighty £492 million pre-tax loss in 2018 following two successive years of profit decline. Its former finance director also renegotiated the company’s £320 million revolving credit facility to avoid breaching its financial covenants after realising the situation was only getting worse. The firm’s new finance chief, Rachel Osborne, has had to pick up the baton and continued the fight to keep Debenhams afloat.

How is Debenhams hoping to turn things around?

Debenhams is currently taking a number of steps to try to get back onto firmer footing. It aims to shut up to 50 stores over the coming years and has cut costs across the business, having raised its annual savings target to £80 million from £50 million in January. It has also announced a sourcing deal with Hong Kong-listed Li & Fung, which not only provides some much-needed confidence but also helps mitigate any scale it loses, and therefore purchasing power, when it shuts down stores. That is significant as its trade credit insurance – which allowed it to free up more capital rather than tying it up in inventory – has deteriorated with its finances. Debenhams has said ranges from the deal are to be stocked in the 'current season' and should lead to better margins and improved efficiency when it comes to day-to-day spending.

Although many would like it to have been faster, digital sales have grown 20% over the last two years and have bounced back from the slow start to the year, rising 6% in the six weeks to 5 January. The nine stores it has refreshed under its new format, although a tiny proportion of its estate, has 'outperformed the core chain'.

Debenhams is also in the process of a major refinancing of loans that are up for repayment in 2020 that, depending on the outcome, will be pivotal to the future of the department store. In February it secured a £40 million bride facility to tie it over while it negotiates a larger £150 million refinancing from the same lenders. The bridge financing, which would be repaid if the larger refinancing is secured, was a vital lifeline for the company as it needs to pay the likes of its quarterly rent later this month.

Read more on Debenhams securing £40 million rescue deal from lenders.

Debenhams, which in addition to store closures has said it is implementing 'rent reduction plans', is also reported to be keen to restructure its obligations in an attempt to secure lower rents to make stores viable again, hoping landlords would rather cut their income than lose it altogether. In December, British Land said it was selling its last-four Debenhams outlets as part of its efforts to reduce exposure to individual retailers in favour of multi-use destinations and large multi-brand centres.

But Sports Direct has other ideas for Debenhams

Sports Direct, the UK's largest sporting goods retailer run by its founder Mike Ashley, is the largest shareholder in Debenhams and has its own vision of where the department store should be heading. Sports Direct purchased its original stake in August 2017 and now owns around 30% of the company, which is just one of a string of retailers the firm has invested in or bought over recent years.

Learn about activist investors and how they work.

Initially, Sports Direct was nothing more than a supportive shareholder but relations have broken down over the last six months with Debenhams’ poor performance prompting Ashley to take action to try to save the business and, of course, his investment. Last year, Sports Direct wrote-down the value of its investment in Debenhams by almost £77 million following the collapse of its share price. Although Sports Direct had been unhappy in the past that Debenhams had failed to take its advice it had accepted its decisions. For example, Debenhams was hoping to sell its Danish business Magasin du Nord for around £100 million to £200 million to raise cash despite calls from Sports Direct not to do so. Still, after realising the deteriorating retail environment meant it wouldn’t secure its desired value, Debenhams abandoned its attempt to sell the business earlier this year.

The big spark that ignited the current fallout between Sports Direct and Debenhams came last December when, upon hearing the department store was looking to secure the £40 million bridge facility, Sports Direct offered to loan Debenhams the same amount but with no interest. That was accompanied by a letter from Ashley that went gung-ho at Debenhams’ management by claiming 'there isn’t any good news out there' and stating: 'the market is saying you’ve got no credit insurance, advisers and the banks are telling key suppliers they shouldn’t trade with you at a level above which they can afford to lose, the suppliers are managing themselves out of stores and, at the same time, you’re discounting product in an effort presumably to try and realise some cash.' Ashley even went as far to say it 'is speculated that the company currently has a zero chance of survival'.

Despite being called out by Ashley, Debenhams turned down his offer down and decided to pursue talks with the banks, which, based on the 40% jump in its share price on announcing the bridge facility, looked to be the right decision. Debenhams said it was in the best interests of 'all shareholders'.

Although the letter said 'we’re not saying don’t try and do a refinancing if that’s what you ultimately want and need to do nor that we won’t be supportive in this regard', Sports Direct has not let the issue lie. At Debenhams’ annual general meeting in January, held just hours after it reported its disappointing Christmas trading figures, Sports Direct and another shareholder, Landmark Group, spectacularly ousted Debenhams chairman Ian Cheshire from the company and chief executive officer (CEO) Sergio Bucher off the board (although he remains CEO) despite only holding a combined stake of around 38%. They were successful not because they hold a controlling stake, but because a huge group of shareholders – owning nearly one-third of the company – didn’t vote, which gave Sports Direct and Landmark considerably more sway. For example, of the votes cast on Bucher’s re-election, 44% were in favour versus 56% against but, excluding the votes cast by Sports Direct and Landmark, 99.6% of the votes supported Bucher. Terry Duddy, an existing senior independent director, took over as interim chairman of Debenhams.

Although Sport Direct’s interference splits opinion, Ashley’s dissatisfaction is justified. Debenhams shares have plunged over 95% since Cheshire took over as chairman in April 2016, and by 94% since Bucher (who joined later in 2016) introduced the Redesigning Debenhams strategy.

It has now taken one step further by requisitioning a meeting to put forward proposals that, if approved, would oust the entire board of Debenhams apart from finance director Osborne, who only joined late last year, and appoint Ashley as chief executive. Debenhams, which said it was 'disappointed' in Sports Direct, has not yet set a date for the meeting but will have to hold one if it is unable to convince Ashley and his team to drop its proposals soon.

Read about Mike Ashley looking to take the helm at ailing Debenhams.

In the meantime, Debenhams has been trying to progress the larger £150 million refinancing which, if secured, would help steady the ship. But, just as it did with the bridge facility, Sports Direct has offered to loan the same amount – but only if Ashley is installed as a director and CEO. Plus, if Debenhams wanted to take the loan interest-free then it would have to ask shareholders for permission to award new shares to Sports Direct to boost its stake by 5% (to about 35%). If approved, Debenhams would not have to pay any interest on the 12-month loan but if shareholders rejected such a proposal then the firm would have to pay interest at 3%. Debenhams has said it would need to gain approval from its other lenders to accept such an offer and make 'material amendments' to its existing debt but has said it will consider the proposal. Sports Direct has asked Debenhams to decide before the end of March, although it is clear Debenhams does not want to accept the offer. Ashley has also added pressure by accusing Debenhams of issuing 'misleading' statements about its performance and outlook, which it said it had referred to regulators.

Why is Sports Direct eager to loan Debenhams money?

The offer of interest-free loans may seem helpful at face value, but there are reasons why Debenhams has refrained from reaching out for Ashley’s olive branch. Some have suggested the offers have an ulterior motive. If Debenhams continues to slide closer toward administration or a company voluntary arrangement (CVA, more on this later), then it is highly likely that shareholders would be wiped out altogether, as its lenders would be the first to be paid from any sums raised. The lenders would be unlikely to get all their money back, let alone leave anything for investors.

With that in mind, some believe the loan offers are an attempt by Sports Direct to become a lender to Debenhams and not just a shareholder, therefore putting it in a better position to recover funds or secure control over certain assets if the department store collapses.

This has unsurprisingly been denied by Ashley, which, in the letter sent late last year offering the initial bridge facility, said he couldn’t fathom how the offer to provide interest-free financing and to inject new equity 'could possibly be seen or portrayed as a negative in any shape or form'.

Why hasn’t Sports Direct bought Debenhams?

Amid the 'frustration' of Sports Direct at Debenhams unwillingness to listen to its advice, many have questioned why Ashley doesn’t launch a takeover bid for the business. It has been on the cards for a while and, with Debenhams shares so cheap, seems logical. However, there are numerous reasons why Sports Direct hasn’t pulled the trigger – for now anyway.

Firstly, it has been limited in its ability to launch an offer over the past six months after issuing a statement last September confirming that it was not preparing to launch an offer for Debenhams. Under takeover rules, that statement meant Sports Direct was only able to launch an offer for the company under certain circumstances, like if another firm bid for the business or the Debenhams board suddenly warmed to the idea. However, that restriction was lifted just days ago, meaning Sports Direct is free to launch a fresh bid if it wants.

But many still think that is unlikely. Under takeover rules, any person or business that acquires over 30% of a company is obliged to make an offer for the entire company. With Sports Direct virtually at that threshold, it would be unable to buy more shares without triggering a larger offer. Now, while this would allow Sports Direct to take control of the company at a rock-bottom price, it would also leave it responsible for Debenhams troubles. For example, there are clauses attached to Debenhams £220 million worth of bonds that mean, if Sports Direct was to takeover Debenhams, it would have to repay the bondholders in full if they elect to do so. It is highly likely that bondholders would take advantage of this considering the bonds are trading at less than half of their face value. But, with Debenhams worth just £40 million, the bondholders may be the only thing stopping Ashley from trying to take over the company through traditional means.

Then there is the argument that Ashley’s comments and interference are aimed at pushing Debenhams share price even lower and closer toward collapse, so he can purchase the business at an even cheaper rate. While no shareholder has an interest to drive down the value of their own investment it is possible Sports Direct, having lost virtually all of the value of its investment already, sees more opportunity pushing Debenhams into further trouble than trying to reverse its fortunes at this late stage in the game. When fellow department store House of Fraser collapsed Sports Direct held over an 11% stake but only launched a takeover offer to 'save' the business once it had fallen into administration. This not only gave it the upper hand in negotiations with the administrators, but it also meant Sports Direct was able to renegotiate the terms of House of Fraser’s leases (to reduce rent, in some cases to zero) and suppliers (to reduce costs). It also did the same when it bought Evans Cycles after it fell into administration. The ability to renegotiate the likes of leases is significant as they have been one of the key cost burdens that has forced so many retailers to collapse, meaning they could become potentially attractive and viable once again if they are cut or removed.

Remembering the fact Debenhams is already closing down 50 stores and has admitted two thirds of its estate pays above average rates, there is good reason to believe Sports Direct will only take the plunge if it knows it can eradicate the costs that got Debenhams into this position in the first place. Debenhams has not prioritised pursuit of a CVA – whereby it would be able to cut rents and escape its leases – but has not ruled it out altogether. Some reports suggest a CVA could be announced in a matter of days so Debenhams can avoid paying its quarterly rent, which is due on March 25.

Will Mike Ashley take over Debenhams?

Ashley certainly wants to, but it is clear he is willing to play the long game and wait for the right time. The acquisition of several other faltering retailers and attempts to take control over the board show Ashley wants to be Debenhams saviour, even if the department store doesn’t want his help. He has proven that, with the help of Landmark, Sports Direct has the ability to steer Debenhams in his desired direction – suggesting the department store will have difficult time getting any future proposals past shareholders without its support.

However, there is a potential quick fix for Debenhams if it can either get Landmark on-side or, what may be considered an easier task, get the rest of its shareholders to vote following the poor turnout at the annual general meeting AGM. It is fair to suggest turnout will be higher in future votes if investors have become aware of the current turmoil and the risk it poses to their investment, but which way they would vote on any future proposals is unknown. For now, Ashley is in command of an oversized influence over the business.

What will happen next in the Sports Direct-Debenhams saga?

The next big announcement in this drama is likely to be Debenhams’s decision as to whether it intends to accept the £150 million loan offered by Sports Direct. The department store is keen to do all it can to avoid having to take money from the shareholder but could warm to the idea if it thinks it would struggle to gain shareholder approval for alternative plans or, of course, if the alternatives disappear off the table altogether. Debenhams is still in decline and the outlook is bleak, meaning the banks will only have so much patience (and money). Ashley has asked Debenhams to make a decision before the end of March.

If Debenhams accepts the loan offer from Sports Direct then Ashley would become CEO and a director of the company (which is likely to see Bucher and others leave). Debenhams would then have to put forward a proposal to all its other shareholders (Sports Direct would not be able to vote on its own proposal) so they can decide whether to award the company new shares worth 5% of its enlarged issued share capital. If approved, Sports Direct will see its stake rise to around 35% and the 12-month, £150 million loan will not bear any interest. If shareholders reject that proposal, then the loan will carry a 3% interest rate and Sports Direct’s stake will remain unchanged.

Neither party has made it clear whether shareholders would have to give approval for Debenhams to accept the loan, but the department store has said it would need to get its existing lenders on-board before it could accept.

Then there is the matter of the extraordinary general meeting (EGM) that Sports Direct has called to propose ousting the entire board (except the finance director). Debenhams has not announced a date for the meeting, which it is obliged to schedule within 21 days of the requisition (on 7 March) and hold within 28 days, suggesting it will be held sometime in April. However, it is highly likely Debenhams will wait as long as it can before pencilling anything in and instead focus on changing Sport Direct’s mind. If Debenhams accepts the loan offer then Sports Direct, with Ashley on the board, is very likely to call off its threat. Either way, Debenhams will be making sure that it is prepared should the vote go ahead by trying to turn its other shareholders around to gather enough support to eradicate Ashley’s (and Landmark’s) voting power. If it can secure its own refinancing, Debenhams will have the tough task of convincing shareholders that it is better to take a pricier loan from the banks than a cheaper one from Sports Direct. It will likely argue Debenhams is better off fighting for its own survival than folding into Ashley’s growing retail empire.

Regardless of how any of that plays out, it does nothing to resolve the true problems nor change the company’s fortunes. Without drastic change, it is simply throwing money at the problem – which is why the caveat attached to Sports Direct’s loan offer requiring Ashley to be in charge if it wants financial aid justified. Why would it give money to a board it doesn’t believe in?

It is not clear how close Debenhams is to collapsing into administration or implementing a CVA but it is steamrolling in that direction. The refinancing – whoever supplies it – will bide it time and see it through 2019, but unless it introduces huge changes this year then it will find itself in the exact same position in 12 months’ time – and Ashley, if he hasn’t pulled the trigger already, will have Debenhams in his crosshairs once again.

What will happen to Sports Direct if Ashley takes the helm at Debenhams?

Sports Direct has said Ashley will step down as CEO if he gets the top job at Debenhams and will be replaced by 'acting chief executive' Chris Wootton, currently Sports Direct's deputy chief financial officer. Some have suggested that title leaves the door open for Ashley’s return, possibly once he is happy with Debenhams and has his own management in place. However, Wootton’s job title could simply suggest the company will look for an external candidate to take over the job permanently.

Either way – be under no illusion – Ashley will still be calling the shots at Sports Direct even if he must stand down.

Why does Mike Ashley want Debenhams?

Ashley is determined to be the saviour of Britain’s high streets and he has big ambitious, long-term plans for the future of retail. Sports Direct already has a long-established Strategic Investment division that has been used to invest in several companies including computer gaming store GAME, clothing brand French Connection, 5/7-aside football competition operator Goals Soccer Centres, online sales retailer MySale Group and Findel, which supplies resources to the education sector and runs a direct-to-mail order business called Studio Retail. Ashley aims to get something out of each investment: whether that be better supply terms from clothing suppliers or to gain exposure to new retail concepts, such as GAME’s new e-gaming arenas.

The company has also rescued several companies after they fell into trouble, including House of Fraser, Evans Cycles, lingerie brand Agent Provocateur and furniture site Sofa.com. While it has been perceived by some as Ashley sweeping in to take advantage of the sector’s weakness, he has saved them from fading into the history books and, in return, hasn’t been rewarded with immediate gain. House of Fraser made a sizeable £31 million loss in the first eleven weeks of ownership alone and burnt through over double that sum in cash. Ashley has recognised the challenges ahead, but this once again shows his long-term focus as he strives to make House of Fraser – which some believe Ashley wants to merge with rival Debenhams – into the 'Harrods of the High Street'.

Although it isn’t the only strategy in play, Ashley is trying to create the ultimate one-stop shopping destination that offers multiple brands under one roof. It describes these as 'large format flagship-style megastores in strategic retail locations that may include one or more of the group's fascias on a single site', including its Everlast gym brand where appropriate. It has built a flagship site in Thurrock that has brought its portfolio together, placing its other brands like Flannels and USC around a central Sports Direct outlet. The site boasts a suave an upmarket look, which is an equally important aim for Ashley who is keen to turn his empire’s bargain basement reputation into a high-end one. This is why House of Fraser was purchased and is supported by the fact its existing brands serving the higher-end of the market, like Flannels, are performing better than its core business.

Read about a 'similar model happening in the UK supermarket industry'.

Although it is clear Ashley wants Debenhams, some argue he has been blinded by his long-term love for the store. Merging it with House of Fraser and folding it into its wider portfolio will help provide scale, yield synergies and cut costs, but ultimately Debenhams is a company in freefall that has little property to offer.

Where next for Debenhams shares?

Debenhams shares are currently trading at all-time lows and the company as a whole is worth just £40 million – a fraction of the £1.7 billion value it boasted at its peak in 2006. It was reported earlier this month by wealth manager Canaccord Genuity that Debenhams was the third most-shorted stock in the UK, having been a regular candidate for the last three years.

The appeal of Debenhams shares is almost non-existent at present. Many expect the bankers would force Debenhams to raise further equity to secure the refinancing it needs, which would dilute if not wipe-out existing shareholders entirely. A debt-for-equity swap, whereby its lenders would effectively write-off debts in return for shares in the company, could also happen and create the same result.

The historic low of Debenhams shares at present does, however, mean it could offer significant upside should it recover.