The Pilot's Log Q&A

Michael Gebauer, head of private equity practice with PILOTpartners, talks to Robert Deri, an interim Executive about internet mail order growth and his latest role as Group Finance Director for Scala Holdings plc and the process resulting in the successful sale of the business.

Robert Deri is an experienced Business Consultant and Interim who has specialized in leading major profit and cost improvement programmes as well as strategic change. Having trained as a Chartered Accountant with KPMG he has worked at senior levels in Retail including mail order and internet, Mobile telecoms, Computer gaming and Technology. Robert was on the Board at BT Mobile Communications, Group Finance Director at both Grattan plc and ZOO Digital plc, Director of Eddie Bauer UK Ltd and has experience of AIM listing, institutional fundraisings, VC transactions and international commercial negotiations. Robert is also Vice Chairman and Chair of the Audit Committee at Scarborough and North East Hospitals Trust.

Recently Robert was placed by PILOTpartners into Scala Holdings plc, a high class Italian fashion mail order business whose brands include Artigiano and Spirito.

Robert, the growth in on-line retailing is much talked about. What was Scala's position in the market and what was your brief?
Well unless you have been living on a different planet for the last few years, you will have been bombarded about e-commerce: from companies telling you about their offers on TV and radio, the numerous news stories about the "shift to e-comm", the hype that surrounds e-commerce companies, the huge valuations being given despite little or no profits and also the fact that everyone has increasing personal experience of buying something on the web.

Scala was founded as a mail order business in the mid 1990s selling high quality Italian designed ladies fashion. The founders sold the company in 2006 via a leveraged buy- out and the business has turnover of approximately £20m with about 30% on-line. Through a subsequent financial restructuring one of the major banks became the majority shareholder and the combination of factors including further investment requirement to fund on-line expansion and wider economic issues meant that the timing was appropriate for the stakeholders to explore an exit. My involvement was to ensure that the trading was being driven appropriately with the right focus on profitability and cash generation and to manage the sale process.

To what extent were you involved were you in the sale process?
I was fully consumed by the preparation, selection of partners and the due diligence processes to make it happen. One should never underestimate the importance of the planning and preparation for a sale. The financial information has to be of a high quality, telling the story of the business properly and the balance sheet has to be fully supported and substantiated. Potential buyers are looking for certainty in asset valuations and at the moment will tend to discount heavily unless the assets are properly justified. I worked closely with PwC in preparing the sale brochure and information memorandum and led management presentations to prospective buyers. In fact, looking back one of the most important aspects was systematically to look at the potential buyers and work through the individual potential benefits for them personally – whether it be particular synergies, increased buying power, back office efficiency etc and to quantify them accordingly.

What kind of buyers were interested?
There was a range including private equity and trade retailers.
The retailers can be categorized as:

• High Street retailers looking to acquire remote shopping capability;
• On line retailers looking to expand and take advantage of greater economies of scale;
• On line retailers looking to expand into high margin fashion goods;
• Concession based retailers looking to develop alternative routes to market.

What is the rationale for existing retailers to buy a company such as this as opposed to just setting one up?
That's a good question and goes to the heart of internet and mail order retailing. You said that internet retailing is much talked about and it is true that the growth in this sector has been phenomenal. However despite lots of activity there are not many players making serious money. In fashion retailing for example you have to bear in mind that returns rates from customers will likely be in excess of 30%. Without an efficient reprocessing infrastructure this will be very costly to manage – and getting it wrong could be terminal! Also with the returns dynamic comes the skills of purchasing the right quantities and be able to reorder winning lines quickly. A contact centre infrastructure where costs can be flexed is vital – and in high quality brands this is not as simple as outsourcing to a low cost operator. One bidder for the company with over 400 shops nationwide said that acquiring Scala would leapfrog their internet business by 4 years as opposed to trying to grow it organically.

Many high street retailers have found it difficult to grow their internet operations profitably and for good reason: their warehouses are not geared for single pick operations to individual customers, they have no returns processing capability, they have no customer management information which analyses the profitability of customer acquisition by different types of marketing spend.... in short many have tried to mix two different business models without success. Probably the most successful at this has been Next with their High Street and Directory businesses; however the Directory grew from the Grattan mail order business and even then it was many years before it became profitable. What we are starting to see now are retailers trialling multi-channel strategies – supposed pure on line players have moved into sending paper out to customers. Whilst these may be dressed up as "Catazines" or "Specialogues" they still amount to printing and posting your offer out in the mail. It will be interesting to see how the dynamics work here in targeting what marketing activity is proving successful at driving profitable sales.

Do you see much ongoing corporate activity in the sector?
Absolutely. A number of internet retailers have expanded to the point where they need "step change" and this will be difficult for many of them to do organically. Warehousing and distribution are key costs and we are already seeing a number of joint venture type partnerships to leverage infrastructural capabilities. Distribution companies such as Hermes or Home Delivery Network have invested heavily recently and now offer competitive third party distribution to all sizes of players in the market with parcel tracking and dedicated delivery times including evenings and week ends. This has served to reduce a significant barrier to entry alongside other serviced solutions. It is reckoned that online expenditure grew by 15% to £21.2bn in 2009, compared to a stagnation in overall retail expenditure. People are becoming more and more used to shopping online and look to it for bargains as well as convenience. Although significant online expenditure growth is forecast it is likely to be a slower pace with the shopper population starting to become saturated, fewer new entrants gaining traction and certainly some market consolidation.

Thank you very much Robert. It sounds an exciting sector to be involved with and it looks like there will lots going on in the months ahead. Good news for you and for us as well!