February 3, 2017

Metro trades retail for portfolio management

Metro Group -- a portfolio manager masquerading as a retailer (photo: Andrey Kiselev-Fotolia)
Metro Group: Run by a succession of portfolio managers masquerading as retailers
Next Monday the long-suffering shareholders of Metro Group will be asked to rubber-stamp management plans to split the German retail giant into two separate public limited companies.

Weird-sounding "Ceconomy AG" will then soon house Europe's largest entertainment electronics retailer, Media-Saturn, while niftily-named "Metro Wholesale and Food Specialist Company" will combine Europe's leading wholesaler, Metro Cash & Carry, and "real,-", Germany’s largest Big Box retailer by sales.

If one harkens to the siren song of Metro Group CEO Olaf Koch, international investors will soon be able to participate in an exciting international growth story: "We are now bringing two strong, successful and strategically-focused companies to the start(ing block)." Is this really the case, or is the financial community being sold another round of snake oil?

A Metro Cash & Carry Outlet in China (photo: Metro Group)
International: A Metro Cash & Carry Outlet in China
Let's try to be fair and first look at some of the good points Koch and Metro's three largest traditional shareholders, Haniel (25 per cent), Schmidt-Ruthenbeck (15.8 per cent) and Beisheim (9.1 per cent), are trying to tout.

With net sales of just under €30bn and operations in around 30 countries on three continents, Metro Cash & Carry is formidably cosmopolitan. Its empire therefore also embraces such exciting economies as Russia, China, India and Turkey.

A Media-Markt Outlet in Berlin (photo: Santiago Engelhardt)
European market leader: One of more than 800 Media-Markt stores in 14 countries
Media-Saturn is easily European market leader and is active in 14 countries on the continent. The company has nearly doubled net sales over the last decade to around €22bn, and, after many years in labour, has finally also developed a coherent online strategy.

The international reach of both multiples means that they are on the radar of other major retailers and therefore a whole range of potential partners or buyers. In this context, one needs only to mention a possible tie-up between Media-Saturn and Dixons or even US giant Best Buy.

The impending demerger will also end Metro's status as an unwieldy conglomerate. The managements of the retail/wholesale businesses will be able to concentrate on honing operations, untrammelled by the complexities of a group holding. This will undoubtedly have a positive effect on the share price.

Metro Group CEO Olaf Koch (photo: Marko Priske)
Metro Group CEO Olaf Koch: Let me tell you a story...
Since his appointment in 2012, Olaf Koch has reduced net indebtedness by €5bn. The 46-year-old finance expert has also used IFRS rules to wipe nearly €580m and €1.3bn in goodwill from the corporate balance sheets of "real,-" viz. Metro Cash & Carry. This will obviously make both companies far more attractive for potential buyers.

Last but not least, Koch speaks the arcane language of the capital markets. Unlike most of his predecessors, the former private equity manager and Metro CFO has always delivered on his promises. These include the sale of department store subsidiary "Kaufhof" to Canadian company HBC and of all "real,-" outlets in Central & Eastern Europe to French retailer Auchan.

Koch has also exited loss-making C&C operations in the UK and Vietnam. Last but not least, he has even succeeded in creating a youthful buzz at staid and grimly authoritarian Metro by implementing a number of online start-ups.

Reality check

But even Koch's financial wizardry falls flat when it runs up against the brutal limitations of the very physical world of retailing. The proceeds from his strategic disinvestments have been primarily earmarked for the reduction of debt. Significantly, and in true Metro tradition, they were hardly used for revamping lacklustre operations.

A real,- hypermarket in Germany (photo: Santiago Engelhardt)
Victim of chronic underinvestment: A real,- hypermarket in Germany
To date, Koch has not succeeded in putting either Metro Cash & Carry or "real,-" back onto a growth path. Revenues at the former are around 2006 levels and ebit is lower today than in 2008.

The picture at "real-" is far grimmer. Revenues are a third lower than eight years ago, while a much-vaunted return to profit on an ebit basis in 2015/16 only puts the hypermarket operator back to roughly what was reached in 2010.

The performance of both subsidiaries looks even weaker when one remembers that the bottom line has been bolstered by real estate profits since business year 2013/14 and obscured by exceptional items.

New world order

And what of the future? Metro was once lauded by analysts for its early entry to a number of dynamic threshold economies around the globe. But this has greatly increased the amount of country risk in a world of increasing geopolitical tension.

Metro C&C Russia (photo: Metro Group)
Stumbling on the steppe: Metro C&C in Russia
The cash & carry business once thrived in Russia with nearly double-digit profit margins. Today we have a worrying political climate, recession, and a painful devaluation of the rouble. This has put plans for an IPO on ice and generally spoiled the soup. Ukraine now teeters on the verge of civil war, while Turkey suffers from an increasingly oppressive president, a growing terrorist threat and a declining currency.

Even growth in China has slowed, and India continues to thwart its tremendous potential in a maze of restrictions and red tape.

Permanent building site

Meanwhile, at home, "real,-", with its nearly 300 outlets, has been one big building site for the last two decades. The hypermarket operator has primarily survived through cost-cutting, which has included the incredibly motivational reduction of Christmas and holiday payments to staff although not, of course, management bonuses.

This has led to chronic underinvestment in the stores, which will hardly be counteracted by future annual capex plans of only around €200m. The company vaunts an admittedly excellent flagship store in Krefeld, but where is the money for a roll-out?

So when Koch says "Metro is happy to own real,-", this is about as credible as when the Beatles claimed their song "Lucy in the Sky with Diamonds" had nothing to do with LSD. He would be far more likely to dance a jig of joy than weep alone in a corner, if a financial investor was ever brave enough to cut this albatross from off his neck.

A house divided against itself

This leaves Metro's jewel in the crown, Media-Saturn, where revenues have continued to grow, but ebit has fallen over the last decade. The new company will also inherit an increasingly vehement quarrel with co-founder and minority shareholder Erich Kellerhals. Admittedly, the demerger and IPO are an elegant way of reducing his influence and potential to create flak, but a full share price will not be realised until the hatchet has been buried.

Caveat emptor

If the demerger and the IPOs on the German MDAX mid-cap stock index go off as planned in the middle of this year, how will history view Metro? The masterminds behind its creation will certainly not be regarded as big generators of capital. If one allows for stock splits and converts from deutschmarks to euros, the share price is hardly more than it was 20 years ago. One can only guess at the opportunity costs...

At any rate, Metro's largest shareholders, Haniel, don't look like guys one would want to turn to for financial advice. The family investment company upped their stake by €3.1bn in autumn 2007 when Metro shares were coming on for nearly double the price they are today. They even managed to finance a large part of this externally when interest rates were considerably more juicy. No wonder the 600-odd members of the Haniel clan are long said to be craving release.

But the real fault was in the original construction. Metro went public in July 1996 combining a disparate bunch of retail/wholesale operations. From then on, its autocratic management never ceased to tout the big synergies that were going to be created between its various subsidiaries. This act of faith was reinforced by the creation of supra-divisional companies which aimed to strengthen buying power etc.

real,- flagship store in Krefeld (photo: Ludwig Heimrath)
Needed 300 times: The real,- flagship store in Krefeld
An interview with former Metro CEO Erwin Conradi, one of the principal architects behind the creation of Metro plc, at his home in (where else?) Switzerland is revealing: "In retrospect it was a mistake to strive for synergies by combining departments because this hindered focus and specialisation, reduced the speed of decision within the company, and increased the level of complexity." Ah, the wonders of hindsight!

Conradi also says: "The (new) group will have more room for manoeuvre, but operations will neither improve nor worsen after the split." This doesn't bode well for retail concepts that are already in the late phase of their store life cycle. Can they be reinvented or at least reinvigorated?

That will depend on the quality of their management. Like so many of his predecessors, Koch is a classical portfolio manager in a group that masquerades as a retailer. Potential investors must soon decide.


Related articles in German: "Wir bauen um!" by Hans Jürgen Schulz & Christiane Preuschat and "Nicht ins offene Messer gerannt" by Gerd Hanke on pages 25 to 35 in Lebensmittel Zeitung, no. 5, 03.02.2017; "Metro geht mit niedrigerem Gewinn in die Spaltung" by Manuela Ohs in LZnet.


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