French Connection (FCCN:36p), a constituent of my market-beating 2016 Bargain Shares Portfolio, remains in play, but it’s proving a tortuous process to find a buyer.
Almost 12 months ago, the directors announced that no fewer than four interested parties had approached the company with regards to a corporate transaction including a potential sale of the business (‘Bargain shares: On the M&A beat’, 22 Oct 2018). Discussions are still ongoing with a number of parties, but shareholders will now have to wait until the end of the year before the long-running strategic review process finally reaches its conclusion, six months longer than the original deadline.
As has always been the case, the value in the business lies in French Connection’s highly profitable wholesale operations which reported an operating profit of £15.2m on revenue of £77m in the 2018/19 financial year, and from lucrative licensing deals that generate average income of around £500,000 per month. Income from both activities was just enough to cover a thumping operating loss of £10.2m on the retail operation and central overheads of close to £10m to eke out a tiny underlying operating profit last financial year (‘French Connection awaits the right connection’, 19 Mar 2019). The latest half-year results reveal that the business has continued to make progress, albeit it has proved tortuous as well.
French Connection’s revenue fell from £58m to £51m in the six months to the end of July 2019, half the decline reflecting a shift in sales in the UK and Europe wholesale business from the first to the second half, and the balance as a result of scaling back the number of stores. That helped reduce operating losses in the retail division, although there is much work still to do. More important is that the seasonal first-half trading loss was cut by a third to £3.7m, and French Connection managed to report a modest increase in like-for-like retail sales on relatively stable gross margins.
Moreover, based on existing winter 2019 order books, and the positive reaction to summer 2020 collections, management guidance is to expect second-half sales to exceed the £77m total in the 2018-19 financial year, buoyed by growth in wholesale in UK/Europe from customers with significant online businesses, and department stores in the US, most notably Bloomingdales and Nordstrom. Retail will remain challenging, but at least it’s proving resilient.
Admittedly, the protracted nature of the sale process means that potential buyers now have greater bargaining power given that retail trading conditions on the UK high street have worsened this year, and that’s not going to change any time soon. However, I still feel a deal can be finally drummed out at a premium to French Connection’s market capitalisation, which is only marginally higher than its net asset value of £33.4m. The balance sheet includes net funds of £10m, so with cash being released from inventories in the second half then almost half book value could be cash backed by early next year to facilitate a buyer that can accelerate the profitability of the business. Hold.
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