Last chance for the high street

House of Fraser has not been without its own operational faults. Like many high-street retailers, the company has been punished for its past debt-fuelled expansion, a strategy that has left it sinking under a huge store estate with long lease terms, and short of the sort of returns needed to offset expenses. These expenses not only include steeper rents, but also rising wage bills and higher business rates.

On the latter point, House of Fraser has company. In fact, higher business rates are causing distress for many businesses, not just retailers, and compounding the existential threats to the British high street in the process. The tax, while rarely the sole driver of business insolvencies, “certainly [is] a contributory factor”, according to Robert Hayton, an adviser on UK business rates at consultancy Altus Group. Unfortunately, this presents the sector with yet another quandary, from which there is no clear path to safety.

Source: Altus Group

Online vs offline

Business rates went up in April, and with them the rising howls of high-street retailers. Tesco (TSCO) chief executive Dave Lewis has called for reform of the tax. Rising rates are near the top of JD Wetherspoon (JDW) chairman Tim Martin’s list of bêtes noires. In explaining the closure of a Covent Garden store, Marks and Spencer (MKS) chief executive Steve Rowe described the site’s near-£0.5m rise in business rates in the space of a year, as “untenable”.

For bigger retail businesses, one of the chief gripes with rate changes has been disparity across the sector. The problem is clear: online behemoths such as Amazon (US:AMZ) and Asos (ASC) aren’t subject to the same charges, despite their significant and growing share of the market. Without a high-street presence, critics argue, these online companies not only fail to contribute to the Treasury, but continue to undercut those determined (or left behind) to foster the survival of the British high street.

Even when it comes to the extensive distribution centres run by online retailers, Altus Group analysis showed that rates on these properties have fallen for companies including Asos and Littlewoods-owner Shop Direct, while Amazon only incurred a business rate tax bill equivalent to £38m this year. The rateable value of its fulfilment centres ranges from £27 per metre square in Swansea to £67.50 per metre square in Hemel Hempstead. That compares with House of Fraser’s Oxford St store, which saw its rateable value rise 57 per cent under the last revaluation to £3.28m, equivalent to £228 per square metre. Similarly, John Lewis’s High Wycombe department store costs the group £155 per square metre – more than double Amazon’s nearby Hemel Hempstead warehouse.

On average, Amazon pays a business rate bill equivalent to £46 per square metre across 13 fulfilment centres, while Altus Group estimates that rises in this year’s rates equated to just 0.7 per cent for 11 of Amazon’s 14 “vast sheds”. In its defence, the Seattle-headquartered company says it pays all taxes demanded under UK law, and that it pays “tens of millions of pounds more in business rates in England and Wales” than the Altus research suggests. Amazon also says it pays more than just the rates on its fulfilment centres – and that its business rates bill “increased significantly” in 2018.

The end of the high street?

Some will also counter that Amazon simply has a better business model, and that the competition needs to catch up or out-innovate the US giant’s redefinition of shopping. But the main argument among UK high-street retailers is that if government policy doesn’t act quickly to make life easier, then the high street will die. A string of high-profile collapses this year – including Maplin, Toys ‘R’ Us, and Poundworld – all point to the difficulties of running a successful retail business. Others, including Mothercare (MTC), Carpetright (CPR) and House of Fraser, have all attempted to use company voluntary arrangements (CVAs) to exit underperforming stores and secure their futures.

The latter solution faces its own form of opposition. A CVA is effectively the first stage of an insolvency procedure, which allows a company with serious debt problems to reach agreement with its creditors regarding repayment of all, or part of its corporate debts over an agreed period of time. As part of this process, the CVA can allow groups to exit punitive property leases ahead of schedule. For listed retailers, equity fundraisings are often part of the deal, so existing shareholders can find their investment diluted, too. But the alternative is often complete collapse, which helps win over legacy stakeholders, and lure fresh investors convinced a turnaround is afoot.

Landlords, however, have dug their heels in. In response to House of Fraser’s use of this scheme, some of its major store owners attempted a legal challenge, claiming the deal to exit 31 of 59 sites and slash the rent bill on the remainder was unfair. But the appeal itself was rendered moot when C.banner, the Chinese owner of Hamley’s, pulled out of a rescue plan to inject £70m in exchange for a 51 per cent stake in the chain. House of Fraser’s subsequent collapse was also short-lived thanks to Mike Ashley’s pledge to buy the company out of administration for £90m. 

While the company’s debt and pension liabilities aren’t part of the package, cash generation will remain a major issue. Mr Ashley has said he wants to keep 80 per cent of House of Fraser stores open, but rates and other fixed costs are still part of the problem. Business rate bills for the department store chain rose 15 per cent to £4m in 2017-18, and could rise again this financial year.

But even companies eligible for discounts, such as pubs, have suffered under the first year of revaluation. According to research by Altus, pubs saw rates bills rise 5.6 per cent despite the £1,000 relief, while restaurants saw rises of roughly 23.3 per cent.

Future relief

Earlier in August, many industries – not just retail – welcomed comments by chancellor Philip Hammond, who hinted that the government would consider the introduction of a tax on online businesses to make up for the disparity in business rate charges. “We want to assure that the high street remains resilient,” said Mr Hammond in an interview with Sky News. “We want to make sure that taxation is fair, between businesses doing business the traditional way, and those doing business online.” But Mr Hammond also pointed out a crucial difference with these online groups, many of which are international, and so would require the renegotiation of international tax treaties to allow for new legislation at home. If international agreements cannot be found, Mr Hammond has floated the idea of temporary tax measures in Britain, which could be enforced until new international rules are agreed. Revenues from these new taxes could then be diverted to ease the burden of property-led retailers on the British high street.

Spreading the risk

The introduction of a new online tax doesn’t seem out of the question. Similar measures were taken in the gambling sector three years ago, with the point of consumption tax, which was designed to stop online gambling groups registering offshore and paying minimal duties on their sold services in the UK market. Now online gambling companies pay a 15 per cent levy on revenues generated where the relevant player is based. Additional levies have since been introduced on cash bonuses too. 

This prospect leaves groups such as Asos and boohoo (BOO) highly exposed, but it’s worth remembering that high-street chains like Debenhams (DEB) – in which Mike Ashley also owns a 29 per cent stake – and Marks and Spencer now have extensive online operations as well. Even if property-related business rates are frozen, an additional online levy isn’t going to ease the pain. This must be a consideration in any new legislation as high-street retailers of a certain size risk facing twice the expense, leaving only small and medium-sized enterprises (SMEs) without an online presence as the true winners. HR