Cortefiel: The Vultures Circle

As the economy slows, Spain's retail sector is having a more and more difficult time, and as they do the vultures are starting to hover. The "vultures" in this case are what are known as vulture funds who specialise in buying-up the debt of ailing companies on the cheap. According to press reports today some of these funds are starting to take the view that debt from Spanish retailer Cortefiel may now be cheap enough to buy, after waiting months for prices of the struggling company's debt to fall further. Such funds, which have allegedly raised billions of dollars to invest on the hopes that a worsening global economy will depress debt prices, have been rumoured to be closely monitoring the Spanish group, whose debt trades currently at about 42 percent of its face value.

Cortafiel debt is well below the value of average bids on Europe's top 40 leveraged loans. which stood at 87.5 percent of face value on August 8, according to data from Reuters Loan Pricing Corp.

Grupo Cortefiel is the second largest apparel retailer in Spain through Cortefiel (traditional clothing), Springfield (contemporary and cosmopolitan look) and Women's Secret (underwear retailer). The Iberian Peninsula accounts for more than 85% of the revenues of the group. The company operates approximately 1,100 stores and is present outside Iberia through international retail formats and franchise operations (Douglas, Milano, Pedro del Hierro). In September 2005, PAI Partners acquired, jointly with CVC Capital Partners and Permira, a 86.8% shareholding in Cortefiel, following a joint take-over bid launched in July 2005.

Cortefiel - like most other Spanish retail groups is struggling in the face of the recent dramatic slowdown in retail sales - this is how effectively the real economy slowdown operates as a positive feedback mechanism on the financial sector crisis, and why the whole thing is crashing down much more rapidly than most conventional analysts (or, needless to say, Spain's government) seem to understand.






Cortefiel borrowed 1.3 billion euros in June last year in a recapitalization of its 2005 buy-out debt, acquired when the three private equity firms bought the company. Cortefiel's debt is now estimated to be about 1.080 billion euros. The trading company holds 650 million euros of debt, while another 450 million euros were borrowed by a holding company in Luxembourg, which own 85 percent of Cortefiel through another holding company according to reuters reports, with the debt held by the Luxembourg vehicle having been use to pay out to the private equity owners.

Cortefiel forecast between 180 and 190 million in annual earnings before interest, taxes, depreciation and amortization (EBITDA), but with the current slowdown it is well behind on meeting those targets.

Distressed funds buy parts of corporate loans hoping that the price will go up following a market improvement. Another strategy, known as loan-to-own, is to buy the debt and wait for a covenant breach, hoping that a debt-for-equity swap will land the funds an equity stake in the company. Cortefiel's net debt-to-EBITDA ratio was 6.2 times in early July, still well below a cap in bank covenants of 7.6 times, a source said in July. But at about 2 times, the EBITDA-to-interest cover ratio was nearer a covenant mark of 1.9 times, the source said.



Housing Output Continues To Rise

But even as retail sales plummet and demand to by property in Spain may collapses the supply of new homes seems to just keep on rising and rising. Construction completions increased by 2.8% - to 269,954 - in the first 5 months of the year when compared with the same period in 2007 according to figures released by the Ministry of Development yesterday.

Indeed construction completions are likely to carry on increasing for at least another quarter, perhaps longer, as new developments started at the peak of the boom are finished off. This swansong building boom (with no purchasers in sight) will however be short lived, since the number of new homes started is now in its turn collapsing - falling by around 60% in the first 5 months of the year.

People may well find it hard to understand why the number of new homes finished in Spain in 2008 will beat all previous records, simply adding insult to injury over the already existing glut of newly built homes languishing idlyon the market. But this was the information provided recently by non other than Jose Luis Malo de Molina, director general of the Bank of Spain, who declared to an astonished audience “The number of new homes this year will hit an all time high, more than in 2007,” at a recent conference in Valencia.

The logic behind this otherwise bizarre behaviour on the part of the Spanish construction industry was provided for us by Benjamín Muñoz, general secretary of the Valencian Region’s developer association. Speaking to the regional daily ‘Las Provincias’, Muñoz explained that “the real estate sector can’t turn around quickly, it works in the medium and long term, so this year the properties started at the end of 2005 and beginning of 2006 will be completed, which means the number of new properties on the market will hit an all time high.” In other words this industry has no on-off switch to press, the new houses simply keep getting churned out until one of the key components in the machinery finally breaks.


Services Sector Contracts In June

Spains services sector contracted again in June. Month on month it was down 0.2% on May, and year on year it was down 4.8% on June 2007.



If we look at the seasonally unadjusted index provided by the national statistics office, we can see that, despite the fact there is some cyclical seasonal variation, the idex readings are now well down from their previous highs.




Construction Output Drops Again In June

And of course Spain's construction output continues on its downward path. In fact at this point in time the slowdown in construction appears to be eurozone wide, and Eurostat reported today that construction output in the euro zone shrank by 0.6 percent in June from May as slowing economies and a bursting of housing bubbles in countries like Spain hit the whole sector. The European Union's statistical unit Eurostat said that compared with June 2007, construction output in the same month this year sank by 2.4 percent. Slovenia and Spain saw the biggest drops in the single currency area, with month-on-month falls in June of 5.8 percent and 3.1 percent respectively.

Spanish construction was down 15.9% year on year.






And if you are wondering how this reduction in activity squares with the earlier news that more houses were being finished in Spain in 2008 than ever, remember that this data referes to completions, and the reduction in activity is due to the steady slowdown in new building starts, which suggests I think that activity in 2009 will be on a very low level indeed, with few houses started this year, and probably even less in 2009 itself.