Tuesday, 1 March 2011

Virtuous Vertu and HMV the Dog

A flurry of activity this morning when I switched on my Blackberry to see trading updates from HMV and Vertu. Let's start with the bad...

HMV Group

The two pieces of news this morning were short and pithy, but no less significant. 

The first announcement was a trading update since the last one a mere seven weeks ago. In that period, profits will now be "moderately" below market expectations (which were £45m of PBT based on the median expectations -  there must be some crazy stuff out for them to use median) due to "challenging" trading conditions.

To compound matters, debt will not be less than £130m due to changing product mix and adverse working capital, and it now expects to breach certain banking covenants based on the full-year tests. The Company has commenced discussions with its lenders, who "continue to be supportive".

In the second announcement, the Chairman has stepped aside (to focus more on M&S presumably) and Philip Rowley has picked up the mantle with immediate effect.

The shares dropped over 20% to 16.5p in early morning trade, giving the Company a market value of £88m.

Before I starting writing this, my mind-set was to ditch HMV along the lines of 'run the winners and cut the losers'. 

It's easy to paint a very bleak picture: tough trading, profits below expectations, covenant breach on the cards, debt higher than forecast, reduced cash generation, big sector/cyclical issues playing themselves out and the Chairman stepping aside.

Is there any Value here?

I have no idea what "moderate" means in terms of black and white (or red) numbers, but let's assume PBT comes in at £30m (two-thirds of median expectations - sounds moderate to me)

Tax this at 28% and EPS equates to about 4p per share. The current share price of 16.5p equates to a PER of 4.1x.

The dividend policy is to aim for say 3-4x times cover, so a theoretical dividend of 1p per share would be possible. The interim dividend was 0.9p, so rule out any further dividends in the short-term from an earnings perspective and in any event, the banks will not permit it if the Company has breached covenants or will breach covenants on a look-forward basis.

EBITDA looks interesting given that that DA was about £45m in FY10 (I would expect it to be higher in FY11) and Interest will be, say, £10m (v £7m in FY10). This gets us to an underlying EBITDA of £85-90m for FY11. Based on an EV of £220m (£130m debt and £90m equity), this represents an EV/EBITDA ratio of 2.5 times.

We would want to look at the rent-adjusted position given that it is a retailer, but I am not sure how much sensible analysis can be undertaken given that they are on a store closing programme.

HMV is priced for failure based on a PER of 4x and an EV/EBITDA of 2.5x. The two aspects that worry me most are (i) cash generation - is the adverse working capital temporary or permanent (if the former, then the level of debt is higher than normalised and cash should come back in) and (ii) the size of the 'exceptionals' and the extent to which these are cash items (eg redundancies and unexpired lease costs).

The other interesting aspects are: the Russian Mamut waiting in the wings and/or the potential disposal of Waterstone's. If Waterstone's was valued at £50m (figure plucked from the air via "media sources"), this would equate to a fully-taxed gain of about 7p per share - from what I can see, this is not reflected in the share price.  I would not be surprised to see a Rights Issue appear sooner rather than later too.

HMV is one sick mutt, but is it terminal? Not yet; I can still see some value here, but the next few months are going to be very interesting indeed. Stick or twist?


Vertu is the Ying to HMV's Yang (if that's the right way around).

Trading has remained strong and results are likely to be ahead of FY11 expectations (EPS of 2.7p as per Digital Look) . Market share has grown, cash generation has been good and a final dividend of 0.3p has been disclosed (full year DPS 0.5p; yield of 1.8%).

On the down-side, there will be exceptional costs in relation to asset write downs and financing costs.

I am topping up my holdings in HMV and Vertu.


  1. "The shares dropped over 20% to 16.5p in early morning trade, giving the Company a market value of £88m."

    16.5p gives HMV an MCAP of 70m. The company was worth 88m yesterday. Interesting analysis, but I disagree with one or two things.

    "HMV is priced for failure based on a PER of 4x and an EV/EBITDA of 2.5x. "

    I don't think 4x PER is priced for failure. I'd say 4x represents some troubles, but a reasonable chance that the company will return to profits in the future. I'm not sure HMV's chances are that great.

    I don't think you need to get bogged down in the numeric details with HMV. Qualitative questions are all that are required.

    Is it likely that HMV will return to full health? I think no chance whatsoever. This 'structural decline' is perminant.

    Can it change the ship before it sinks? I think not. HMV live is obviously a viable busines, but it's profits will easily be swallowed by the main business's loses.

  2. Anon

    I took the market cap from the LSE website. It could be that because the share price was jumping around so much, I forget to refresh the screen - apologies - but at £70m it makes it look even cheaper!

    In terms of numeric detail, yes I do want to get bogged down in them - the more the better. It's easy to get caught up in emotion when every press report screams along the lines of 'sell...it's going bust...head for the hills' etc. The price dropped c20% yesterday as there was a huge imbalance between buyers and sellers (a ratio of 1:19 per LSE yesterday). Did the underlying value fall by 20% yesterday? Maybe, maybe not.

    For the time being, I'm in the 'maybe not' camp. The market is pricing HMV at <4x PER and <2.5x EV/EBITDA, which is very cheap for a conventional share. Ok, it's not a conventional share and, as you rightly point out, if it was really priced for failure, the share price would be a lot lower if not zero.

    The higher debt levels and adverse working capital are a huge cause for concern, and the near-time future of the company will be in the hands of the banks. I am not going to disagree with the structural issues, but can I see a future for a profitable multi-channel music retailer? Probably

    I am prepared to stand aside from the herd for the time being and will revaluate my position as and when new information comes to light. I am expecting a rocky road