Debenhams - Richard Parry

DEBENHAMS: A CASE STUDY
by
Mr. Richard H. Parry MEng (Hons.) Oxon.
A thesis submitted in partial fulfillment of
the requirements for the degree of
Sloan Fellowship MSc.
London Business School
2006
Approved by ___________________________________________________
Supervisor
__________________________________________________
__________________________________________________
__________________________________________________
Program Authorized
to Offer Degree _________________________________________________
Date __________________________________________________________

LONDON BUSINESS SCHOOL
ABSTRACT
Debenhams: A Case Study
by Mr. Richard H. Parry MEng (Hons.) Oxon.
Supervisory: Professor Eli Talmor
Department of Accounting
A thesis presented on the case study of a private equity investment in
Debenhams by the Baroness Retail Consortium: a consortium that includes the
private-equity groups CVC Capital, Texas Pacific and Merrill Lynch PE

Figure 1: Debenhams: Britain’s Favorite
Department Store
i

TABLE OF CONTENTS
List of Figures.....................................................................................................................iii
List of Tables.......................................................................................................................iv
Acknowledgments...............................................................................................................v
Executive Summary...........................................................................................................vi
Chapter I: The History of Debenhams....................................................................1
Chapter II: The Private Equity Firms ......................................................................8
Chapter III: The Leveraged Buyout Model ..........................................................12
Chapter IV: The Transaction Timeline,,
.................................................................21
Chapter V: How Baroness Won the Bid...............................................................27
Chapter VI: Baronesses Investment in Debenhams...........................................49
Chapter VII: The Debenhams IPO and The Performance of the Buyout.....58
Chapter VIII: Conclusion.........................................................................................76
Glossary...............................................................................................................................78
Appendix A: Pre-2003 Acquisition Stock Price.....................................................1
Appendix B: Abridged Profit and Loss Accounts – UK GAAP........................2
Appendix C: Abridged Balance Sheets – UK GAAP...........................................3
Appendix D: Funding Debt – UK GAAP..............................................................3
Appendix E: Effective Interest Rates.......................................................................4
Appendix F: Abridged Cash Flow Statements – UK GAAP..............................5
Appendix G: Director and Non-Executive Directors..........................................7
Appendix H: Source of Deal Value Creation.......................................................12
Appendix I: Debenhams Estimated ROCE Analysis........................................13
ii

LIST OF FIGURES
Number Page
Figure 1: Debenhams: Britain’s Favorite Department Store ......................................i
Figure 2: Debenhams: UK Department Store Sales (Source: Company data).......3
Figure 3: Debenhams: FY 2005 Sales Mix (Source: Company data)........................4
Figure 4: Debenhams: Designers at Debenhams Sales (Source: Company data)..4
Figure 5: Debenhams: Own bought versus Concessions Mix (Source: Company
data)........................................................................................................................5
Figure 6: ROCE Analysis of a fictional company; Flexible Connections..............17
Figure 7: Reaching New Heights...................................................................................26
Figure 8: Laragrove Offers Capital Structure..............................................................28
Figure 9: Relative Performance of UK Mixed Goods Retailers by Size (UK
Office of National Statistics) ...........................................................................34
Figure 10: Baroness Bids Senior Management Team................................................35
Figure 11: Baroness Capital Structure for the 455p bid............................................38
Figure 12: Baroness Capital Structure for the 477p bid............................................44
Figure 13: Nectar Rewards Partner...............................................................................48
Figure 14: Capital Structure at the 28th August.........................................................52
Figure 15: Capital Structure at the 3rd September 2005...........................................55
Figure 16: Debenhams: UK Department Store Sales (Source: Company data)...58
Figure 17: Debenhams: Designers at Debenhams Sales (Source: Company data)
...............................................................................................................................59
Figure 18: Debenhams: Bought versus Concessions Mix (Source: Company data)
...............................................................................................................................59
Figure 19: Debenhams 2006 Brand Mix (Source: Company data).........................60
Figure 20: Debenhams Brands Appeal versus the competition..............................60
Figure 21: Debenhams Supply Chain Improvements...............................................62
Figure 22: Debenhams use of sourcing from low cost countries..........................63
Figure 25: Designers at Debenhams.............................................................................64
Figure 23: Debenhams EBITDAR performance.......................................................69
Figure 24: Estimated ROCE analysis...........................................................................73
iii

LIST OF TABLES
Number Page
Table 1: Key Debenhams Facts.......................................................................................7
Table 2: Laragrove Offer: Transaction Sources and Uses (£m)..............................30
Table 3: Debenhams scheme of arrangement, expected timetable of principal
events, 3rd November 2003.............................................................................42
Table 4: 2003 Acquisition: Transaction Sources and Uses (£m).............................45
Table 5: Interviews with Philippe Costeletos, lead buyout partner from the Texas
Pacific Group......................................................................................................71
Table 6: Interviews with Philippe Costeletos, lead buyout partner from the Texas
Pacific Group......................................................................................................71
iv

ACKNOWLEDGMENTS
I would like to thank Professor Eli Talmor and Philippe Costeletos for their
assistance in the preparation of this thesis. I found Eli’s course, Venture Finance
and Private Equity, at the London Business School to be a fantastic grounding
for this case study. Philippe, the partner who conducted the buyout for the Texas
Pacific Group, provided useful information and a first hand insight into the case.
In addition, I would like to thank my wife, Comfort and my children, Oliver and
Violet for their patience and support during this undertaking.
v

EXECUTIVE SUMMARY
The three-year private equity investment by the Baroness Retail Consortium has
returned CVC, Texas Pacific Group, and Merrill Lynch Private Equity a
handsome profit. The deal, awarded European Buyout of the Year, is a two and a
half year story of individual courage, opportunism, great timing, and good
management.
Ultimately, Baroness beat Laragrove to take Debenhams private, because they
took a differential view about how to create additional value at Debenhams, and
because they took a more optimistic view of the UK retail sector. By backing an
experienced turnaround management team, Baroness was able to convince key
stakeholders that they could create additional value. This, in combination with
having a more optimistic view of the UK retail sector, allowed Baroness to justify
paying a higher price for Debenhams.
The bidding strategy and implementation by Baroness were innovative and
impressive. The lead buyout partner, Philippe Costeletos, was new to his job at
Texas Pacific and yet was able to convince key stakeholders to pursue a bid.
Baroness managed to convince Debenhams to pay £1m per week to catch up
with Laragrove’s due-diligence, and prevented others from bidding. The second
winning bid by Baroness exposed divisions within Laragrove that, along with a
shortened bid timeline allowed Baroness to win. The use of a scheme of
arrangement saved money on taxes and more easily facilitated fund raising.
Once in place, the new management team embarked on a new growth strategy.
They created value by transforming Debenhams’ business model from a cost
heavy ‘high-CAPEX, low-growth’ model to a more cost-efficient ‘high-growth,
vi

low-CAPEX’ model by (1) improving operational effectiveness, (2) driving core
sales and margin growth and transforming the supply chain, and (3) identifying
new growth sources and areas for geographical expansion.
The result was a 3.3x return on equity to investors at the IPO. An impressive 2.5x
returns were achieved through operational improvements to the Debenhams
business. These returns were 4.7x greater than if this transaction had been one
hundred percent equity financed which would have only returned 0.7x1
the
original equity. However, the impact of the British Land transaction on ROCE
needs to be investigated further. Without an accurate measure of the capital
employed in the business over the period of private ownership it is difficult to
conclude that ROCE has increased during private ownership.
The higher equity return enjoyed by Baroness did not come without additional
risk. In addition to the structural problems of department stores competing with
lower cost outlets and the cyclical risk of the UK retail market, there was
considerable interest rate risk in this transaction. Baroness chose to mitigate
business risks by conducting extensive due diligence and imposing a highly
experienced management team to transform the business. Baroness mitigated
interest rate risk through the use of hedging instruments. Baroness also mitigated
its investment risk by choosing to invest equity in other businesses that are in
other sectors and countries and by having a realistic exit strategy.
1 Company data and the following calculation: Return/(EV+Costs)=(2021-608)/(1868+40)
vii

C h a p t e r I : T h e H i s t o r y o f D e b e n h a m s
DEBENHAMS HISTORY2, ,3 4
Debenhams dates back as far as 1778. However, the name Debenhams did not
appear until 1813 when Clark and William Debenhams began retail operations, in
partnership, on Wigmore Street in central London.
The Debenhams name was first used in 1813 when Thomas Clark and William
Debenhams began retail operations as the Clark and Debenhams partnership on
Wigmore Street in central London. The business grew to include a number of
retail outlets across the UK and in 1905 Debenhams opened its first department
store and became and incorporated company.
In 1919, Debenhams acquired Harvey Nichols and, in 1928, Debenhams
acquired Drapery Trust, to gain control of several regional retailers. Subsequently,
Debenhams listed its shares on the London Stock Exchange and traded as an
independent company. In 1958, Debenhams had a failed bid for Harrods and in
1972 Debenhams was unsuccessfully bid for by UDS. By 1985 Debenhams had a
2 Debenhams website
3 Debenhams plc IPO Offer Prospectus (Citigroup, 4th May 2006), p22
4 Debenhams plc (DataMonitor), p6
1

2
portfolio of 65 department stores and owned a number of other companies,
including Hamleys, Harvey Nichols and Lotus.
In 1985 The Burton Group (now Arcadia) acquired Debenhams for £560m in a
hostile bid. The following business were subsequently disposed of:
Hamleys – 1985 to Harris Queensway
Lotus and HM Rayne (shoe retailers) – 1986 and 1987
Wellbeck Fiancé (credit cards) – 1990 to GE Capital
Harvey Nichols – 1991 to Dickson Concepts
In addition to these disposals, the late 1980s and early 1990s Debenhams
introduced exclusive ranges of own-bought merchandise in key product areas and
significantly increased its portfolio of stores. By 1997, Debenhams introduced its
first international franchise store in the Middle East.
In January 1998, Debenhams was demerged from The Burton Group and was
listed on the London Stock Exchange. Debenhams was an independent company
once again. In 1999, Debenhams launched an eCommerce website and continued
its international expansion with the launch of a store in Dubai. By December
2003, Debenhams had 104 stores in the UK and Ireland plus 10 franchises.
Debenhams delisted from the London Stock Exchange in December 2003,
following a trend set by its competitors BHS, Selfridges, and Arcadia. It was
acquired by Baroness Retail Limited, a company owned indirectly by a group of
funds managed or advised by CVC Capital Partners, Merrill Lynch Global Private
Equity and Texas Pacific Group, other institutional investors and the

management team. Baroness trumped an offer from Permira, through the use of
mezzanine financing, and paid £1.74bn in a leveraged buyout.
Since the 2003 acquisition the group has undergone a number of refinancing
rounds. In May 2005, the group underwent a major refinancing and restructuring
in which the company became the parent of the group.
In May 2006, Debenhams was IPO’ed .
DEBENHAMS TODAY5,6
Debenhams is a leading multi-category retailer and the second biggest department
store chain in the UK with approximately 18.6% of total in the United Kingdom
department store sales, having increased its market share from 15.3% in 2003.
11.8
12.9
12.3 12.1 12.1
12.8
13.4
13.8 13.7
13.3
12.2% 13.0%13.0%13.8%14.7%
18.6%
15.2%16.4%
12.0%
14.8%
11
11
12
12
13
13
14
14
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005E
0%
5%
10%
15%
20%
Market Value (£Bn) Debenhams Market Share
Figure 2: Debenhams: UK Department Store Sales
(Source: Company data)
5 Debenhams website
3

Debenhams has a strong presence in every key product category, including
women, men, childrenswear, cosmetics, and household goods. Along with its
range of women’s, men’s and childrenswear, Debenhams also offers a personal
shopping service, a wedding service, in-store catering, Debenhams Direct (home
shopping catalogue), financial services, and a fully transactional website.
Womenswear
28.4%
Menswear
17.4%
Childrenswear
5.3%
Home & Gift
16.9%
Health & Beauty
13.6%
Accessories
10.2%
Food Services
2.8%
Lingerie
5.4%
Figure 3: Debenhams: FY 2005 Sales Mix (Source: Company data)
Debenhams sells a number of international and designer brands, as well as its
own brands, including Designers at Debenhams. Sales from Designers at Debenhams
ranges’ sales have increased substantially in recent years.
2 4 8 13 83 143 208 266 324
450
0
100
200
300
400
500
1996/97
1997/98
1998/99
1999/00
2000/01
2001/02
2002/03
2003/04
2004/05
Target
Value (£M)
Figure 4: Debenhams: Designers at Debenhams Sales (Source: Company data)
4

Debenhams has a successful own brand portfolio of approximately 55 own
brands (such as Debut, Maine New England, Red Herring and Thomas Nash)
including 25 Designers at Debenhams brands. The Designers at Debenhams range offers
customers exclusive product lines at mainstream prices by designers such as
Jasper Conran, Julien Macdonald, John Rocha and Matthew Williamson. Third
party brands are either bought by Debenhams (such as Estée Lauder and Levi
Strauss) or available through in-store concessions (such as Oasis).
75 76 76 74 72 70 75
25 24 24 26 28 30 25
2000 2001 2002 2003 2004 2005 Target
Own Bought Concessions
Figure 5: Debenhams: Own bought versus
Concessions Mix (Source: Company data)
Debenhams has 123 stores, including three Desire by Debenhams stores, across
the UK and Ireland, with approximately 9.3 million square feet of trading space
and around 20,000 employees. The stores are located in various locations,
including town centres, high streets and shopping centers and cover a wide
geographic and size range.
5

In addition, Debenhams has successfully expanded into international markets by
partnering with a small number of dedicated, regional franchise partners.
Debenhams currently has 29 international franchise stores in 15 countries outside
the UK and Ireland, with a further 15 franchises scheduled to open by the end of
the 2008 financial year. Debenhams is able to offer a unique value proposition to
its international clients through the use of the Debenhams brand, its portfolio of
over 100 successful designer and own brands, and Debenhams ability to adapt
their stores to local consumer preferences or cultural requirements.
Currently, Debenhams operates franchise stores in Bahrain, Czech Republic,
Cyprus, Denmark, Hungary - Budapest, Iceland - Reykjavic, Indonesia, Kuwait
Qatar - Doha, Saudi Arabia – Jeddah and Riyadh, Malaysia, Philippines, Sweden -
Stockholm, UAE - Dubai and Sharjah, and Turkey.
6

KEY FACTS
Head Office Debenhams Retail plc
1 Welbeck Street London
W1G 0AA
Phone 084 4561 6161
Fax 020 7408 3366
Web Address www.debenhams.com
Gross Transaction Value (£M) £1810.2m (GAAP 2003)
£2,224.7m (IFRS 2006E)
EBITDA (£M) £218.1m (GAAP 2003)
£331.7m (IFRS 2006E)
% of GTV 12.0% (GAAP 2003)
14.9% (IFRS 2006E)
Financial Year End August
Employees 21,194 (August 2003)
20,262 (March 2006)
SIC Codes SIC 5311 Department Stores
NAICS Code 45211
Company Registration Number: 83395
VAT Registration Number: 698 7979 22
Table 1: Key Debenhams Facts
7

C h a p t e r I I : T h e P r i v a t e E q u i t y F i r m s
LARAGROVE7
Laragrove was a private equity consortium led by Permira that consisted of
Permira, Blackstone, Goldman Sachs PLA, and the Directors of Debenhams.
Permira
At the time of the transaction, Permira was one of Europe’s leading private equity
firms advising funds of nearly €9 billion. Permira was an independent business
with offices in London, Frankfurt, Milan, Paris, Stockholm, and New York and
focused on European buy-out transactions. Since 1985, funds advised by Permira
had invested in more than 250 transactions.
The Blackstone Group
The Blackstone Group is a private investment firm that was founded in 1985. At
the time of the transaction, The Blackstone Group, had offices in New York and
London and had raised over $14 billion for private equity investment. It had
approximately $6.5 billion in committed capital through its primary investment
vehicle, Blackstone Capital Partners IV. In addition to private equity, The
Blackstone Group also consists of private retail investing, corporate debt
investing, marketable alternative asset management, mergers and acquisitions
advisory, and restructuring and reorganisation advisory.
7 Recommended Cash Offer by Laragrove Limited for Debenhams (UBS Investment Bank, 04/08/2003),
p10-11
8

Goldman Sachs PLA
Goldman Sachs is a leading global investment banking, securities and investment
management firm that provides a wide range of services worldwide to a
substantial and diversified client base. This client base includes corporations,
financial institutions, governments and high net worth individuals. Founded in
1869, Goldman Sachs is one of the oldest and largest investment banking firms.
The firm is headquartered in New York and maintains offices in London,
Frankfurt, Tokyo, Hong Kong, and other major financial centres.
At the time of the acquisition, Goldman Sachs Capital Partners and investment
partnerships affiliated with Goldman Sachs had committed capital of
approximately $5.25 billion. GSCP 2000 was the primary investment vehicle of
Goldman Sachs for long term investments in equity, equity related securities in
privately negotiated transactions, leveraged buyouts and acquisitions. Goldman
Sachs and its partners had made global and diversified investments of
approximately £11 billion in around five hundred companies since 1986. Notable
investments included Yankees Entertainment and Sports Network, LLC and
R.H. Donnelley Corporation. Major European investments included Cognis,
Messer Griesheim, Legrand, and the cable television operations of Deutsche
Telekom.
BARONESS RETAIL CONSORTIUM8
Baroness Retail Consortium was a private equity consortium led by CVC that
consisted of CVC, Texas Pacific Group, Merrill Lynch Global Private Equity, and
the Independent Directors of Debenhams.
8 Recommended Cash Acquisition by Baroness Retail Limited for Debenhams by means of a Scheme of
Arrangement (Baroness Retail Limited, 12/09/2003), p12-13
9

CVC
At the time of the acquisitions, CVC Capital Partners was a leading independent
pan European private equity group with a strong, local European network of 11
offices focused on medium to large management buy-outs. Since 1993, CVC
Capital Partners had raised over US$8 billion that was to be invested in European
buy-outs. CVC Capital Partners’ current portfolio included 65 companies with a
combined turnover of €33 billion, which operated in 25 countries and employed
over 200,000 people.
Texas Pacific Group (TPG)
David Bonderman, James G. Coulter and William S. Price, III founded the TPG
GROUP in 1993 to pursue public and private investment opportunities through a
variety of methods, including leveraged buyouts, recapitalisations, joint ventures
and strategic public securities investments. TPG Partners III, L.P., (together with
certain parallel investment entities) is a US$4 billion private equity fund formed in
1999 to make investments in corporate acquisitions, and will be the principal
TPG Fund investing in Debenhams. The TPG Funds and their predecessor
funds currently manage over US$8 billion of committed capital. Over the past
decade, the TPG Funds, their predecessor funds and their principals have
invested over US$6 billion of equity capital in over 50 transactions.
Merrill Lynch Global Private Equity (MLGPE)
Merrill Lynch is one of the world’s leading financial management and advisory
companies, with offices in 36 countries and total client assets of approximately
US$1.4 trillion. As an investment bank, it is a leading global underwriter of debt
and equity securities and strategic advisor to corporations, governments,
institutions and individuals worldwide. Through Merrill Lynch Investment
Managers, the company is one of the world’s largest managers of financial assets.
MLGPE is the private equity arm of Merrill Lynch, and manages the MLGPE
10

Vehicles. The MLGPE Vehicles carry out long-term equity and equity-linked
investments in securities in private transactions, buyouts, and acquisitions.
11

C h a p t e r I I I : T h e L e v e r a g e d B u y o u t M o d e l
The Debenhams acquisition by Baroness Retail Consortium is a classic example
of a leveraged buyout. At the time of the leveraged buyout a small group of
investors purchased all of the equity of Debenhams. Baroness Retail Consortium
finances this acquisition with debt that was secured against Debenhams’ assets.
After the leveraged buyout the debt was restructured and assets were acquired
and divested. Debt restructuring allowed Debenhams to achieve lower rates of
interest on their debt and enabled Debenhams to achieve a greater distance of
their debt from their assets. This reduced interest costs and prepared Debenhams
for an eventual IPO. Real estate assets were divested to British Land to reduce
expensive borrowing, allow the business to focus on core activities, and to reduce
the amount of capital employed in the business. New store locations were
acquired to enable expansion of the business. Over the course of Baroness Retails
investment in Debenhams, cash was swept out of the business to pay down the
debt used to acquire Debenhams. These activities increased the enterprise value
of Debenhams and the percentage of equity in the investment. I believe that
Baronesses most likely exit was always going to be an IPO on the London Stock
Exchange. However, the consortium could have chosen to conduct a new
leveraged buyout of Debenhams or to have exited the investment through a trade
sale to another retail company.
THE EFFECT OF LEVERAGE ON AN INVESTMENT
Most young house buyers in the UK would surely appreciate the effect of
leverage on an investment. Low interest rates and an increasingly sophisticated
financial market for debt have allowed young house buyers to borrow increasing
12

13
multiples of their incomes to purchase property. These factors along with
demographic factors (increased immigration and more single households) have
boosted the demand for housing whilst tight planning regulations and a lack of
investment in travel infrastructure has restricted the supply of housing.
The corporate world has seen a similar phenomenon. Historically low interest
rates and an increasingly sophisticated financial market have allowed acquirers to
leverage their transactions at much higher levels and with lower cost debt. This
has caused a resurgence in the popularity of leveraged buyouts. How does
leverage increase the return to equity? Let us consider two examples:
Example One: One hundred percent of equity
ULeveraged Buyout (year 0)U
EBITDA: 5
EV/EBITDA
multiple: 10x
E = 50
UExit (year 3)U
EBITDA: 7.5
EV/EBITDA
multiple: 12x
E = 90
Cash multiple: 90/50 = 1.8x
IRR = 1.8P
1/3
P –1 = 22%
50
90
0
20
40
60
80
100
LBO Exit
Equity
1.8x

14
Example Two: Thirty percent of equity
EV = 50
D = 35
E = 15
UExit (year 3)U
EV = 90
D = 20
E = 70
Cash multiple: 70/15 = 4.7x
IRR = 4.7P
1/3
P –1 = 68%
15
70
35
20
0
20
40
60
80
100
LBO Exit
Equity
Debt
Clearly, a leveraged buyout has a higher internal rate of return than a pure equity
investment. However, this is misleading. If the enterprise value of the company
was reduced substantially the leveraged buyout financing could potentially have
their equity investment wiped out. In comparison, a one hundred percent equity
investment would not suffer as large a loss. Let us examine two further examples
where the value of the firm halves.
Example Three: One hundred percent of equity
EBITDA: 5
EV/EBITDA
multiple: 10x
E = 50
UExit (year 3)U
EBITDA: 7.5
EV/EBITDA
multiple: 12x
E = 25
Cash multiple: 25/50 = 1/2x
IRR = 0.5P
1/3
P –1 = (21)%
50
25
0
20
40
60
LBO Exit
Equity
1/2x
4.7x

15
Example Four: Thirty percent of equity
EV = 50
D = 35
E = 15
UExit (year 3)U
EV = 25
D = 20
E = 5
Cash multiple: 5/15 = 1/3x
IRR = (1/3)P
1/3
P –1 = (31)%
15
5
35
20
0
20
40
60
LBO Exit
Equity
Debt
In the examples above the reduction in the equity value of the company was
more heavily felt by equity investors in the leveraged transaction. Indeed, the
higher potential return (and risk of loss) of a leveraged buyout is reflected in a
higher market cost of equity that is expected for a leveraged transaction.
Profits from leveraged buyouts have fuelled interest in Private Equity, a
previously much ignored form of ownership. This has increased the multiples at
which acquirers are now required to pay to acquire targets. Indeed in many
industries, trade buyers who were thought to have been able to bid more for
companies through achieving synergies with their existing business(es) are being
outbid by purely financial buyers. Financial buyers traditionally were able to pay
more because low interest rates have allowed these investors to achieve higher
financial returns through increased leverage than trade buyers can achieve
through creating value through releasing synergies. As mainly public companies,
trade buyers have not been able to match this degree of leverage due to pension
and other responsibilities of public ownership.
1/3x

16
SOURCES OF VALUE CREATION IN A LEVERAGED BUYOUT
A leveraged buyout can earn a return to equity in one of three ways. UValue
creationU ( V∆ ) occurs by improving the operating, investment, and / or capital
efficiency of the company. UValue arbitrageU ( P∆ ) exploits mispricing and is
essentially a transfer of value from the existing shareholders to new shareholders.
Value transfer ( O∆ ) transfers value from other stakeholders to the shareholders.
These three sources of value creation will be examined in turn.
Value Creation ( V∆ )
Value is created by improving the operating, investment, and capital efficiency of
the company. Many people use EBITDA and EBITDA/ Sales to gauge value
creation. This has the advantage of being a number that is ‘close to cash’ that can
be used with a multiple to see the impact on the value of the company. How this
measure neglects to include capital that is employed in the business. Additional
capital can destroy value but increase EBITDA and EBITDA. A ROCE analysis
provides an alternative viewpoint that can be used in conjunction with EBITDA
and EBITDA/Sales growth. The diagram below shows a ROCE analysis of a
fictional company, Flexible Connections.
The x-axis (Sales/CE) is a measure of capital efficiency. The y-axis
(NOPAT/Sales) is a measure of operating or profitability of the company.
Together they show the ROCE of the company, the curved lines of constant
value. By increasing ROCE, shareholder value should be increased. So, any
additional investment (the addition of capital employed in the business) needs to
generate sufficiently profitable sales in order to maintain or enhance ROCE and
therefore shareholder value.

17
Sources: Flexible Connections Case & My Analysis
FLEXIBLE CONNECTIONS LIMITED ROCE ANALYSIS
2004
2005
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
20%
0.000 0.500 1.000 1.500 2.000
NOPAT / Sales
Sales / CE
= £20M Revenue
13.3% ROCE is attractive, however NOPAT/Sales declined from 9.7% in 2004 to 8.6% in
2005. This was despite FCL focusing on the more profitable ‘Direct Order’ segment.
ROCE
(%)
20
10
13.3%
14.8%
12
14
16
18
8
6
4
2
Figure 6: ROCE Analysis of a fictional company;
Flexible Connections
Sources of value creation include portfolio company, product, and asset
adjustments that enhance profitability and / or capital efficiency and efficiency
gains through cutting unnecessary costs, better control of inventories and
accounts receivables.
Value Arbitrage ( P∆ )
The ‘buy low’ and ‘sell high’ view of leveraged buyouts seek to source deal that
exploit mispricing in equity markets. Firms may take a contrarian view about the
market and / or buy in an industry down cycle. A private equity firms longer
investment horizon allows them to be able to ride the cycle to its peak before
exiting at a profit.

18
Value Transfer ( O∆ )
Tax Savings: very high leverage generates substantial tax savings for a leveraged
company. Indeed, many companies do not pay any taxes during their period of
high leverage. Due to the increasingly competitive nature of the bidding process
for leveraged buyout transactions these gains are being priced into the premium
paid to conduct the leveraged buyout.
Transfers from new creditors: new creditors may overvalue the leveraged
buyouts financial claims. During the 1990’s the junk bond overheated and
creditors lost out. Many people have similar concerns over the current market.
Risk shifting to existing creditors and preferred stock holders: existing
covenants may not sufficiently protect existing creditors. This depends on the
covenants that have been agreed between the creditor and the company.
Employees: the new owners may be tougher in pay negotiations because of the
need to finance their increased debt load.
What makes a good deal for shareholders?
A good deal for acquiring shareholders requires that:
CPOV +∆+∆>∆
So, the value created in the transaction must be greater than the value transferred
to other stakeholders, the premium paid to the old shareholders, and the costs of
the transaction.
What makes a good leveraged buyout candidate?
A good leveraged buyout candidate has the ability to sustain a huge debt load and
has the potential for efficiency gains.

To sustain a large debt load high and stable cash flows are required. Examples are
found in market leading companies that are in mature and recession proof
industries and who do not require large amounts of capital expenditure. Larger
amounts of debt can be achieved at lower rates if this company has a relatively
liquid balance sheet (collaterisable assets and excess cash/liquid investments),
separable non-core assets and a low current leverage.
Efficiency gains can be achieved by running the company more efficiently to
achieve cost reductions and / or top-line sales growth that improve profitability.
For example, a store refurbishment program that uses less capital but that
achieves the same results would be an example. So would reducing the value of
inventory whilst obtaining the same gross margins and sales. This is a very large
area that will be examined in more detail later in this paper for the Debenhams
transaction.
What are the key risks of a leveraged buyout and what remedial action can
be taken to address these risks?
Interest rates could rise: The western world currently enjoys historically low
interest rates. This combination of a low interest rate environment and more
sophisticated, liquid, and more relaxed lending policies by banks have, I believe,
been instrumental in causing asset prices to rise across the economy. Leveraged
buyouts should automatically do well in a low interest rate environment with
rising asset prices. Many people in the private equity and financial markets fear
the impending reversal of this trend. A rising interest rate environment would
cause a fall in asset prices and an increase in variable interest rates. Leveraged
buyout firms can and have protested themselves from these risks by taking out
fixed rate debt and / or by using hedging instruments to protect cash flows from
rising interest rates.
19

The private equity company might overpay due to adverse information
asymmetry: Information asymmetry between the buyer, the private equity
company, and the vendor: UK takeover regulations require all company
information to be shared with a potential buyer. Sufficient due-diligence enables
this gap to be reduced. Indeed, the private equity buyer may indeed have an
informational advantage because they seek to obtain a differential and more
valuable view of the company that allows the private equity company to pay more
for a winning bid.
The firm might not be able to afford it’s interest payments: Reduction in the
firms cash flows: Appropriate investment selection allows the selection of
investments that have robust cash flows during a downturn and a portfolio of
investments allows a fund to spread non-systemic risk between investments.
20

C h a p t e r I V : T h e T r a n s a c t i o n T i m e l i n e 9, ,10 11
The events of this deal can be broken down into two periods: (1) How Baroness
won the bid and (2) Baronesses investment in Debenhams. The remainder of this
chapter will present the key events during these two periods before discussing
further the events in these two time periods in the next two chapters.
HOW BARONESS WON THE BID
1998
Debenhams completes their London IPO and demerges from the Burton Group
May 12th
2003
Debenhams receives a proposal from Permira to acquire all of the share capital of
Debenhams. A committee of Independent Directors is appointed to consider the
proposal by the management team and Permira.
May 19th
2003
Philippe Costeletos starts his new job with responsibility for retail at the Texas
Pacific Group.
June 5th
2003
CVC and Texas Pacific Group meet their proposed new management team.
9 Debenhams plc IPO Offer Prospectus (Citigroup, 4th May 2006)
10 Interviews with Philippe Costeletos, lead buyout partner from the Texas Pacific Group
11 Recommended Cash Offer by Laragrove Limited for Debenhams (UBS Investment Bank, 04/08/2003)
21

Mid June 2003
CVC and Texas Pacific Group partner, together with Merrill Lynch Private
Equity and the new management team to form Baroness Retail.
June 29th
2003
Debenhams reveals that it has had an approach from Baroness and agrees to pay
Baroness £1m a week for 6 weeks diligence.
July - August 2003
Baroness conducts team diligence and site visits at Debenhams.
July 23rd
2003
The board of Laragrove (a consortium led by Permira, Blackstone, and Goldman
Sachs PIA) announce that they had agreed the terms of a recommended cash
offer of £4.25 per share for Debenhams. This values Debenhams at ~£1.5bn and
was recommended to shareholders.
August - September 2003
Baroness runs a dual track financing process.
August 4th
2003
The Laragrove offer was made to Debenhams shareholders.
September 5th
2003
The Baroness team change their financing to a senior and high yield structure.
These documents are produced over one weekend.
September 12th
2003
Baroness Retail Consortium, consisting of CVC, Texas Pacific Group, and Merrill
Lynch Private Equity, and the Independent Directors announced a £4.55 per
22

share cash offer for Debenhams to be completed under a scheme of
arrangement.
On the same day Laragrove stated that it was considering its position.
Debenhams stock trades at above £4.55 for the next month.
September 29th
2003
Baroness Retail Ltd. publishes a scheme of arrangement for the proposed
acquisition of Debenhams.
October 23rd
2003
Baroness Retail increased its cash offer to £4.70 per share.
October 24th
2003
Laragrove confirmed that it would not be increasing its offer or participate in a
bidding process that was scheduled to start on October 31st
2003.
November 1st
2003
Baroness Retail Ltd. publishes a revised scheme of arrangement for the proposed
acquisition of Debenhams.
November 5th
2003
European Commission grants unconditional clearance under the EC Merger
Regulation for Baroness Retails proposed acquisition of Debenhams.
December 5th
2003
Debenhams shares are de-listed from the London Stock Exchange.
23

BARONESSES INVESTMENT IN DEBENHAMS
December 4th
2003: The Acquisition of Debenhams by Baroness
Baroness Retail Consortium acquire Debenhams in a £1.9bn public to private
transaction. The deal is financed by £608m equity, £335m Property Bridge
financing, and £956m term debt.
April 23rd
2004: Refinance of bridge with a mortgage facility
£375m mortgage facility was raised to refinance the more expensive property
bridge financing.
2004: Refinance of Mezzanine Facility with a High Yield Bond
The original acquisition mezzanine facility of £325m is refinanced with a high
yield bond of a similar amount.
February 22nd
2005: The British Land Sale-and-Leaseback Transaction
Debenhams completes a sale-and-lease-back with British Land of 23 freehold and
long leasehold Debenhams stores. Debenhams receives a £490m consideration
from British Land.
May 16th
2005: The 2005 Acquisition
The capital structure of Baroness is changed to deliver a £1.3Bn dividend to
investors. This dividend was funded by cash generation within Debenhams,
proceeds from the sale and leaseback of properties and through the refinancing
of acquisition debt.
May 26th
to June 23rd
2005: Senior Credit Agreement
Debenhams completes £2.05bn refinancing with Credit Suisse, Merrill Lynch,
Morgan Stanley and Citigroup.
24

19th
April 2006
Debenhams completes a ‘New Credit Agreement’ with The Royal Bank of
Scotland, The Governor and Company of the Bank of Scotland, Lloyds TSB
Bank, and Barclays Capital.
April 2006
Debenhams announces its £1.74bn flotation
5th
May 2006
Debenhams returns to the London Stock Exchange
25

Figure 7: Reaching New Heights
26

C h a p t e r V : H o w B a r o n e s s W o n t h e B i d
PERMIRA’S FAILED BID
The retail sector in 2003 was expected to perform badly 2003. The Debenhams
LBO, at the price ultimately paid by Debenhams, went against market sentiment
at the time and was a gutsy move by the leader of the buyout Philippe Costeletos.
Philippe joined the Texas Pacific Group on the 19th
May 2003 to head up the
retail practice and organized the Baroness Retail Consortium bid. This bid
included a number of innovative features and took a different and more valuable
view of Debenhams and the sector than that of Permira.
The Permira Offer
In mid-May 2003, Debenhams received a cash offer of 425p per share from
private equity firm Permira Ltd.12
Permira was given until the end of June to
complete due diligence and finalise funding arrangements. New bidders were
prevented from launching a bid because (1) Permira was months ahead in their
due diligence, (2) the existing management team supported the Permira bid, (3)
there was a breakup fee that would compensate Permira should another higher
winning bid arise (4) The bid arguably represented a fair price with the existing
management in place and reflected the prevailing financial market sentiment of
the sector.
12 Mintel, Department and Variety Store Retailing – UK (Retail Intelligence, June 2003), p85
27

Funds advised
by Permira
(37.5%)
Funds advised
by Balckstone
(20.8%)
Funds advised
by GSCP
(20.8%)
Co-Investors
(10.9%)
Baron LP
Baron Guernsey 3 Ltd
(C&D shares)
Laraway
Debenhams Ltd.
Other
Subsidiaries
Debenhams
Card Handling
Services
Debenhams
Gift
Vouchers Ltd.
Debenhams
Property Ltd.
Debenhams
Retail plc
Senior
Facility
Management
(10%)
Laraplace
Wheehurst
Laragrove
(B shares)
Secured Bridge
Facility
Mezzanine
Facility
Deep
Discounted
Bonds
(A shares)
Equity of £528,404,647
Funds advised
by Permira
(37.5%)
Funds advised
by Balckstone
(20.8%)
Funds advised
by GSCP
(20.8%)
Co-Investors
(10.9%)
Baron LP
(C&D shares)
Laraway
Debenhams Ltd.
Other
Subsidiaries
Debenhams
Card Handling
Services
Debenhams
Gift
Vouchers Ltd.
Debenhams
Property Ltd.
Debenhams
Retail plc
Senior
Facility
Management
(10%)
Laraplace
Wheehurst
Laragrove
(B shares)
Secured Bridge
Facility
Mezzanine
Facility
Deep
Discounted
Bonds
(A shares)
Equity of £528,404,647
Figure 8: Laragrove Offers Capital Structure
28

The Financing of Laragrove’s Bid For Debenhams
The capital structure of the holding companies that formed the Laragrove
bidding consortium was organized in a tax efficient manner. The proposed capital
structure of the transaction is shown in Figure 8: Laragrove Offers Capital
Structure.
This capital structure was used to enable Laragrove Consortium members to be
able to recoup money from the transaction in a tax efficient way. The consortium
provided an equity injection of £528,404,647 in a limited partnership Baron LP.
This limited partnership owned four classes of shares in three limited companies
in Guernsey. The equity investment was protected from possible dilution in
further rounds of investment by using deep discounted bonds that were held by
another company owned by the Guernsey limited companies, Laraway. Laraway
owned Laraplace, Whelhurst, and the bidding vehicle, Laragrove. Debt used to
finance the transaction along with the proceeds from the aforementioned equity
injection would have been used to buy Debenhams.
The debt used to finance the transaction, unlike the deep discounted bonds, were
placed close to the assets Debenhams and its collaterisable property. Three types
of debt were used. A senior facility of variable rates at different premiums to
LIBOR and of varying terms constituted the bulk of the money that would be
used to finance the transaction. This facility also included a multi-currency
revolver to enable efficient running of the business. A bridge facility secured
against the freehold and long leasehold properties of Debenhams provided a
cheaper source of interim finance. Finally, there was a high yield component on a
short-term basis that provided that remainder of the finance.
29

Transaction Sources and Uses
Laragrove committed £528 million of equity to the purchase of Debenhams. The
transaction had an enterprise value of £1669 million with additional costs of £55
million incurred. This represented a leverage ratio of 68%.
Sources Uses
Term loan - A 280 Purchased equity1
1541
Term loan - B 120 Debt refinanced2
128
Term loan - C 120 Other3
55
Deep discount bonds 506
Bridge facility 325
Mezzanine facility 350
Ordinary equity 22
Total 1723 1723
Table 2: Laragrove Offer: Transaction Sources and
Uses (£m)
Notes
1. Baroness Retail Consortium paid £4.25 per share. The offer document,
4th
August 2003, used 362,543,038 issued shares to calculate the
Laragrove offer. This represents a purchased equity value of £1.541bn.
2. On the 30th
August 2003, Debenhams had £127.8m of net debt
outstanding. This figure represents an estimate of the net debt
outstanding at the time of the transaction.
3. The remainder is expected to consist primarily of transaction fees relating
to the transaction and variation in the amount of the net debt
outstanding.
30

Immediate Refinancing Post Acquisition
The Laragrove offer document contained agreements to setup a mortgage facility
for £160 million secured on Debenhams stores and sale and leaseback
agreements to Legal and General of £144 million, to Ravenscroft £22.4 million,
and RBS (if no other offer was received) of £145 million. Together these
transactions amounted to £471.4 million.
Interest Rate Risk Mitigation Plan
Hedging contracts were entered into that would protect two thirds of the interest
costs of the debt used to finance the acquisition. It was the intention of Permira
to refinance most (if not all) of the acquisition debt within a short timeframe after
the acquisition. So variable rate debt and hedging contracts were used to mitigate
exchange rate risk rather than the use of fixed interest rate debt.
BARONESS ENTERS THE RACE
Shareholder objections and the entry of Baroness
Permira’s offer at this stage looked like it was a done deal. However, there were
objections from Debenhams shareholders about the price that Permira was going
to pay. Some shareholders regarded the lack of a competitive process and the fact
that private equity companies had had a recent history of making large amounts
of money from the retail sector as sufficient reasons to correctly conclude that
Permira was going to buy Debenhams at too low a price.
“Before we entered the process, there was little incentive for Permira to revise is
price, even though some institutional shareholders were expressing concerns”13
31

Philippe Costeletos starts his new job at the Texas Pacific Group
Philippe Costeletos started his new job at the Texas Pacific Group on the 19th
May 2003. He had responsibility for leading the retail industry sector at the Texas
Pacific Group in their London office. Philippe seized the opportunity to put
together a competing bid for Debenhams. He had a differential view of both the
company and sector in mind that would allow him to create additional value in a
take-private of Debenhams. Crucially, he also had in mind a plan to catch up on
the months of due-diligence that Permira had already completed. Ultimately,
Philippe Costeletos would be the lead partner for the transaction and would earn
himself and his company European Buyout of the year for this transaction.
Baroness Persuades Debenhams to Pay for Due-diligence
Philippe’s decision to ask for due diligence to be paid was a crucial one. He was
new in his job at the Texas Pacific Group and had to establish the credibility to
persuade his investment committee that his differential view was worth exploring
and Debenhams that this was worth paying for.
“… Given how far ahead the competitors were in the process, we couldn’t justify
going out of pocket with the diligence costs, so we asked to be compensated for
it. This wasn’t something that had been done before, but we felt it was the only
way to move forward. As a result, the advisors were able to add some competitive
tension to the sales process and ultimately a much higher price for
shareholders.”14
Philippe’s ability to persuade his investment committee that he would be able to
catch up due diligence work was aided by UK competition law which, as long as
his team asked for same questions as the Permira team, meant that he would
receive the same information as Permira. Nonetheless to persuade the investment
32

committee that this could be done was brilliant and only matched by his ability to
deliver on his promise to catch up with Permira.
In order to add competitive tension to the bidding process, Debenhams agreed to
pay £1.06m per week to Baroness to conduct due-diligence on Philippe’s
differential view of Debenhams future potential and prospects. Details of this
inducement fee15
are contained in the Laragrove offer prospectus. The
inducement fee of £8.5m would compensate Laragrove and Baroness should a
higher bid be accepted. This feature also provided up to £6m for CVC and TPG
to conduct due diligence on Debenhams over a period of five weeks. This fee,
limited to 1% of any offer for Debenhams, also provided an additional
disincentive of up to £23m for any other bidder to enter the bidding race for
Debenhams.
BARONESSES DIFFERENTIAL AND MORE VALUABLE VIEW OF
THE BUSINESS
Baroness ultimately had a differential view to Permira that resulted in a higher
valuation and bid for Debenhams. This differential view was based on a more
optimistic view than the market of the UK retail sector and that the Debenhams
business could be more effectively managed under a new set of managers. This
differential view was crucial to Philippe and Baroness pursuing a bid for
Debenhams:
“We were working on a different plan [than Permira]. If we didn’t have our own
strong management team and investment thesis, we wouldn’t have bid.”
15 Recommended Cash Offer by Laragrove Limited for Debenhams (UBS Investment Bank, 04/08/2003),
p12
33

A Different View of the Sector
A financials markets at the time had concluded correctly that at best that the
department store retail market in the UK was flat. The large-mixed goods retail
sector, although the fastest growing segment, was only growing at a compounded
annual growth rate of 3.7% between 2000 and 200316
. Analysts were worried that
consumer spending was going to hit the wall in the UK. Baroness took a different
view by looking to the USA, which was ahead of the UK in the economic cycle.
From this they concluded that the UK consumer would get used to living with
higher levels of debt. At worst a slow down was predicted but not a sudden fall in
consumer expenditure and therefore in the prospects of Debenhams. Indeed,
Debenhams had a better track record and stronger growth prospects than its
competitors.
100
103
109
116
121
123
127
100
110
120
130
1998 1999 2000 2001 2002 2003 2004
All Retail Sales Mixed Goods Retailers Large Mixed Small Mixed
Figure 9: Relative Performance of UK Mixed
Goods Retailers by Size (UK Office of National
Statistics)
A Better Management Team
Baroness also believed that they had a management team that would be better
than the incumbent managers at Debenhams. The senior management team that
16 Office of National Statistics
34

Baroness proposed is shown in Figure 12: Baroness Bids Senior Management
Team below. Rob Templeman, Michael Sharp, and John Lovering - who turned
around Homebase and Halfords were employed to turn around Debenhams.
John Lovering, assumed the part time role of Chairman of Debenhams in
addition to his duties as a Director of Baroness Retail. Ordinarily one would
question the validity of this argument as the existing management were skilled,
experienced, and knowledgeable about the Debenhams business. This should
have given the Laragrove bid an edge.
John Lovering
Chairman
Rob Templeman
CEO
Chris Woodhouse
FD
Michael Sharp
COO
Nigel Palmer
Retail Ops Dir.
Nikki Zamblera
HR Director
Figure 10: Baroness Bids Senior Management
Team
However, the three senior members of the executive management team that were
brought onboard were very strong indeed. They had over seventy years of retail
experience between them at the time of the 2003 Acquisition (see Appendix G:
Directors Details). Both Rob Templeman (CEO) and Chris Woodhouse (CFO)
had worked together during the turnarounds of Homebase and Halfords. They
both have a reputation for being able to grasp the details of the business,
resulting in a deeper understanding of the business. Michael Sharp (COO) was
the effective number two to CEO Terry Green when Debenhams demerged
from Burton in early 1998. At the Burton Group, Michael was regarded as one of
35

the strongest operators in the Burton Group. He is also the former Managing
Director of Principles.
Ultimately this gave the Baroness team the experience, credibility, and fresh
perspective that allowed them to demonstrate additional value from their
management team vis-à-vis the incumbent management team backed by Permira.
Indeed, the lead buyout partner from the Texas Pacific Group stated that “For us
to really gain conviction in this deal, we just referred back to the [management’s]
track record of success”17
THE FIRST BARONESS BID FOR DEBENHAMS
Debenhams decision to invest in due-diligence by Baroness was validated and
rewarded with a £4.55 conventional cash offer. This cash offer was made with
the option for Debenhams to convert this bid to a scheme of arrangement.
Ultimately, Debenhams exercised the option to use a scheme of arrangement.
Capital Structure of the Debenhams Transaction
The capital structure of the holding companies that formed the Baroness bidding
consortium was organized in a tax efficient manner. The proposed capital
structure of the transaction is shown in Figure 12: Baroness Capital Structure for
the 455p bid.
This capital structure was used to enable Baroness Consortium members to be
able to recoup money from the transaction in a tax efficient way. The consortium
provided an equity injection of £599,000,000 in a limited partnership Baroness
Group LP. This limited partnership owned Baroness Group Holdings. The
36

equity investment was protected from possible dilution in further rounds of
investment by using deep discounted bonds (called the senior credit facility) that
were held by Baroness Group Holdings. Baroness Holdings UK is a wholly
owned subsidiary of Baroness Group Holdings and owns a number of
intermediate companies. These intermediate companies own Baroness Retail Ltd.,
the bidding vehicle for the transaction. Debt used to finance the transaction along
with the proceeds from the aforementioned equity injection would be used to
buy Debenhams.
As with the Laragrove bid, the original financing package included a senior facility
with a mezzanine bridge funded by a high-yield bond. The bank consortium
consisted of Credit Suisse, Merrill Lynch, Morgan Stanley, and Citigroup. The
debt used to finance the transaction, unlike the deep discounted bonds, were
placed close to the assets Debenhams and its collaterisable property. Three types
of debt were used. A senior facility of variable rates at different premiums to
LIBOR and of varying terms constituted the bulk of the money that would be
used to finance the transaction. This facility also included a multi-currency
revolver to enable efficient running of the business. A bridge facility secured
against the freehold and long leasehold properties of Debenhams provided a
cheaper source of interim finance. Finally, there was a high yield component on a
short-term basis that provided the remainder of the finance. Most of the debt was
raised as a high yield debt because “The high-yield market was more liquid than the
market for mezzanine debt. It had a deeper investor pool, meaning you could raise more.”
[Brian Gray, Freshfields Partner18
]
18 Cushnie, L. “Debenhams’ return to the LSE ensures saga ends well for all” The Lawyer, Vol. 20 Issue 18
(8th May, 2006), 13-13
37

Funds advised
by TPG
(37.9%)
Funds advised
by CVC
(37.9%)
Funds advised
by MLGPE
(15.4%)
Management
(8.8%)
Baroness Group LP
Baroness Group
Holdings
BF VI
Baroness Retail Ltd.
Debenhams Ltd.
Senior Credit
Facility
Term £566m
Revolver £125m
Baroness
Holdings UK
BF I
BF II BF IV
BF III
BF V
Mezzanine
Facility
£300m
Bridge
Facility
£354.7m
Deep Discounted
Bonds
A = £289.4m
B = £165.8m
C = £165.8m
Total = 621m
Equity of £599,000,000
Funds advised
by TPG
(37.9%)
Funds advised
by CVC
(37.9%)
Funds advised
by MLGPE
(15.4%)
Management
(8.8%)
Baroness Group LP
Baroness Group
Holdings
BF VI
Debenhams Ltd.
Senior Credit
Facility
Term £566m
Revolver £125m
Baroness
Holdings UK
BF I
BF II BF IV
BF III
BF V
Mezzanine
Facility
£300m
Bridge
Facility
£354.7m
Deep Discounted
Bonds
A = £289.4m
B = £165.8m
C = £165.8m
Total = 621m
Equity of £599,000,000
Figure 11: Baroness Capital Structure for the 455p
bid
38

BARONESSES USE OF A SCHEME OF ARRANGEMENT19
A scheme of arrangement (section 425 of the Companies Act 1985) is a court-
based procedure that is announced in the same way as a conventional offer.
However, instead of the target’s shareholders receiving an offer document the
shareholders receive a scheme document instead. This scheme document
contains notice of a shareholders’ meeting to approve the scheme and any other
resolutions that required for its implementation. For example, resolutions are
often required to approve the reduction in capital of the company.
Schemes of arrangement have traditionally been considered as being a
cumbersome and inflexible alternative to a conventional offer for companies that
are being taken private. They have both advantages and disadvantages that make
their use on balance make their use increasingly desirable in private equity
transactions.
Advantages
A lower acceptance threshold is required to acquire the company. Under a
conventional offer the bidder can only acquire the minority shares once the bid
has been accepted by 90% of the shares. A scheme of arrangement has a much
lower threshold of only 75% of the shares that vote at the meeting! It also less
likely that the bidder will be left with having to placate the interests of minority
shareholders.
Stamp duty savings (of 0.5% of the offer value) on the acquisition of the targets
shares can be made by adopting a cancellation scheme of arrangement. This
19 Compagnoli, M. and MacDougall, M. “UK switches on to schemes of arrangement: 2005 Guide to Private
Equity” International Financial Law Review, Vol. 24, p72-75
39

involves the cancellation of all shares in the target by a reduction in the targets
capital, followed by an issue of new shares to the bidder.
Share options are triggered with a conventional offer that allows minority
shareholders to exist post the transaction. If a scheme is used this problem can
be negated as these share options will be triggered at the moment the scheme
becomes effective.
Under a conventional offer, the bank has a higher degree of financial risk because
the bank can avoid any risk that the bidder will not wholly own the target and
that this situation will occur more quickly. Under a scheme of arrangement debt
can be secured on the assets of the target immediately after the scheme has
become effective.
Disadvantages
The scheme of arrangement is a court based procedure and is subject to the
timetable of the court. In contrast, a conventional offer requires only the majority
acceptance of shareholders to accept the deal in order for the bidder to obtain
control.
In order for the Baroness Retail Consortium to gain control of Debenhams they
needed to gain the approval of 70% of the voting stock of the company. On the
day of the approval of the scheme of arrangement the major shareholders were
Prudential (12.5% of the voting shares), Schroder Investment Management Ltd.
(11.51% of the voting shares), and CGNU plc. (4.79% of the voting shares).
Together, these companies represented 41% of the votes needed to pass the
scheme of arrangement if all shares were voted. Their acceptance of the deal was
critical to the scheme’s approval.
40

Market purchases prior to the shareholders meeting are excluded from the shares
that are able to vote on acceptance of the bid. Such purchases are often at a lower
price than the final bid price and allow the bidder to be more confident that their
bid will be accepted. However, should the bid fail the bidder will not be left with
shares in the company that would need to sell at a potential loss.
It is more difficult to obtain irrevocable undertakings from shareholders to accept
the bid prior to the shareholder meeting that accepts the scheme. There are
complex legal issues that arise regarding potentially different classes of shares.
Conclusion
It is now common for banks, when arranging finance, to provide loan
documentation with the transaction structured as a scheme of arrangement and as
a conventional bid. During hostile or competitive bids conventional offers
provide a higher degree of flexibility for the target to achieve a higher price. Once
the bid has been accepted or if the bid is friendly and uncompetitive the bid can
revert to a scheme of arrangement. Such a structuring of the deal has a number of
advantages for private equity transactions. This was evidential in the take-private
of Debenhams by the Baroness Retail Consortium.
Latest time for lodging blue forms of
proxy for the Court Meeting
11:00 am on 8 November 2003
Latest time to lodge pink forms for the
Debenhams EGM
11:15am on 8 November
Voting record time
6:00 pm on 8 November
Court Meeting
11:00 am on 10 November
Debenhams EGM
11:15 on 10 November
41

First Hearing Date (to sanction the
Scheme)
28 November
Hearing Record Time
6:00 pm on 1 December
Second Hearing Date (to sanction the
reduction of capital)
2 December
Last day of dealings in Debenhams
Shares
3 December
Scheme Record Time
6:00 pm on 3 December
Effective Date of the Scheme
4 December
Delisting of Debenhams Shares
7:30 pm on December 5th
Latest date for dispatch of cheques
18 December
Table 3: Debenhams scheme of arrangement,
expected timetable of principal events, 3rd
November 2003
PERMIRA’S CONSORTIUM STARTS TO DISSINTEGRATE
After Baroness had tabled the £4.55 bid for Debenhams there was disagreement
in the Laragrove consortium about how high they could go without overpaying.
Ultimately, Laragrove had a different (and lower value) view about Debenhams
prospects. This differential view arose from a different view about the
performance of the retail sector in the UK and the performance of the
management team.
42

Permira was relying on the existing management team, whereas Baroness was
relying on a new management team.
Goldman Sachs had the most conservative view of Debenhams prospects and
began to have cold feet. As the Laragrove team and bid began to waiver,
Baroness strengthened its team by recruiting Merrill Lynch Private Equity.
Baroness then took the unusual decision to up its bid to £4.75. Philippe explained
this rational as follows:
“We knew we had to move fast. We were starting to hear that Permira was trying
to get more banks on board to put in a higher offer. It’s not easy to submit a bid
over your own, but we felt their consortium was starting to waiver, and we went
in with the new bid when we felt we had the best advantage.”20
THE SECOND AND FINAL BARONESS WINNING BID
The Revised Baroness Bid
The revised bid of £4.77 was 4.8% higher than the previous high Baroness bid
and proved to be the difference between the consortiums bids and at a bid level
that provided the transaction with a very good expected return on expected risk21
.
43

Funds advised
by TPG
(37.9%)
Funds advised
by CVC
(37.9%)
Funds advised
by MLGPE
(15.4%)
Management
(8.8%)
Baroness Group LP
Baroness Group
Holdings
BF VI
Debenhams Ltd.
Senior Credit
Facility
Term £571m
Revolver £125m
Baroness
Holdings UK
BF I
BF II BF IV
BF III
BF V
Mezzanine
Facility
£325m
Bridge
Facility
£354.7m
Deep Discounted
Bonds
A = £289.4m
B = £165.8m
C = £165.8m
Total = 621m
Equity of £607,534,661
Funds advised
by TPG
(37.9%)
Funds advised
by CVC
(37.9%)
Funds advised
by MLGPE
(15.4%)
Management
(8.8%)
Baroness Group LP
Baroness Group
Holdings
BF VI
Debenhams Ltd.
Senior Credit
Facility
Term £571m
Revolver £125m
Baroness
Holdings UK
BF I
BF II BF IV
BF III
BF V
Mezzanine
Facility
£325m
Bridge
Facility
£354.7m
Deep Discounted
Bonds
A = £289.4m
B = £165.8m
C = £165.8m
Total = 621m
Equity of £607,534,661
Figure 12: Baroness Capital Structure for the 477p
bid
44

The Financing of the Debenhams Winning Bid
The financing structure of the winning £4.77 bid was nearly identical to the
previous £4.55 bid by Baroness. The new bid required an additional £7.5m of
equity from the consortium in order to maintain the same leverage ratio of
~67%. The remainder was financed through an increase of £25m in the
mezzanine facility and £5m in the term portion of the Senior Credit Facility.
Transaction Sources and Uses
Baroness committed £608 million of equity to the purchase of Debenhams. The
transaction had an enterprise value of £1868 million with additional costs of £40
million incurred. This represents a leverage ratio of 67%.
Sources Uses
Term loan - A 289.4 Purchased equity1
1740
Term loan - B 165.8 Debt refinanced2
128
Term loan - C 165.8 Other3
40
Deep discount bonds 606.3
Bridge facility 354.7
Mezzanine facility 325.0
Ordinary equity 1.0
Total 1908 1908
Table 4: 2003 Acquisition: Transaction Sources and
Uses (£m)
Notes
1. Baroness Retail Consortium paid £4.7 per share. At 11:15am on the 10th
November, 2003 the scheme of arrangement was approved. At this time
there were 370,180,593 issued shares. This represents a purchased equity
value of £1.74bn.
45

46
2. On the 30P
th
P August 2003, Debenhams had £127.8m of net debt
outstanding. This figure represents an estimate of the net debt
outstanding at the time of the transaction.
3. The remainder is expected to consist primarily of transaction fees relating
to the transaction and variation in the amount of the net debt
outstanding.
Interest Rate Risk Mitigation Plan
Hedging contracts were entered into that would protect a substantial portion of
the interest costs of the debt used to finance the acquisition. It was the intention
of Baroness to refinance most (if not all) of the acquisition debt within a short
timeframe after the acquisition. So variable rate debt and hedging contracts were
used to mitigate exchange rate risk rather than the use of fixed interest rate debt.
THE TRANSACTION PREMIUM PAID BY BARONESS
The 2003 Acquisition price paid by Baroness was far in excess of the net asset
value of Debenhams and represented a substantial premium to the NAV and the
pre-offer and alternative offer prices for Debenhams. The stock price for
Debenhams is charted in HTUAppendix A: Pre-2003 Acquisition Stock PriceUTH from the
9P
th
P May 2003, which was the last closing price before the announcement of a bid
by Laragrove, too the 4P
th
P December, which was the last closing price before
Debenhams shares were delisted from the London Stock Exchange. Baroness
Retail was required to pay the following premiums to acquire Debenhams:
The final Laragrove bid price: U10.6 percent higherU than the £4.25 price
per share announced by Laragrove on the 29P
th
P July 2003.

47
The pre-bid speculation price: U83.6 percent higherU than the £2.56
closing price per share on the 8P
th
P April 2003. This was the last closing
price prior to the announcement of a possible offer for Selfridges plc.
This announcement started speculation that Debenhams would also be
made an offer.
The last business day before Laragrove’s first offer on the 12P
th
P May:
U42.0 percent higherU that the May 9P
th
P 2003 closing price of £3.31 per share.
The six-month average closing price prior to bid speculation: U66.6
percent higherU than the average six-month closing price prior to May 9P
th
P,
2003 of £2.82 per share.
The lowest closing price in the six-month period prior to bid
speculation: U87.3 percent higherU than the lowest price paid per share of
£2.51 in the six-month period prior to bid speculation.

Figure 13: Nectar Rewards Partner
48

C h a p t e r V I : B a r o n e s s e s I n v e s t m e n t i n D e b e n h a m s
FINANCING ACTIVITIES DURING PRIVATE OWNERSHIP
Summary
The financing activities during public ownership where designed to accomplish
several aims. The first was to release quasi dividends to Baroness in the form of
cash. The second aim was to replace expensive debt with less expensive debt
(Appendix E: Effective Interest Rates). Finally, the debt structure of the business
was altered to move debt away from assets, as was the case at acquisition, to the
group level in order to prepare the company for an eventual IPO (Appendix D:
Funding Debt – UK GAAP). This would allow Baroness to achieve an exit on
their investment. These financing activities are described below.
Pre-Take Private
Pre take-private, Debenhams debt included only bank overdrafts and lease
obligations. These totaled only £146m at the 30th
August 2003.
4th
December 2003: Acquisition Financing
Please see section on financing the winning bid Chapter V: How Baroness Won
The Bid: The Second and Final Baroness Winning Bid: The Financing of the
Debenhams Winning Bid)
Immediate Post Acquisition Financing
Post acquisition financing was concerned chiefly with refinancing higher interest
rate bridge and mezzanine facilities with mortgage and high yield facilities
respectively. In total over half of the acquisition debt, ~£700m, was refinanced
out of a total acquisition debt of ~£1.3bn. These actions marginally reduced the
49

effective interest rate of the debt used to acquire Debenhams and moved debt
further away from Debenhams Ltd.
April 23rd
2004: Refinance of Bridge with a Mortgage Facility
The bridge facility, at an interest rate of 6.5%, was an interim facility and was
refinanced by a mortgage on properties held by BF Properties (No. 3) Ltd. The
facility was due in 2011 and has an effective interest rate based on LIBOR of
6.5%
2004: Refinance of Mezzanine Facility with a High Yield Facility
The £325m mezzanine facility at an interest rate of 10.5% was an expensive
facility that constituted one of the principal components of the 2003 acquisition
financing. This was refinanced by a high yield term facility of £209m at an
interest rate of 10.5% due in 2012 and a 172 million euro facility at 9.5% also due
in 2012. The costs of this refinance were also expensed immediately.
Balance Sheet at the 28th August 2004
Both the mortgage facility, although secured against freehold and long leasehold
assets, and the high yield senior note facility ensured that debt was moved away
from the core Debenhams business and towards Baroness Holding UK Ltd. See
(Figure 15: Capital Structure at the 28th August 2004). This prepared Debenhams
for an eventual IPO and made it easier for Baroness to receive a dividend in a tax
efficient manner from Debenhams. Because the senior note debt was moved
further away from the cash generation of Debenhams Ltd. The banks were taking
on additional risk in issuing this debt. Baroness was able to achieve the
mezzanine refinancing due an improvement in the cash generation capacity of the
Debenhams business. This was the result of the first stage in the Baroness plan to
improve the financial and operational performance of the Debenhams business.
50

Debenhams managed its exchange rate risk by holding a number of interest rate
swaps at between 4.9% and 6.0% interest to a total value of £939m.
51

Funds advised
by TPG
Funds advised
by CVC
Funds advised
by MLGPE
Management
Baroness Holdings
UK Ltd.
Intermediate Parent
Companies
BF III
Issuer (Debenhams
Finance Holdings plc)
Senior Notes
Debenhams Ltd.
Other
Subsidiaries
Debenhams
Card Handling
Services
Debenhams
Gift
Vouchers Ltd.
Debenhams
Property Ltd.
Debenhams
Retail plc
Senior Credit
Facility
Mortgage Facility
Baroness Group LP
Deep
Discounted
Bonds
Funds advised
by TPG
Funds advised
by CVC
Funds advised
by MLGPE
Management
Baroness Holdings
UK Ltd.
Intermediate Parent
Companies
BF III
Issuer (Debenhams
Finance Holdings plc)
Senior Notes
Debenhams Ltd.
Other
Subsidiaries
Debenhams
Card Handling
Services
Debenhams
Gift
Vouchers Ltd.
Debenhams
Property Ltd.
Debenhams
Retail plc
Senior Credit
Facility
Mortgage Facility
Baroness Group LP
Deep
Discounted
Bonds
Figure 14: Capital Structure at the 28th August
52

The Dividend Payment and Preparing for an IPO
February 22nd
2005: The British Land Sale-and-Leaseback Transaction
Debenhams management had already separated the real estate assets from the
operating company. In February 2005, Baroness completed a sale-and-leaseback
of 23 freehold and long-leasehold Debenhams stores to British Land. Profits
from the £495m deal were used to pay down debt (the mortgage facility), formed
part of a dividend that was paid to Baroness alter in the year, and provided cash
for Debenhams to expand.
May 16th
– June 23rd
2005: The 2005 Acquisition and Refinancing
The 2005 Acquisition and refinancing was a vehicle for Baroness to recover a
£1.3bn dividend payment from Debenhams. £1,196m was paid to the sponsor
consortium and £84m was paid to management and employees. Effectively a new
leveraged buyout occurred whereby the old company, Baroness Group Limited
Partnership was dissolved and replaced by a new company Debenhams Retail
Holdings Limited. £589.2m of equity was invested in the same proportions as
before by the consortium and £1.82bn of senior term loan debt was raised. This
debt was held further away from the cash flows generated by Debenhams Ltd. By
Debenhams Retail holdings Limited, which refinanced new loan, notes held
Baroness Group Holdings. These loan notes were no longer needed as this
refinancing not only delivered a £1.3bn dividend payment but also gave the
group the necessary capital structure to prepare for an eventual IPO.
Freshfields Bruckhaus Deringer advised Debenhams on the £2.05 billion
refinancing of its third-party and shareholder debt and on the related corporate
restructuring22
. CSFB, Citigroup, Merrill Lynch and Morgan Stanley acted as lead
22 “Banking and Restructuring” International Financial Law Review, Vol. 24 Issue 7 (July 2005), 13-13
53

arrangers for the syndicated loan facilities23
. Shearman and Sterling advised the
lead arrangers24
.
The market had some concerns about the amount of cash that Baroness was
taking out of Debenhams. Their concerns regarding the leverage and pricing of
the refinancing are detailed below in a European Venture Capital Journal article
of the time.
“Leverage is aggressive for a company operating in the notoriously difficult UK retail market and
some lenders have expressed concern that second lien pricing is too fine, especially as the
recapitalisation will see £800m of equity removed from the company.”25
The Balance Sheet at the 3rd
September 2005is shown in Figure 24: Capital
Structure at the 3rd September 2005.
25 M. Brizard, “REFINANCINGS” European Venture Capital Journal, 123 (June 2005), p25-26
54

Funds advised
by TPG
(37.9%)
Funds advised
by CVC
(37.9%)
Funds advised
by MLGPE
(15.4%)
Management
(8.8%)
Debenhams Retail
Holdings Limited
Baroness Group
Holdings
Intermediate
Companies
Debenhams Ltd.
Baroness
Holdings UK
Loan Notes
B = £50.1m
C = £22.3m (BELP)
Total = 589.2m
Equity of £589.2m
Senior Term
Loan
£1.82bn
Funds advised
by TPG
(37.9%)
Funds advised
by CVC
(37.9%)
Funds advised
by MLGPE
(15.4%)
Management
(8.8%)
Debenhams Retail
Holdings Limited
Baroness Group
Holdings
Intermediate
Companies
Debenhams Ltd.
Baroness
Holdings UK
Loan Notes
B = £50.1m
C = £22.3m (BELP)
Total = 589.2m
Equity of £589.2m
Senior Term
Loan
£1.82bn
Figure 15: Capital Structure at the 3rd September
2005
Final Preparations for an IPO
April 19th
2006: The ‘New Credit Agreement’
Once IPO’ed Debenhams would become a FTSE250 company. FTSE250
companies reach a different investor base and so Debenhams was able to secure
better funding levels from the banks prior to its IPO. The New Credit
Agreement provided senior facilities up to £1,350m. This consisted of a £1,050m
55

term loan and a £300m multi-currency revolving facility. “They hit the market with
perfect timing to get as much from the debt as they could” [Brian Gray, Freshfields Partner26
]
The proceeds were intended to refinance the existing package of debt and
included the early repayment of a second lien. The new credit agreement was
entered into with The Royal Bank of Scotland, the Governor and Company of
the Bank of Scotland, Lloyds TSB Bank, and Barclays Capital. The refinancing
prepared Debenhams for a near term IPO by making sure that the loan
documentation included sophisticated qualified public offering provisions.
PERFORMANCE IMPROVEMENT
The Baroness strategy is fundamentally a relatively simple and classic strategy:
Baroness bought an underperforming business whose industry and business
prospects were undervalued by the financial markets. Baroness immediately
improved the operational effectiveness of the business and adjusted the portfolio
of what was being sold to higher margin and higher growth segments whilst
taking cost out of the business by reducing non-core activities, investments, and
negotiation. These improvements then create new growth opportunities that were
exploited through the use of cash flow generated from improvements. The result
is a more profitable business that is valued at a higher multiple because of its
improved prospects. By leveraging the equity investment higher returns were
achieved than through the use of all equity financing.
26 Cushnie, L. “Debenhams’ return to the LSE ensures saga ends well for all” The Lawyer, Vol. 20 Issue 18
(8th May, 2006), 13-13
56

Baroness essentially set about transforming the operations of Debenhams. They
did this by transforming Debenhams business model from a cost heavy ‘high-
CAPEX, low-growth’ model to a more cost-efficient ‘high-growth, low-CAPEX’
model. This released cash to invest in growing the business.
The next chapter will seek to expand on and quantify the sources of value that
the Debenhams management team and Baroness created at Debenhams.
57

C h a p t e r V I I : T h e D e b e n h a m s I P O a n d T h e
P e r f o r m a n c e o f t h e B u y o u t
OPERATIONAL EQUITY RETURNS
Sales Growth (£213m equity gain)
Although the market declined between 2003 and 2005, from £13.8bn to
£13.3bn27
(see figure below), a 3.6% reduction. Debenhams was able to increase
its market share of the UK department store market from 15.3% to 18.6% during
the same period28
. Market share gains accounted for a £213m increase in the
equity value of Debenhams over the period of the transaction (see Appendix H:
Source of Deal Value Creation) and produced a 35% return on equity for the
sponsor consortium. A number of initiatives were pursued in order to achieve
these impressive gains.
11.8
12.9
12.312.112.1
12.8
13.413.813.713.3
11
11
12
12
13
13
14
14
1996
1997
1998
1999
2000
2001
2002
2003
20042005E
0%
5%
10%
15%
20%
Market Value (£Bn) Debenhams Market Share
Figure 16: Debenhams: UK Department Store
Sales (Source: Company data)
58

2 4 8 13
83
143 208 266 324
450
0
100
200
300
400
500
1996/97
1997/98
1998/99
1999/00
2000/01
2001/02
2002/03
2003/04
2004/05
Target
Value (£M)
Figure 17: Debenhams: Designers at Debenhams
Sales (Source: Company data)
75 76 76 74 72 70 75
25 24 24 26 28 30 25
2000 2001 2002 2003 2004 2005 Target
Own Bought Concessions
Figure 18: Debenhams: Bought versus Concessions
Mix (Source: Company data)
59

Figure 19: Debenhams 2006 Brand Mix (Source: Company data)
Figure 20: Debenhams Brands Appeal versus the
competition
60

Other Initiatives – Beating the sector average
Debenhams has actively promoted and enhanced the position of its own brands
and has increased its customer differentiation versus its competitors (Figure 20:
Debenhams Brands Appeal versus the competition). This along with a logical
extension of product sold through its designer range (and additional designers)
has enabled and increase in sales performance.
International Expansion
The opportunity to expand internationally was first presented to Debenhams by
the long-established, Kuwait-based Alshaya Group. The Alshaya Group is a
company with a wealth of experience in the retail sector of the Middle East and
an understanding of western retailing.29
In 2001, the Alshaya Group was
operating four hundred franchise outlets in seven Middle Eastern countries and
was a leading operator of international brands. They had franchise agreements
with Mothercare, Liz Claiborne, Next, River Island, Etam and Clarie’s
Accessories.30
Continued partnership with companies such as the Alshaya group
drives top-line growth and moves the business down the experience curve
through creating an increased bargaining power vis-à-vis suppliers.
Margin Improvement (£439m equity gain)
Reduction in Overhead and Increased Store Efficiency
Head office overhead reduced is likely to have been reduced as a proportion of
sales. Head office headcount has remained constant despite an increase in gross
transaction value31
.
29 J. Glynis, “Taking Debenhams International,” European Retail Digest, Issue 36 (Dec2002), p22-25
30 “Exploring the Middle East as a Region of Retail Excellence conference proceedings,” World Class
Retailing, 30-31 (October 2001)
31 Company data.
61

Store efficiency was increased through the achievement of improved lead times,
flexing space to be responsive to changing customer fashions and by ensuring
that high traffic floor space is used to sell higher margin product. Historically
Debenhams was part of the Burton group and much of its floor space was
devoted to selling those products, which was lower margin concession product.
Selling a more profitable mix of products
During private ownership, gross merchandise margin improved seventy basis
points from 42.2% to 42.9%. This was achieved through improved space
management in the stores, creating a differentiated and premium offering to the
customer (Figure 20: Debenhams brand appeal versus the competition), by
increasing the proportion of higher margin own brand rather than concession
products32
(Figure 18: Debenhams: Bought versus Concessions Mix), and by
increasing the mix of more profitable Designers at Debenhams sales (Figure 17:
Debenhams: Designers at Debenhams Sales).
Supply Chain Improvements
44.0%
47.7% 49.0% 49.3% 50.0%
671
579
434
380
260
40%
42%
44%
46%
48%
50%
52%
2001/02 2002/03 2003/04 2004/05 Target
0
200
400
600
800
Mix of Top 30 Number of Suppliers
Figure 21: Debenhams Supply Chain
Improvements
32 See Figure 18: Debenhams 2006 Brand Mix for a description of Debenhams major brands
62

The number of suppliers has fallen dramatically from 679 in 2002/03 to 380 in
2004/05. This has likely resulted in volume, transaction cost, distribution cost,
and payment term savings. However, the mix of the top thirty suppliers has only
increased from 47.7% to 49.3% during the same period. A consolidation of the
supplier base imposes additional risk to the business. Reducing the number of
smaller suppliers rather than increasing the concentration of the largest suppliers
has mitigated supplier concentration risk on the business.
A new distribution center has replaced several other smaller centers and can
provide additional capacity for future growth.
Sourcing from Low Cost Countries
Debnhams sources most of its merchandise by value from low cost countries. It
has adopted a sourcing strategy run on a country rather than supplier basis to
protect itself from political and macro-economic risks. This strategy has kept its
sourcing costs low.
Far East
56%Europe
23%
Turkey
10%
Indian
Region
6%
Rest of
World
5%
Figure 22: Debenhams use of sourcing from low
cost countries
63

Figure 23: Designers at Debenhams
64

Improved Targeting of Customers
In October 2002, Debenhams joined a new loyalty card venture with non-
competing brands Sainsbury’s, BP, and Barclaycard. An independent company,
Loyalty Management UK, manages the venture. The take up of the scheme
exceeded all expectations and by Spring 2003 there were 11mn33
active cards in
use. Shared access to the customer database has provided Debenhams with more
accurate customer information. This has enabled Debenhams to more effectively
market itself and attract new customers. Consequently this has improved
mix/pricing and has helped to drive Lfl sales increases.
Cash Flow and Working Capital Improvements (£282m equity gain)
Cash Flow and Working Capital improvements generated a £282m equity gain
for the deal. Baroness was very effective in this area and acted very quickly to
achieve these gains.
When Baroness took Debenhams private, the new management team found that
7.2%34
of stock was terminal (Terminal stock is stock that has reached the end of
its selling season). Indeed, stock was lying around in non-shop floor areas of
stores gathering dust. The new management managed to achieve a five hundred
basis point reduction in terminal stock to only 2.2%35
at the end of the 2005
financial year. This was achieved through an immediate fire sale that cleared this
stock and generated some immediate cash for the business36
.
33 Mintel, Department and Variety Store Retailing – UK (Retail Intelligence, June 2003), p84
34 Management Accounts
65

Management also took action to increase average creditor days. During the same
period average creditor days were more than doubled from 27 days to 60 days37
and had the effect of freeing both cash and working capital for the business.
Initiatives such as those described had the effect of freeing up a substantial
amount of working capital. Indeed before the take-private average working
capital was £25m38
. At the end of the 2005 financial year average working capital
was reduced by £145m to £(120)m39
.
NON-OPERATIONAL EQUITY RETURNS
The following presents a discussion of the non-operational equity returns for the
Debenhams deal. It is worth considering that multiple expansion will contain an
unknown proportion of gains that are caused by improved prospects in the
Debenhams business. These gains are the result of operational improvement
made by the Debenhams management team.
British Land Transaction ($315m equity gain)
This transaction provided a £315m (51% ROE) gain in the value of the
transaction on £600m+ of property transferred to British Land40
. Any sale of
property assets that are necessary to conduct business should be reflected in
higher lease payments in future years. This should, all things being equal, reduce
future expected cash flows and cancel out the money made on this gain. See
limitations of value analysis later in this chapter.
66

Expenses (£421m equity gain)
Expenses were incurred to incentivise management. At £221m these are much
smaller than the operational value created in the business. Fees and expenses paid
to lawyers, bankers, and consultants totaled £200m are cost of conducting a
leveraged buyout. It would be easy to regard these as destroying value in a
business. However, I regard them as cost in facilitating a step-level change in the
performance of the Debenhams business. Whether, this could have been
achieved under public ownership with appropriately designed incentives is
questionable and is the subject of much debate in management literature.
Multiple Expansion (£595m equity gain)
Multiple expansion accounted for a £595m increase (97% ROE) in the equity
value of Debenhams. It is unclear the extent to which the multiple expanded as a
consequence of a rising market for buyouts. However, the Debenhams
management team was successful at demonstrating improved growth prospects
for the business. This has been achieved by creating new business sales growth
opportunities by improving the economics of new Debenhams stores so that they
can now be sited in smaller markets. These markets could not previously justify
the capital expense of a new store. In addition, the Desire by Debenhams new
store concept provides an exciting small store format that can tap new smaller
markets.
Reduced New Store CAPEX
New store CAPEX has been a major success story for the Baroness team. Capital
spending per square foot for new stores has decreased by 39.3% from £178 per
sq ft to £108 per sq ft. This has been achieved by reengineering the process of
investing in new stores. Debenhams states that this has allowed them to justify
expansion into smaller markets that would have otherwise have been
uneconomic. However, the difficulty of some of its major competitors such have
67

Alders, have allowed a large amount of store space to come onto the market at a
lower cost than in the past. Whether this is included in the calculation of new
store CAPEX is not clear and also makes comparisons across stores to
benchmark performance all the more challenging.
Desire by Debenhams
Desire by Debenhams operates on a smaller 20,000 sq ft footprint and sells
higher margin Debenhams products such as the Designers range, accessories, and
cosmetics. The store is aimed squarely at women who want to purchase
Debenhams products in their smaller local town. Such a concept, if successful,
promises to increase sales per square foot and lower the cost base of the entire
company through improved company buying power. However, with only three
stores in operation at the time of the IPO, this new store concept is still in its
early stages of proving its long-term viability.
The case for multiple expansion has largely convinced the financial markets.
However, in my mind the case is not so clear. I think that time will tell if new
stores that have undergone the new CAPEX program require refurbishment
earlier than before, if lease acquisition payments are included in new store
CAPEX and if Desire is a hit.
VALUE CREATED
The result of the Debenhams management team and Baronesses strategy was an
improvement in EBITDAR (EBITDA adjusted to include rent escalators from
the British Land transaction) during the period of private ownership from
68

£218.1m to £378.8m41 (see Figure 19: Debenhams EBITDAR performance).
This is a CAGR of 20.2%42.
218.1
254.2
318.0
378.8
12.0%
13.4%
15.2%
16.7%
0
50
100
150
200
250
300
350
400
2003 2004 2005 2006e
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
Adjusted EBITDA % of GTV
Figure 24: Debenhams EBITDAR performance
The operational improvements achieved in the business are impressive. £934m of
value was created through improving the operational performance of the
Debenhams business. £479m of value was created in non-operational
performance improvements. This deal achieved a total increase in value of
£1,413m.
41 Company data
42 Company data
69

THE IPO TRANSACTION AT £1.95
On the 4th
May 2006, Debenhams returned to the London Stock Exchange. This
partial exit (Baroness, management, and employees still held thirty eight percent
of the equity in Debenhams post IPO) allowed Baroness to release a further
£1.045bn in cash. Debenhams was very consistent in its financial outlook leading
up to the IPO and stated a few weeks before the IPO that “The prospects for
Debenhams' trading for the financial year ending August 2006 remain in line with
management expectations.”43
Citigroup and Merrill Lynch were the joint global
co-coordinators of the offer, while Citigroup, Merrill Lynch, Credit Suisse and
Morgan Stanley were the joint book runners for the offer.
P/E 12.8x
2006E analyst forecast of NI £131.2m
Implied equity value £1,675m
Analyst forecast of post IPO Net debt £1,200m
Enterprise value £2,875m
Primary issuance (includes fees) £700m
Selldown at IPO £345m
Total equity issuance at IPO £1,045m
Free float post IPO 62%
Implied value of initial investors equity
at IPO price
£975m
Less Selldown at IPO (gross) £345m
43 Debenhams press release.
70

Holding post IPO £630m
% Holding 38%
Table 5: Interviews with Philippe Costeletos, lead
buyout partner from the Texas Pacific Group
DEAL ECONOMICS
Sponsor
Consort um (4)i
Management
and Employees
(2)
Initial Investment (5th
December 2003) £602m £6m
% Of company 86% 14%
Dividends at Recap (16th
May 2005) £1,196m £84m (3)
Share of Selldown at IPO (5th
May
2006)
£306m
Value of equity still invested (5th
May
2006)
£529m
% Of company 32%
Fees (5th
May 2006) £19m
Total Value from Investment (1) £2,012m
Multiple of Initial Investment 3.3x
Internal Rate of Return on Investment
(5)
98.0%
Table 6: Interviews with Philippe Costeletos, lead
buyout partner from the Texas Pacific Group
Notes
71

1. This figure is net of IPO fees and includes the value of remaining stock.
2. Includes senior management and the Debenhams Retail Employee Trust.
3. Includes cash and Debenhams loan notes.
4. There were press reports of an immediate £130m dividend paid to
Baroness post take-private. However, this amount is not included in the
figures provided by the Texas Pacific Group.
5. Calculated using the XIRR function in Microsoft Excel. This function
discounts the cash flows on the exact date that they occurred.
The Baroness Retail buyout of Debenhams returned the sponsor consortium a
3.3x return on equity to investors at the IPO. However, at the time of the IPO,
twenty six percent of the total value from the investment was not in cash and was
in the form of Debenhams stock. This left this return vulnerable to fluctuations
in the stock price and was not as liquid a return as cash. Management and
employees total value from their investment of £6m was £221m. The internal
rate of return of 98.0% is much higher than a private equity firm’s normal
requirement of at least 35%. 2.5x returns were achieved through operational
improvements to the Debenhams business. The sources of these gains are
presented in Appendix H: Source of Deal Value Creation.
LIMITATION OF VALUE ANALYSIS
General
Such an analysis is dependent upon the information that is available to analyze
decisions taken by management and their results. No attempts has been made to
72

separate the results of actions taken by past management and either been enjoyed
or regretted by the buyout management team. In addition, short-term measures
that are presented as savings from long-term trends (and therefore value
enhancing) could prove to be false economies. And projections of future
performance based on one or two years of running may prove to be too
optimistic. These risks are inherent in such an analysis.
Return on Capital Employed is a better measure of value creation
The value analysis does not consider the return on capital employed in the
business. Over the course of private ownership by Baroness, considerable capital
was released from the business on a sale and leaseback basis. In order to get a
true measure of the capital employed in the business, the present value of future
lease payments needs to be recognized as a fixed asset in order to arrive at a true
and comparable value of the capital employed in the business.
Capitalizing Leases to arrive at ROCE
2003 2004 2005
Capitalised leases (IFRS) na na 3789.5
Operating leases (GAAP) 55.3 64.8 107.2
Scaling factor 52% 60% 100%
Estimated Capitalized Leases 1954.8 2290.7 3789.5
Capital Employed excluding goodwill 852.1 1015.8 536.5
CE excl. GW and incl. Est. Cap. Leases 2807 3306 4326
Gross Sales 1810 1903 2087
EBITDA/GS 12.0% 13.3% 14.7%
GS/CE 0.64 0.58 0.48
ROCE 7.8% 7.7% 7.1%
Figure 25: Estimated ROCE analysis
73

The information needed to conduct this analysis is not included in sufficient
detail for me to be able to conduct a thorough analysis. For example, note 29 in
the IFRS statements details future lease commitments for 2005. However, figures
for 2003 and 2004 are not available under IFRS. The GAAP statements in note
27 provide summary operating lease commitments for 2003, 2004, and 2005.
However, using the GAAP figures as a scaling factor to arrive at a rough figure
for capitalized lease costs for other years could be misleading because of the size
and long-term nature of the deal vis-à-vis the other leases. In addition, freehold
properties would need to be removed from tangible fixed assets to arrive at a
better figure for capital employed in the business. Taking a rough figure using a
scaling factor for leases and not including goodwill, ignoring property price rises,
or removing freehold fixed assets, capital employed in the business increased
from £2,807m in 2003 to £4,326m in 2005.
Value would have been destroyed, as ROCE would have declined over the period
from 7.8% to 7.1%. In effect, the gains from operational improvements would
have been negated by the increase in the capital employed in the transaction from
the British Land transaction (see Appendix I: Debenhams Estimated ROCE
Analysis). The results from this analysis however are not conclusive and more
information is required to obtain a more accurate figure for capitalized lease
costs.
Ignoring the British Land Transaction
Ignoring the impact of the British Land transaction, I can proceed as follows.
Asset Turnover: Excluding property transaction, I believe that through working
capital reduction and reductions in the CAPEX required for new and refurbished
stores and ignoring goodwill, that asset turnover should have increased over the
period of private ownership.
74

EBITDA Margin: During the period of private ownership, adjusted EBITDA
margin increased from 12.0% by three hundred and eighty basis points to
15.8%44
.
From this analysis, I conclude that (excluding the property transaction) return on
capital employed in the Debenhams business has risen during the period of
private ownership.
75

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