Ever since Eric the Red settled Greenland and his son Leif the Lucky discovered America, Iceland’s Vikings and their descendants have put to sea in search of prosperity. The desolate island, where putrefied shark meat is considered a delicacy and people still speak a variant of the medieval language of the Norse sagas, has only 286,000 inhabitants. Fleets of huge, modern fishing trawlers provide most of their wealth.
Perhaps it’s not utterly shocking, therefore, that the co-founders of Baugur, Iceland’s No. 1 retailer, are looking to other shores for growth. The surprising part is that after picking up U.S. discount chain Bill’s Dollar Stores at a bankruptcy auction last April, the father-and-son team launched a bid for British clothing retailer Arcadia Group, a target five times Baugur’s size. Jóhannes Jónsson, 61, who was Baugur’s CEO until he passed the title to his son in 1998, tends like many Icelanders to fall into oceanic imagery in his speech. The takeover attempt, he admits, is like “a porpoise trying to swallow a whale.”
Indeed. On January 31 Arcadia broke off three months of talks, explaining that Baugur was taking too long to assemble its financing and that the negotiations were distracting management. Jónsson and his 33-year-old son, Jón ásgeir Jóhannesson, were offering between £530 million and £568 million ($759 million to $813 million) for the 79.9 percent stake in Arcadia that Baugur doesn’t already own. They hoped to line up about £350 million worth of syndicated loans to finance the purchase and pay down the target company’s debt. So far, bankers have been reluctant to give their project the green light.
For one thing, Baugur made its mark by introducing competitive pricing to Iceland, mainly in the food business. It was so successful that the government introduced the country’s first antitrust legislation, in 1995, largely to halt the company’s metastasizing market share. But skeptics wonder whether Jónsson and Jóhannesson can do as well abroad, especially in the fickle fashion industry.
For another, their acquisition target has problems. Although Arcadia has reversed an earnings decline, closing more than 400 unprofitable stores and posting a Christmas 2001 sales increase of 9.4 percent, it still derives nearly 70 percent of its £1.9 billion in annual sales from somewhat stale clothing brands aimed at older shoppers, including midprice men’s chain Burton; midprice women’s chain Dorothy Perkins; the high-end women’s chain Wallis; and Evans, a specialty shop for larger women. Jónsson and Jóhannesson are said to want to sell off those chains and concentrate on Arcadia’s popular youth brands, Topshop and Miss Selfridge, but finding buyers for the rejects won’t be easy.
In addition, in a notoriously cyclical sector, Arcadia is even more vulnerable than rivals to a retail slowdown. That’s because apart from its flagship Oxford Circus store, it is locked into long-term leases for most of its 2,124 stores, paying annual rent of £200 million. “That burdensome bill means funding debt could become a major issue in an economic downturn,” says Keith Wills, a retail analyst at Goldman, Sachs & Co. in London. Perhaps most alarming, few industry observers think Britain’s red-hot retail market, fueled by record consumer spending, can keep growing as fast as it has for the past couple of years.
Nevertheless, Baugur will probably try again. “We are still the largest single shareholder in Arcadia and continue to take a keen interest in that business,” says Jóhannesson. “We are still evaluating our options, but there is nothing that would prevent us from proceeding with a bid for Arcadia.”
Analysts think Jónsson and Jóhannesson are likely to wait, however, until Arcadia’s stock price, which has risen to 295 pence per share on the strength of its 2001 performance and on the takeover talk, cools down a bit. Says Arcadia CEO Stuart Rose: “We have had detailed, frank and friendly discussions with Baugur, but there was a mismatch of their expectations of giving an offer and ours of receiving one. This does not preclude them from coming back.”
Jóhannesson, meanwhile, stands by his strategy. “We have had no choice but to look overseas for growth,” he says. “If we try to grow any bigger in Iceland, we will get into trouble with the antitrust authorities.” In the 13 years since its birth as a 350-square-meter discount food outlet, Baugur has grown huge by the small republic’s standards. It controls 45 percent of Iceland’s food sales, 30 percent of retail clothing sales and 50 percent of prescription drug sales. With 2,000 workers, Baugur is Iceland’s third-largest employer.
Thanks to Jóhannesson’s push overseas, however, the company now derives more than half of its $410 million in annual sales from abroad - mainly from Florida-based Bonus Stores, the parent of Bill’s Dollar Stores, and increasingly from Scandinavia, where Baugur bought Arcadia’s franchise in late 1999 and is building a chain of Topshops and Miss Selfridges. A born entrepreneur, Jóhannesson is winning growing respect from retail market watchers in Europe, the U.S. and especially the U.K. His quiet accumulation of 20.1 percent of Arcadia’s stock has made him the biggest Icelandic investor outside his country. If Baugur ever wins control of the British retailer, it will be the largest acquisition in Icelandic corporate history.
And Jóhannesson has a vision for Arcadia. He sees the future in its youth brands, which he believes can travel. “There is similarity across the international fashion market when you are targeting younger rather than older people,” he says. “Their tastes are the pretty much the same from country to country, but there are not many stores that target young people exclusively the way Topshop and Miss Selfridge do.”
With roughly 15 percent each, Jónsson and Jóhannesson control Baugur, which is listed only on Iceland’s seven-year-old stock exchange and has been publicly traded since 1998. (The other major shareholders are Kaupthing Bank, Iceland’s biggest investment bank; Íslandsbanki, its biggest commercial bank; and Reitan Narvesen, a Norwegian supermarket chain.) Together the father and son resemble a rock impresario and his star client. With a white goatee and standing 6-foot-2, Jónsson is the friendly face Icelanders associate with Baugur. He negotiates with suppliers, visits the stores and talks with customers. Jóhannesson, who rarely meets the public, manages the company’s financing and maps out strategy. He favors all-black designer clothing - never a necktie - and sports shoulder-length brown hair. In his rare moments of leisure, Jóhannesson, who is divorced with three children, likes to tool around the solitary Icelandic outback on a snowmobile.
Jóhannesson is the man who decided Baugur should try to buy Arcadia. He began building his stake in the British company in October 2000, when its stock was trading at a ten-year low of 38p. The retailer had posted a £152 million loss for the fiscal year, having expanded from nine brands to 14 in less than two years, even though clothing prices had fallen by 20 percent since 1997 under pressure from new domestic discount chains. Total market capitalization was just £71 million, a little more than two weeks’ sales. Many investors feared Arcadia would have to issue shares or sell its Oxford Circus store to avoid bankruptcy.
But Jóhannesson knew Arcadia better than most. “Considering the price and the company’s assets, we thought people’s fears were exaggerated,” he says. “The idea of making a bid for the company was already in the back of my mind, but we principally bought because it was just a great deal that gave us lots of options for the future.”
At first, Baugur had partners in its Arcadia investment: Gaumur, a private holding company owned by Jónsson and Jóhannesson that serves as the principal ownership vehicle for their stakes in Baugur; Íslandsbanki, in which Gaumur holds a 7 percent stake; investment bank Kaupthing; and Gilding, an Icelandic private equity investment fund. Altogether the partners put in an estimated 3.3 billion kronur ($32.2 million) for a stake now worth about $160 million.
In November 2000 Arcadia brought in a new chief executive, Stuart Rose, who had turned around and then sold troubled U.K. food wholesaler Argos and who had once run Arcadia’s Burton chain. Rose reduced the number of chains from 14 to six, shuttered 450 underperforming stores in the U.K. and cut costs by 6 percent. Sales at the remaining chains rose 8 percent last year, and gross profit margins were up 4.5 percent, to 50.6 percent. The restructuring allowed Arcadia to pay off £100 million of its £240 million debt. Arcadia is now on track to bring debt down to £90 million this year and to report a net profit of £44.5 million, after losing £66.5 million last year.
Thrilled by the turnaround, investors pushed up Arcadia’s stock by 473 percent in the year before Baugur’s bid was announced in October 2001. By that time, Baugur had bought out its partners’ stakes, at a premium to their purchase price but at a roughly 26 percent discount to the prevailing market price (paying with debt provided by the two banks), to become Arcadia’s largest shareholder. The stock jumped a further 23 percent, to 268p, when takeover negotiations were prematurely announced on October 25 after Arcadia’s investment bankers, Schroder Salomon Smith Barney, accidentally faxed Baugur’s expression of interest to a wrong number, forcing Rose to make a public statement. The mistake, says one of Jóhannesson’s advisers, “meant we had to work in a harsh spotlight and without the leisure we would have had if initial contacts had been kept secret.”
Now Jóhannesson and his potential lenders, Deutsche Bank and Royal Bank of Scotland Group, are back at the drawing board. Baugur has already lined up about £100 million in equity financing and would borrow about £60 million against the Oxford Circus building. Jóhannesson still thinks he can get syndicated loans worth at least two times Arcadia’s 2002 estimated earnings before interest, taxes, depreciation and amortization of £172 million. “That’s the standard range for retail deals, so in theory, it is definitely financeable,” says an adviser to Jóhannesson.
Another element that Baugur’s advisers claim was close to being clinched at the time talks were called off is a sale-leaseback deal for the Oxford Circus building and some of Arcadia’s other real estate assets. Approximately £120 million of the £180 million or so of equity in the Oxford Circus facility is currently pledged as collateral for existing loans to Arcadia. A sale-leaseback of Arcadia’s real estate could raise £250 million, according to one of the retailer’s advisers.
Baugur wouldn’t be getting a problem-free company. Many analysts and investors believe that even after Rose’s brand streamlining, Arcadia remains overdiversified and offers little potential for growth compared with more focused chains. “Arcadia just doesn’t have the focus of the best brands, nor the same ability to respond to changing taste,” says Goldman Sachs’ Wills.
So why is Jóhannesson convinced that acquiring the company would be good for Baugur? “We are willing to do things with Arcadia that U.K. investors won’t,” he says. “That means we can exploit opportunities that would be neglected otherwise.” Specifically, he says, he plans to take Arcadia’s brands to Europe and the U.S. “What convinced us this could work was the popularity of the Arcadia stores we’ve already opened up in Sweden,” Jóhannesson says. “It’s only after we opened those shops that we decided it would be worthwhile bidding on all of Arcadia.”
Baugur’s international push would focus on Arcadia’s youth brands - the stores that worked in Sweden. The portability of youth fashion means that transplanted Miss Selfridges and Topshops can benefit from huge economies of scale. According to Jóhannesson, 95 percent of the goods bought for an overseas Topshop will be identical to those bought for the U.K. market, so the group will wield enormous buying power. “The idea could work,” says Wills, who notes that other focused chains enjoy gross profit margins close to 60 percent, versus Baugur’s 27 percent and Arcadia’s 51 percent.
Jónsson and Jóhannesson may be only fledgling fashion executives, but they are passionate retailers. Jónsson is a second-generation food merchant who for 17 years was a senior executive at the supermarket operation of Southern Slaughterhouse Association, a farmers’ cooperative that has since retreated to the wholesale market. His son started stocking Coca-Cola for him at age 6 and at 14 went into business for himself, selling popcorn. When he was 16 his father took him to Germany and lent him the money to buy 20 dime-store animal rides for kids. Set up in front of the cooperative’s supermarkets, they helped support Jóhannesson during four years at the Icelandic College for Commerce and Trade.
Jónsson traveled frequently to Germany and Denmark, negotiating with food importers for his employer. Familiar with discount grocery chains like Germany’s Aldi Einkauf and Denmark’s Netto, he saw a chance to bring the model to Iceland. When his son graduated from the business school in 1989, at age 20, Jónsson suggested that the two of them open up Bónus, Iceland’s first discount food store.
Father and son invested $4,500 each in a spartan, two-room shop in the Skútuvogur industrial park on ReykjavÍk’s outskirts. The store revolutionized food shopping in Iceland. Bónus initially had only three employees - Jónsson, Jóhannesson and an assistant - and offered only 800 products. To avoid buying expensive, electricity-guzzling coolers, the father and son reserved one room for meat and vegetables, keeping it chilled to 4 degrees centigrade. Most important, they brought bar codes to Iceland. “That’s the key to our success,” says Jónsson. “Bar codes allowed us to enter income and costs automatically into our books. That basically meant we could run the store with a minimum of manpower.” They could also charge prices that were as much as 25 percent less than those of competitors. Lines of shoppers regularly stretched around the block.
The two shook up established practices in other ways as well. Unlike their competitors, they did not accept credit cards, which allowed them to pay suppliers in cash every week. In exchange for the quick payments, they negotiated further discounts. As they built new stores, they kept opening hours limited, saving on wages and electricity and further undercutting the competition. Perhaps most significant, Bónus refused to fall in line with Iceland’s political patronage system and work exclusively with one of the two shipping companies aligned with Iceland’s two main political parties. Instead, the company introduced competitive bidding - unprecedented in the tiny Icelandic retail market.
In 1992, after opening half a dozen Bónus supermarkets, the father-and-son team scored one of their most stunning coups. The country’s only large supermarket chain, Hagkaup, which had a roughly 30 percent share of Iceland’s retail food sales, was on the point of opening a rival discount food store. Faced with the prospect of a cutthroat price war, “we offered them a deal they couldn’t refuse,” says Jónsson. “Rather than compete, we proposed cooperation.”
Hagkaup bought 50 percent of Bónus and agreed to a shareholders’ pact that left Jónsson and Jóhannesson firmly in charge of the discount chain. With one deal the father and son had eliminated the only rival large enough to compete with them, had obtained money for further expansion and, by combining their buying power with Hagkaup’s, could now negotiate cheaper prices with suppliers and offer better bargains to shoppers.
When Hagkaup’s founder died in 1998, Jónsson and Jóhannesson got equity financing from Kaupthing and Íslandsbanki and bought out the inheritors. They renamed the combined company Baugur and listed 1 billion shares, or 10 percent, on the Iceland Stock Exchange, raising Kr996 million. The restructured company began rapidly diversifying into other areas of retail. At the same time, Jóhannesson became CEO.
In four years at the top, Jóhannesson has increased sales almost 126 percent and net profit 223 percent, to Kr1.3 billion. Nonfood sales, which are more profitable than food sales, are up from less than 5 percent of the total four years ago to an estimated 50 percent today. Along the way, in addition to the coincidentally named Bonus Stores chain in the U.S., Arcadia’s Scandinavian franchise and his stake in his acquisition target, he bought the Scandinavian franchise for Britain’s Debenhams department store chain and, most recently, the Icelandic franchise for Spanish mass-market women’s clothing retailer Zara. Within Iceland he bought the country’s two leading discount drug chains, its biggest toy store, its largest sporting goods shop and its No. 1 chain of after-hours convenience shops. Baugur more or less reached the limit of its growth in Iceland in October, when it opened eight food and clothing shops in the country’s newest and biggest mall, Smáralind.
Jóhannesson does more than just buy retail chains, however. In the U.S. he has proved himself something of a turnaround artist: Bill’s Dollar Stores registered its first postbankruptcy profit in September and is forecast to earn $3.4 million in 2002 on sales of $370 million.
Jóhannesson’s other foreign success story has been Arcadia’s Scandinavian franchise. In a little over a year, he has opened two Topshops and two Miss Selfridges in Sweden and says sales forecasts have been “surpassed by a factor of three.”
If the bid for Arcadia does not work, Jóhannesson could always cut his ties and sell the stake, which was worth about £112 million in late February. He could use it as leverage to acquire another European retailer or even set up his own operation from scratch. He could also invest it in his U.S. chain. But Baugur representatives say he is going to hang on and make another attempt at Arcadia when the time is right. Notes a person close to the talks, “There are not going to be that many opportunities that are as good as Arcadia and which they can afford.”
