Friday Letter Where's the value in Woolies?

Private equity real estate opportunity funds have been saying for months they expect a wave of juicy distressed assets out of the global economic turmoil. And they’d be ready when the wave hits. So now that an opportunity has come to buy 800 stores from a UK retailer in administration, why is there little interest to date from private equity real estate?

For those that haven’t been following the story, Woolworths is one of the best-known names in British retailing with 99 years of history behind it. However, trading has been poor to say the least in recent years, and this week the business finally succumbed. Administrators Deloitte officially took charge of its sorry affairs this morning.

Woolworths could pose a turnaround situation for someone with the right skill set, but to private equity real estate it is the properties that are most relevant. There are 800 of them and most are well located in towns and cities across the nation.

According to the Financial Times today, Deloitte has been ‘flooded’ with people who want to buy the stores and/or the retail business. But is Woolworths as a whole of interest to large opportunity real estate firms? The answer is probably ‘no’.

The reasons are straight forward. One is that doing such a deal would be too much work. Even the largest real estate funds don’t want to tie up human capital and squander man hours investigating everything from an £81 million (€97 million; $124 million) pension deficit to staff salaries and £385 million of debt.

Second, the freeholds on most of the stores have been sold off already, including 180 that went to Goldman Sachs and London & Regional for £614 million in 2001. The investors subsequently broke up the portfolio and many were sold at auction, so there is no control over the assets. To gain permission to alter something at a property now would involve the permission of Mr and Mrs Jones of Acacia Road.

Further, what you’d be buying are leases which may not become valuable again for a long time. Woolworths is a liability and real estate funds are in no mood to buy one of those at the moment. UK retail is going through a savage phase and the signs are that it will get crushed. Just this week, MFI, another household name in British retailing plunged into administration. Consumer spending is waning and the poorest performing businesses are failing. Many more retailers will struggle to pay rents in 2009. As a deal-maker at one large fund said to PERE, this is “toxic”.

Put it all together – toxic assets that you won’t fully control in a sector where tenants will struggle to pay rents – and you begin to understand why Woolworths hasn’t sparked much excitement yet among private equity real estate.

Richard Ellis, the global property services firm, has been instructed to sell the stores at the same time as Deloitte tries to sell the business as a concern. Supermarkets are likely to pick up chunks of stores.

Don’t be mistaken: it is possible that someone will be willing to pay a token £1 for the whole of Woolies, work their socks off and do ok. Also, some real estate investors could well pick off some stores. But as far as buying the business to get at the assets is concerned, there are far easier wins to be had. For example, you could be buying heavily discounted debt backed by well located real estate with steady cash flow. This is more likely to be where the action takes place for the largest opportunity funds, not a troubled high street retailer whose time is surely over.