17 Jan 2013

HMV has just been crushed by the weight of its borrowings. Were banks less reluctant to write off bad debts, it would probably have gone a year ago. Yet its key strategic error, according to commentators, was to fail to respond to the threat of the internet. This charge seems almost unbelievable but it is a reminder of how difficult it is for established businesses to change. Argos, owned by Home Retail Group, is a business model that many people find laughably “old economy”. It was based on a printed catalogue of competitively priced goods that could be bought by filling out small order forms in stores that were like retail warehouses. The typical Argos customer is from the less affluent half of the population, though you might be surprised to know that more than 70% of all UK households buy something from Argos at least once a year. Despite the excellent financial state of the Home Retail Group, many analysts have thought that Argos is a doomed dinosaur. In August 2012 (the half year report), Argos had net cash of £211m and generated free cash flow of £129m in the six month period. Given that its market capitalisation is (at 124p) £1billion, implying a free cash flow yield of 16%, if it generates zero free cash in H2, there ought to be something pretty wrong with this company. If its problems are fixable, it should probably be on a FCF yield of c.10% implying a share price of 185p. So are its problems fixable? The group’s management certainly thinks so. It has a five year plan to “reinvent  Argos as a digital leader”. Its stores will all have free wi-fi and customers will be able to order goods from their mobile devices. Home delivery will be introduced. This will incur extra capital expenditure of £100 million over three years and restructuring costs of £50 million. Total capex is expected to be £175 million for the next three years (it was £135 million in FY 2012). These are significant but not excessive numbers. The group expects to maintain a net cash position during the transformation period. Its target is to raise Argos revenues to...