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THE NEXT WAVE OF M&A IN RETAIL AND FASHION Overview - Portugal

THE NEXT WAVE OF M&A IN RETAIL AND FASHION Overview - Portugal. June 2014. M&A IN RETAIL AND FASHION. CONTEXT. Background Portugal Full member of EU for more than 25 years Founding member of the Eurozone Part of Schengen Agreement

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THE NEXT WAVE OF M&A IN RETAIL AND FASHION Overview - Portugal

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  1. THE NEXT WAVE OF M&A IN RETAIL AND FASHION Overview - Portugal June 2014

  2. M&A IN RETAIL AND FASHION CONTEXT • Background Portugal • Full member of EU for more than 25 years • Founding member of the Eurozone • Part of Schengen Agreement • Portugal has a transparent and mature real estate market • Context • Small southern European open economy • Highly vulnerable • Caught in full by economic crisis • Restructuring • intense political effort to attract foreign investment • Credit crunch and the austerity measures imposed by the bailout from the IMF, EU and ECB: fall in prices which is now giving rise to a wide range of opportunities

  3. M&A IN RETAIL AND FASHION SHAPING UP OF THE RETAIL MARKET • Fast growth in the 90ies which further accentuates in the first decade of the 21st century • Historically: a market that was shaped up by legal contingencies • Unfavorable lease law • Distinct legal frameworks for lease of high street retail and tenancy in shopping centre • Consequences: Retail concentrates in shopping centres; High street retail is very underdeveloped • Volume of investment in the real estate market was at its best around 1,3 billion euro/year in 2006 and 2007 • Players: both domestic and international investors • In thefashion sector • Tradition in textile industry: mostly to export to international brands • All major international apparel brands

  4. M&A IN RETAIL AND FASHION SLOWDOWN Fonte: ICSC • 2008 to 2010: accentuated slowdown - Reasons: • Economic crisis, credit crunch, decrease of • consumer market • Real estate retail market is mature/saturated • 2009/2010 still some investment: real estate market is slow to react • 2011/2012: investment disappears/ zero openings of shopping centres

  5. M&A IN RETAIL AND FASHION REBALANCING & TURNAROUND • During 3 years: • Correction of prices • Optimization of business • Shutdown or relocation of stores • Adaptation to the consumer: • increased proximity and convenience commerce • increase of promotions and loyalty plans • Second semester 2013 and 2014: turnaround • Drivers: • very good quality of retail assets • price adjustment • perception that the lowest point in the cycle has been reached

  6. M&A IN RETAIL AND FASHION CURRENT TRENDS: MARKET SITUATION AND PERSPECTIVES • Economic growth, clear restart of the market: relevant acquisitions in the pipeline. • Return of real estate investment in 2013: • 80% is carried out by institutional investors: investment funds (private equity) • 70% of investment is FDI • 50% is in the retail market • Investors’ profile • Institutional investors (including PE funds) • Family offices • Private investors • Origin : Brazil/ China/ Angola/ Germany • Investments’ profile • Diverse: from opportunity acquisitions to value enhancement driven long term deals

  7. M&A IN RETAIL AND FASHION HIGH STREET RETAIL • The fashion and accessories market in Street retail locations grew counter cycle during the crisis: • Intense opening of international luxury apparel brands in prime locations • 2 reasons • Increased demand for luxury brands by growing tourism of non-European origin as a result of successful strategy to attract foreign wealthy individuals: golden visa and non-domtax system • Renovated offer of high street retail space due to new legal framework

  8. M&A IN RETAIL AND FASHION SHOPPING CENTRES Despite the increase of high street retail, shopping centres are still dominant in the retail market Stock of shopping centres is around 3,6 million sqm of GLA distributed by 170 shopping centres Shopping centres correspond to 80% of the market; retail parks 12% and factory outlets 6% Offer of shopping centres is relatively recent: average 13 years Already a few relevant openings (over 100.000 sqm GLA)

  9. M&A IN RETAIL AND FASHION OTHER KEY FACTORS • Rents • Prime locations: • Increase of demand and increase of rent • Non-prime locations: • Economic downturn: decrease of available income • and demand; no credit; increase of available retail • sqm • Consequence: owners are available to renegotiate • rents, accept grace period, accept fit out expenses, • accept variable rents • Yields: • Decrease continuously until 2007; then abrupt increase; now starting to decrease again. • Financing: • Acquisitions still depend on relevant percentage of equity • Retail is traditionally a hard sector to bank as it is closely linked to the economy and consumer’s discretionary spending

  10. M&A IN RETAIL AND FASHION M&A - DRIVERS • During economic downturn: • Economic weakness - too many shops, too few shoppers - causes pressure on prices • Works as a driver for consolidation: M&A is a potential salvation for some low margin chains • Deals ensure organizational shake ups • Opportunistic deals • Now that economy is pulling itself out of recession: investment in retail is returning • Environment is once again right for retail consolidation • Larger companies look for growth without oversaturating the market • Smaller firms look for financial boost and to get to the next level • Importance of M&A: • Retailers may be unable to count on consumer spending as much as in the past to sustain growth • A major effect of the recent downturn is the increase of the consumer savings rate • Good reason to believe there will be a new wave of M&A in retail

  11. M&A IN RETAIL AND FASHION PLAYERS - PRIVATE EQUITY VS. INDUSTRY PURCHASER • Acquisition by a larger retail rival: • Knowledge of the market • More realistic expectations • More interest in long term gains • Acquisition by private equity investor: • Usually strict growth strategy that includes an exit deadline (5 years or less) • Pressure to grow on a schedule that may not line up with the economy and consumption • Often burden the company with debt that can be difficult to overcome • Currently very diverse acquisition profiles and players are still at play in retail M&A market: • New wave of interest from institutional investment funds: relevant acquisitions in the pipeline • High street retail: presence of the brand; part of an internationalization strategy; belief in long term value enhancement (also in connection with programs for the renovation of Lisbon and Porto traditional commerce locations) • Still some discount deals (distressed assets)

  12. M&A IN RETAIL AND FASHION TYPICAL TRANSACTION STRUCTURE • Asset deal (or acquisition of going concern) • Pros: • Risk of transfer of liability to the purchaser is lower (encumbrances/ leases/ priviledged credits) • Cons: • Triggers real estate transfer taxes payable by the purchaser • May trigger reassessment of the property which for the purchaser means higher annual real estate tax • Triggers capital gains taxation in the hands of the seller • Share deal (possibly preceded by spin off into a newco) - usually the preferred solution • Pros: • Avoids real estate transfer taxes • Use of exempt local vehicles to optimize taxation of capital gains or dividends (real estate investment fund/ real estate investment company) • Possible tax neutrality • Possible use of tax losses • Fiscally efficient model for investors to provide shareholder debt and to facilitate future refinancing when debt markets return to equilibrium • Cons: • Liability of newco for debts prior to spin off up to the amount of assets transferred

  13. M&A IN RETAIL AND FASHION SELECTED LEGAL ISSUES OF INVESTMENT IN RETAIL SECTOR • Securing future incomes: rental guarantee in a shopping centre acquisition: • Tenants usually provide guarantee for rents (bank guarantee; security deposit; group guarantee) • Due diligence: identification of any contingencies in connection with the agreements (change of control clauses in lease agreements; non-transferability of guarantees) • The buyer should also require the seller to provide estoppel certificates (e.g., no defaults, no prepaid rent, status of security deposits and the like) from each of the tenants prior to closing • Contractual risk limitation in the SPA: Flexibility • Seller pre [or post] closing action in order to secure continuation of lease agreements and guarantees • Representations and warranties as to transferability and continuation of such agreements and guarantees • Indemnity mechanism to cover loss in case of breach of the seller’s representations and warranties or failure to perform covenants • Purchase price adjustment mechanisms to cover for loss of cash flows or pay indemnity

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