KKR could yet pull off huge Boots coup

Allister Heath
<!--StartFragment--> TOGETHER with Guy Hands&rsquo; purchase of EMI, the creation and buy-out of Alliance Boots, the pharmacy-led health and beauty group, was one of the symbolic deals of the boom years. The firm was created when Alliance UniChem merged with Boots in 2006, before becoming the first FTSE 100 member to be taken private by a buy-out firm in the following year (it was also Europe&rsquo;s biggest ever private equity deal). The huge debt taken on after the buy-out, which was managed by KKR &ndash; of Barbarians at the Gate fame &ndash; meant that many worried about its sustainability come the credit crunch and recession. In fact, the deal, which took place at the very peak of the bubble, ran into trouble immediately after it was completed, with banks that were part of the syndication team struggling to sell on its debt.<br /><br />Yet all of this now looks like ancient history. Yesterday&rsquo;s preliminary results for the year ended 31 March 2009 look remarkably good. Stefano Pessina, the firm&rsquo;s executive chairman and 15 per cent owner, is so far pulling off what many thought was impossible: he is pushing through cost cuts at a faster than expected rate, buying smaller rivals, increasing cash flow generation, boosting profits and seeing off the likes of Tesco and J Sainsbury. This is not say that he is out of the woods yet, of course, with interest payments gobbling up the majority of profits, but Pessina and KKR are obviously creating huge value and could make a killing when the economy recovers and the firm is floated.<br /><br />Its financials make interesting reading. Total revenues, including its share of associates and joint ventures, jumped 15.5 per cent to &pound;20.5bn; in the UK, revenue rose by 3.2 per cent, a good performance. Boots UK&rsquo;s like for like revenues were up 1.3 per cent. Group-wide earnings before interest, tax, depreciation and amortisation (Ebitda), including its share of associates and joint ventures, rose 11.3 per cent to &pound;1.245bn, while trading profit was up 11.6 per cent to &pound;953m.<br /><br />Such figures look great, of course, but the whole point of Ebitda measures is that they exclude interest payments &ndash; which makes little sense when evaluating a highly leveraged business. But there is good news here too: Pessina generated &pound;1.045bn in cash from operations, against interest payments of &pound;705m on net debt of &pound;9.03bn at the end of the year. So while leverage remains uncomfortably high, interest payments are far from crippling, net profits are surging yet the corporation tax bill remains low. The fact that the debt was issued at a time when lenders were stupid enough not to insist on strict covenants means that Pessina looks much safer than previously thought, especially if the recession begins to abate. Most of the debt does not mature until 2014-2017, by which time its owners hope the firm will be ready to sell at a huge profit. Alliance Boots even took advantage of the distressed price of its credit by snapping up more than &pound;400m at barely half of face value yesterday.<br /><br />Despite all the bad press that has plagued Alliance Boots, and the continuing worries of its bondholders, the deal is starting to look as if it could spectacularly defy its critics. Pessina&rsquo;s performance certainly compares well to what we will get from Marks &amp; Spencer&rsquo;s Stuart Rose today, even though the latter has received far better PR in the past year. It makes for an intriguing comparison.<br /> <!--EndFragment-->