Waterstone poised for a new chapter

HE has spent much of his time in recent months talking down the prospect, but the latest dismal trading news from HMV has given renewed life to speculation that Tim Waterstone could yet regain control of the book chain that has borne his name since he set up the first shop in 1982.

The founder's interest in his progeny is no secret, as he has tried several times to resume the helm since first selling Waterstone's in a 47 million deal to WH Smith in 1993. He played a key role in the chain's subsequent transfer to HMV in 1998, becoming founder chairman of the merged group before resigning in 2001 amid accusations that HMV was "destroying" his brainchild.

It's been a different story since the start of last year, when a new management team including HMV chief executive Simon Fox and Waterstone's managing director Dominic Myers took the helm. Despite reports this past autumn that Waterstone was still stalking his namesake, he has repeatedly dismissed such chatter as mischievous.

Wednesday's dire trading update from HMV - which surprised analysts for being even worse than their dour expectations - rekindled talk of a fresh bid even though HMV insists the chain of 314 book shops is not for sale.

Soon after HMV released its update on Wednesday, Nick Bubb, retail analyst for Arden Partners, said the sale of Waterstone's could just about "salvage the wreckage" at the entertainment group. Many others joined the chorus, prompting Waterstone to reiterate that he would not act unless the chain was offered up for sale.

"I am certainly not mounting an aggressive bid, but if they want to sell I'd certainly be interested in talking to them about buying it," Waterstone said in a radio interview later that evening.

Despite HMV's assertions to the contrary, analysts believe the group could be forced into offloading Waterstone's, which has put in a relatively stronger performance than its sister chain of 285 music and entertainment stores. Like-for-like sales at the former were down just 0.4 per cent during the five weeks to 1 January, compared to a 13.6 per cent decline in the UK and Irish shops of HMV.

Fox did his best to shift a chunk of the blame for the decline on to December's severe weather, though it was clear to all that the wintry conditions only amplified HMV's existing woes. Its core business of selling music has been under sustained pressure from the ease of internet downloads and cut-price competition from online retailers and the supermarkets.

Investors were even more spooked by news that HMV faces a "tight" banking covenant test in April, which has prompted a raft of cost-saving measures including the closure of 40 HMV and 20 Waterstone's stores. Even before Wednesday's announcement, the signs were not good. The surprise closure of the Waterstone's branch at the east end of Edinburgh's Princes Street on Christmas Eve was clearly a harbinger of the bad news to come.

Experts say the thinning down will have to continue beyond that, with a few predicting there will ultimately be no need for specialist entertainment retailers on the high street. However, most agree that a small number of "destination" outlets will form part of any future HMV.

"There probably is a role, particularly in cities like Edinburgh and Glasgow, in having a very well-equipped store that is doing a very different thing from simply saying: 'Here are some of the things you might like to buy,'" says Joshua Bamfield, director of the Centre for Retail Research.

Robert Gregory, research director for Planet Retail, says "it is clear" that there will be no place in the future for mega-chains of entertainment stores with hundreds of shops throughout the UK.

"I think the Waterstone's and HMV chains will separate, but for both of them the future lies in selling off a lot of stores and really streamlining, and making significant investment in their online offering," Gregory says.

The consensus seems to be that while Fox and his team are generally on the correct course, they have been too slow in implementing change. Moves to branch into sales of merchandise such as gaming machines, clothing and concert tickets have not come quickly enough to offset the slump in CD and DVD sales.

"They haven't been aggressive enough in those changes, and they have not yet got their offering right," says Matt Piner, senior retail analyst at Verdict Research.

As a result, Fox must focus squarely on the immediate challenge of passing its bankers' financial strength test in April.

HMV is relying on quick returns from its latest store closure plan, as well as other unspecified cost savings of up to 10 million. If this frees up enough cash - and suppliers aren't spooked in the same scenario that hastened Woolworths demise - the group seems likely to meet its covenants in April. If not, Arden's Bubb says HMV faces limited options. Given the group's sagging share price and the likelihood that the final dividend will be axed, a rights issue would be a big ask of shareholders.

"The big question is will they have to sell Waterstone's to make ends meet," says Bubb. "I am not pretending that a Waterstone's-less HMV is an attractive proposition but there may not be any choice."

Apart from its founder, potential buyers for the book chain appear a bit thin on the ground. Having taken out practically all of its high street rivals, a trade sale looks unlikely.

Experts are also nonplussed by the intentions of Alexander Mamut, the Russian billionaire who recently increased his stake in HMV to 5 per cent.Known as the "Yeltsin family banker" during his involvement in the Bank of New York money laundering scandal in the late 1990s, Mamut emerged uncharged and unscathed, and invests in interests ranging from real estate and construction to retail and internet concerns. Mamut and Waterstone were investors in Bookberry, a chain of Russian bookstores that is now bankrupt.

If Waterstone's is put up for sale, the key for its founder will lie in securing backers. Although debt markets remain fragile, a distress sale by HMV would keep the asking price low. "It will come down to funding," says Piner. "There is no doubt that Tim Waterstone is interested, but although he has expressed an interest, there is a big difference between that and coming up with the money."