Match of the Day

JD SPORTS Fashion is pitching to swallowup failing rival JJB, but saving the firmis a tall order, finds Kristy Dorsey.

If retailers had football strips, the colours of JD Sports Fashion would feature in the front shop window alongside the likes of Manchester United or Arsenal, while those of counterpart JJB would be stuffed on the sale rack at the back of the store.

The contrasting performance of the two supposed rivals has been such that it no longer feels comfortable to think of them as being in the same league. That they might be united through a takeover of JJB by JD is considered a positive move by some, but there may be a number of significant hurdles to sealing a deal.

"There are many highly protracted issued relating to this, not least of which would be the substantial additional investment you would clearly have to make to address all of the problems at JJB," says Peter Smedley of Charles Stanley Securities.

JJB, headquartered in the same town as English Premier League laggards Wigan Athletic, has been struggling for more than two years to overcome a series of scandals and trading setbacks that could reasonably have been expected to sink the firm by now. With trading continuing to slide, JJB has warned investors that it will need to tap even more cash on top of the roughly 130 million already raised during the past year.

JD's nearest footballing neighbour is League Two Bury on the outskirts of Manchester, but the retailer's fortunes more closely parallel those of the city's Premier League giants. The severe winter weather that felled so many on the high street at the end of last year appeared to leave the sporting specialist unscathed, with JD reporting a 2.5 per cent rise in like-for-like sales during the five weeks to 1 January.

JD is said to have made its approach several weeks ago, but it was not confirmed until Wednesday, when JJB released a dire market update including news of an 11 per cent slide in latest like-for-like sales, a downgrade to the Alternative Investment Market, and a warning that it is in danger of running out of cash by the end of March. Had the statement not also mentioned the "highly preliminary" takeover talks, JJB's penny status shares in all likelihood would have collapsed further.

On its current business plan, JJB needs a staggering 110m to continue, though chief executive Keith Jones is chucking that in the shredder as he puts together a new, lower-cost strategy for the company.The restructuring will almost certainly include closures across its chain of some 245 stores, and could also entail disposals or a company voluntary agreement (CVA), which allows insolvent firms to continue trading while paying back a proportion of their debts.

In addition to the obvious implications for JJB's 6,300 employees, such moves could also have an impact at cash-strapped Ibrox, which itself is working to pay down debts to Lloyds Banking Group.

Rangers FC is entering into the fifth year of a ten-year licensing deal that gives JJB exclusive rights to distribute merchandise in exchange for guaranteed minimum annual payments of 1.7m. Such payments would likely be cut in the event of JJB entering a CVA or some similar kind of arrangement.

Freddie George, retail analyst with Seymour Pierce, says JJB faces radical alterations if the talks with JD come to nothing.

Shareholders who agreed to an emergency 31.5m capital raising on Christmas Eve - which postponed demands by Bank of Scotland for a test of JJB's 25m debt facility - have pledged to come up with a second similar sum in the near future. However, George says this could prove to be the bottom of the well. "The shareholders may very well take the view that it is 30m or nothing," he says. "JJB has got to come up with a viable plan for the next two years working on that basis."

Key investors include Harris Associates, Crystal Amber, GoldenPeaks Capital and the Bill and Melinda Gates Foundation, who collectively hold more than 44 per cent of JJB's shares. While they may be tempted by an exit from JJB, the sums they have put in make it unlikely that any reasonable price will prove attractive.

Meanwhile, JD Sports would find it difficult to justify paying over the odds for a firm with a market value in the region of just 30m, but whose annual losses are closer to 50m. John Stevenson, retail analyst with Peel Hunt, says JD could cut down on those losses, as about 40m are linked to central costs with just 10m or so stemming from shop-floor trading. However, it would still be "quite a big task" to return JJB to profit. "If JD does take this on, they are going to have to run with those losses for a while," Stevenson says. "JJB is at least two years away from profitability."

JD, led by chief executive Barry Brown, has a track record in taking over barely or unprofitable retailers. This most recently resulted in January's purchase of Champion, an Irish sports chain with 22 shops.

While JD's overall performance has not suffered from such deals, analysts note that it has taken a while to turn some around, such as its Scotts and Bank chains. In addition, JJB would be much larger than any of these previous deals.

Another wildcard is what stance - if any - might be taken by Mike Ashley, whose Sports Direct owns an 11.9 per cent stake in JD.It will not have escaped his notice that a JD-JJB combine could pose a potential threat to his own business interests.

Sports Direct represents the mainstream of the three routes to customers that major sporting brands such as Nike and Adidas want in any given market. The discount model of Sports Direct sits at the opposite end of JD's upmarket and exclusive product offerings, while JJB occupies the middle ground. "With JJB, the suppliers want to make it work, so there are some positives there," says Stevenson.

Smedley at Charles Stanley Securities agrees, though he says the branded supplier relationship could slow down any meaningful efforts to turn the tide at JJB. Smedley says JD prospers because it has a stranglehold on products that are in demand via exclusive agreements for certain branded items. This proves a strong draw for customers, while JJB managed to confuse consumers with a "constant change of pricing policy and product mix".

Rather than trying to challenge Sport Direct's dominance of the discount model, JD would need to bring additional exclusive ranges into the JJB portfolio. Securing such contracts would take months of negotiations, and when added to lead-in times of six to nine months for bringing in new stock, it could take a year or more to put high-demand products on JJB's shelves.

Whether on its own or as part of JD, the task ahead for JJB will be arduous. "What is key in this industry is the support of the two major branded suppliers," says Smedley. "They have been supportive already, so there is a basis for survival. But it is still a long way back for JJB given the bleak, dire situation that the company now finds itself in."