City Insider: What now for Thomas Cook?

City Insider: What now for Thomas Cook?

City Insider - FT journalist David Stevenson on the travel industry

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It’s been a strange few weeks. Apparently we’ve just averted a global financial meltdown courtesy of decisive action from our European political masters, although the US government still seems to be teetering on the edge of an unholy mess with its tortuous debt limit negotiations.

Back in the world of travel I have to say that I never believed that we would see shares in Thomas Cook trading at around 70p. At this price the travel giant is valued at a measly £600m (give or take a few million) which puts it at number 177 in the long list of companies that comprise the FTSE 250. Just a few days ago it was close to the top.

Obviously this fall in the value of the group has prompted much soul-searching. The biggest question mark seems to surround the future of Manny Fontenla-Novoa, the group chief executive. The prevailing wisdom among the shareholders I talk to seems to be that Thomas Cook is a complex beast and that Manny probably needs to stay around long enough to sort it out.

Many investors and analysts also seem to be rather morbidly focusing on the danger of Thomas Cook breaching its financial limits (i.e. its debt covenants). As I wrote last week I can’t see this happening, because a) we’d have heard about any breach by now b)Thomas Cook isn’t actually in that desperate a cash position and c) the travel giant is probably too big to fail.

Thomas Cook has also managed to secure pretty decent terms on its debt mountain – which is looking rather large compared to that puny market valuation. This week the group announced  a one-year extension of its committed bank facilities to May 2014, including a £200m term loan and an £850m revolving credit facility.

Crucially, the group also managed to secure a lower interest rate. According to Thomas Cook “the margin over LIBOR on the term loan facility has reduced to 2.25% and on the revolving credit facility has reduced to a rate between 2.00% and 2.50% dependant on the proportion of the facility that is drawn - the margin was previously 2.75% for both facilities”.

The debate now centres on what comes next. The smart money is on a private equity bid, but Thomas Cook is a still big chunk for nearly all the major funds to bite off, so that means the pointy heads who sit in the financial engineering rooms of the big private equity houses will probably spend at least another few weeks scouring the financial stats and running their due diligence on the trading business.

Two new ideas have emerged in my conversations with ‘interested parties’. The first is that the dividend paid out by Thomas Cook will be chopped to improve confidence in Thomas Cook’s financial position.

Everything will now be thrown at a strategic effort to cut debt levels and improve cash inflows – assets will be sold as quickly as possible and suppliers squeezed. Yet the biggest cash saving has to be that dividend of 10.75p a share, which in the last financial year amounted to £60m.

The market is already signalling this eventuality in the share price – with the shares trading at 70p the market is implying a current yield of around 15%. Talking to market makers – who run the platforms that enable trading – it seems that many income-oriented investors are beginning to quietly unwind their positions ahead of a dividend suspension.

The more radical idea being mooted in a few dark corners could emerge from the successful conclusion of the merger with The Co-operative Travel. That the Competition Commission has given this merger a provisional nod is great news and will help Thomas Cook create "the UK's largest multi-channel travel retailer". 

The deal will help improve the sales channel, kick in some cost savings and allow Thomas Cook to reinforce its dominant high street position in advance of any possible pickup in demand later.

This “tying up” of loose ends raises an interesting notion – with much of the hard work done on the UK business, why not sell it? I realise the idea of breaking up an integrated pan-European operator is at first sight a mad one, but consider cold, harsh financial reality.

Groups like Thomas Cook are simply federal collections of national franchises comprising valuable financial assets that can be traded for a value. It’s in the interests of corporate managements to talk up words like synergy and group cross-selling benefits but this doesn’t fool hard-headed financial analysts.

Thomas Cook’s buying power including the UK sales channel is valuable in reducing costs but frankly it wouldn’t make much difference if it was without the UK business – scale matters, but not quite as much as everyone likes to let on.

The UK business is now damaging the combined group, largely because the UK high street is such a dreadful place at the moment. Why not finish off the hard work and then sell to a player with deep financial pockets who could afford to wait for the up-tick in retail revenues in 2012?

Industry experts would of course instantly think of a massive number of challenges, not least on the branding and marketing front, but in my experience all these worries can be massaged away if the numbers look right.

A quick perusal of the full-year 2010 data only serves to reinforce this observation – last year the Anglo Saxon businesses kicked in EBIT of £117m yet the continental businesses poured in £253m.

One part of the business is in a risky market, going through a multi-year debt ‘cleansing’ cycle, while the other is in a regional economy with strong financial basics, where consumer confidence remains buoyant and the group has enviable brand positioning. Do the maths.


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