Homebase M&A deal puts scheme security in the spotlight

The UK retail group announced recently it was in “advanced discussions” with Australian conglomerate Wesfarmers over the potential sale of DIY chain Homebase for £340m. The sale is yet to receive the go-ahead from HRG shareholders, but is expected to complete at the end of March.

A £50m payment to the trustee of the group’s main DB arrangement, the £1bn Home Retail Group Pension Scheme, has been set within the terms of the deal.

Look longer term – not just at the break-up – but whether what’s left of the sponsoring employer will have the prospect of supporting the scheme long term

Chris Martin, Independent Trustee Services

It is understood that liabilities for the HRG scheme, which closed to future accrual on January 31 2013, will remain within the remit of HRG, as the majority of its 8,000 members are attached to the group’s Argos subsidiary.

At the last triennial valuation the scheme deficit was valued at £158m. The group plans to release the outcome of the 2015 valuation around the date of the 2016 financial year-end.

Home Retail Group declined to comment.

M&A boom

Last year’s boom in merger and acquisition activity is expected to continue through 2016, according to consultancy Deloitte’s latest M&A index.

Companies in the UK were the most sought-after targets in Europe during 2015, attracting $313bn (£220bn) in M&A investment from both eurozone and overseas buyers.

Cross-border deals, such as the proposed sale of Homebase to Aussie buyer Wesfarmers, have been a major feature of the M&A wave, a trend expected to continue in 2016 amid increasingly divergent economic and monetary policy.

Corporate transactions do, however, pose serious challenges for scheme trustees.

Faith Dickson, partner at law firm Sackers, said the impact of disposals on covenant strength can be difficult to assess.

“If you’re selling a chunk of the business that’s actually contributing quite a lot to the bottom line, then trustees are going to be very concerned about the affordability and sustainability of the scheme going forward,” she said.

Dickson said trustees may have to “flex their muscles” to ensure security for schemes, which can be achieved through a variety of means, including cash contributions, parent company guarantees and contingent asset arrangements.

If you’re selling a chunk of the business that’s actually contributing quite a lot to the bottom line, then trustees are going to be very concerned about the affordability and sustainability of the scheme

Faith Dickson, Sackers

However, she added that trustees’ negotiating power is “generally pretty restricted”.

“Trust deeds and rules don’t generally give trustees a huge amount of power in disposal scenarios, although sometimes they might have power to wind up the scheme or set contribution rates, which encourages the employer to engage a bit more,” she said.

Dickson added corporate sponsors must be careful to ensure that efforts to break up and sell off parts of their business are not interpreted by the Pensions Regulator as an attempt to abandon scheme obligations.

Long-term outlook

Chris Martin, managing director of Independent Trustee Services, said trustees must assess where the value lies in the sponsor business in order to gauge the post-sale covenant strength.

Trustees must also look further ahead and consider the future sustainability of the scheme beyond a before-and-after “snapshot” of the transaction.

“Look longer term – not just at the break-up, but whether what’s left of the sponsoring employer will have the prospect of supporting the scheme long term,” he said.

Chris Roberts, trustee representative at professional trustee Dalriada, said the level of security required to ensure long-term security for scheme members rests on funding levels and the length of the recovery plan. 

Roberts said high volumes of acquisitions in the retail sector over the years have resulted in many schemes becoming “truncated and difficult to break down”.

In scenarios where companies consider a scheme merger, Roberts said trustees must assess the covenant strength of both parties.

“They have to check the covenant of the new entity is sufficient to trump the covenant of the selling entity,” he said. “[Trustees] must look at the solvency position.”