Why Ted Baker has been a disaster and a gift in equal measure

Any investment which loses more than 95% of its value can only be described as a disaster. However, the lessons learned from this disaster are so powerful I would have to describe Ted Baker as a gift, albeit a painful one.

Key points

  • Ted Baker produced consistent, rapid growth for many years
  • Ted’s growth was largely funded by banks and landlords rather than shareholders
  • External funding was used to drive growth because of Ted’s weak profitability
  • Even before the pandemic, Ted had more debt and leases than it could comfortably afford.

Investment summary

“A quintessentially British brand, Ted Baker is famed for its quirky yet commercial fashion offering, high quality design detailing and distinctive use of pattern and colour.”

Purchase price
2164p on 07/08/2018
Sale price
72p on 07/07/2020
Holding period
1 year 11 months
Capital gain
– 96.6%
Dividend income
Annualised return
– 82.0%

Ted Baker has been by far my worst investment since I switched from deep value to defensive value investing almost a decade ago.  Within two short years, Ted went from consistent growth to a suspended dividend and a significant rights issue (technically it was an equity raise rather than a rights issue, but let’s not split hairs).

On the surface this collapse was surprising because, until recently, Ted Baker had what appeared to be an exceptionally impressive track record of success. 

For example, when Ted joined my model portfolio in 2018 it had a ten-year Growth Rate of 19% and Growth Quality of 100%, which means it had grown very rapidly and extremely consistently over the previous decade. On top of that it had a ten-year average net return on capital employed (net ROCE) of 22%, compared to about 10% for the average company.

Those are exactly the sort of stats I’m looking for, and when I invested in Ted I thought it was a high quality retailer that was still in the relatively early stages of building a truly global footprint.

If you want the full details of why I bought Ted Baker, you can read my original purchase analysis (PDF).

You can also download a PDF version of this post-sale review.

But I was wrong. Even before the pandemic, Ted ran into a series of serious problems culminating in two changes of leadership, a suspended dividend and a large dose of new equity capital raised from institutional investors, which had the inevitable side effect of massively diluting the holdings of existing shareholders.

So my investment in Ted was a disaster, but it was also a gift.

It was a gift because I now understand the importance of taking lease liabilities into account, especially when you’re looking for high quality companies producing consistent and, more importantly, sustainable growth.

Buying what appeared to be a highly profitable business growing quickly and consistently

Ted Baker started life in 1988 as a single store in Glasgow selling men’s shirts. The company was founded by Ray Kelvin who entered the clothing industry as a schoolboy, working in his uncle’s menswear shop. The founding premise of Ted Baker was that it would be a quirky, fun, brand-focused clothing business.

The company expanded gradually, adding new stores through the early 1990s. In the mid-90s Ted launched of a series of iconic “acid house” shirts that became immensely popular, with queues stretching outside the company’s stores and down the street. By 1997 revenues were up to £14 million and Kelvin decided to take Ted onto the London Stock Exchange.

By 2002 Ted had expanded to 18 stores and revenues of £70 million, up almost five-fold just five years after becoming a public company. Ted blasted through the dot-com downturn as if it wasn’t there, and by the time the credit crunch appeared in 2008 Ted’s revenues had more than doubled again to over £140 million. 

After pausing briefly in The Great Recession, Ted rocketed back into growth mode and doubled revenues again by 2014. By 2017, 20 years after it joined the stock market with less than ten stores and revenues of £14 million, Ted had grown more than ten-fold to 114 stores, over 300 department store concessions and revenues exceeding £400 million. 

Those are some seriously dramatic results and that is the successful track record I bought into in 2018.

Consistent rapid growth made Ted Baker look like a quality business

However, soon after joining the portfolio Ted began to run into serious problems.

The pre-pandemic slowdown in 2018 and 2019 hit Ted Baker surprisingly hard

The first sign of trouble came in February 2019, when the company revised down its expectations and announced a £5 million write down on the value of clothing stock. In the grand scheme of things that didn’t seem too serious, and when the 2019 results were announced in March they were okay, with the dividend held more or less flat.

In April 2019 the company’s founder left amid a “hugging” scandal and Ted’s long-time CFO took over as CEO.

In June 2019 the company said trading conditions had been “extremely difficult”, with consumer uncertainty driving “elevated levels of promotional activity” across the globe. Revenues at that point were ahead of the prior year, but pre-tax profits were expected to be around £50 million, some £10 million down on 2019 and £20 million down on 2018. Ted’s shares fell 40% following the announcement, which seemed excessive to me.

In October 2019 the company announced an unexpected loss in the first half and a dividend cut of more than 50%. The market reacted with a further 30% price decline, taking the full decline from mid-2019 to about 70%. 

Management said the loss was mostly down to “unprecedented and sustains levels of promotional activity” (i.e. discounting) and structural challenges facing high street department stores, where Ted sells much of its wholesale stock through in-store concessions. 

There were also one-off costs, primarily from restructuring its Asia business and from the acquisition of its global footwear licensee. But despite making a loss and halving the dividend, management were generally quite upbeat. Despite the obvious problems, management’s focus still seemed to be on growth and expansion, with the negative trading environment merely a small obstacle to be navigated around.

In December 2019, shortly after the arrival of a new CFO, the company announced that clothing inventory on the balance sheet was overvalued by as much as £25 million. A week later a trading updated said results were behind expectations and that it was “appropriate to take a more cautious outlook”. That was a serious understatement because at the same time the dividend was suspended and the CEO and Chairman resigned.

The speed and extent of Ted Baker’s collapse was almost shocking. However, rather than panic-selling in an attempt to avoid further losses, my immediate reaction was to open up the wound of my mistake and examine it as closely as possible in order to a) understand why Ted had fallen apart so quickly and b) avoid similar situations in future.

What I found was a small number of interrelated factors which together were the cause of Ted Baker’s impressively rapid rise as well as its (un)impressively rapid decline.

Problem 1) Weak profitability once lease liabilities were taken into account

Whilst Ted Baker was busy falling apart, another holding in the model portfolio was having similar problems. 

That company was The Restaurant Group and its history was eerily similar to Ted’s. In other words, on the surface it looked like a quality company producing high returns on capital employed along with rapid and consistent growth, but when the economy slowed in 2018/2019 it quickly found itself in very serious financial trouble.

As I looked at these two companies it dawned on me that they were both property-heavy businesses, dependent on rented stores or restaurants. And yet despite this dependence on property, there was no mention on either company’s balance sheet of rented properties as an asset or their related rent obligations as a liability.

I was aware that some investors adjusted the calculation of capital employed to take account of lease liabilities, but I didn’t. Like most investors, I just calculated capital employed from the balance sheet using equity capital and debt capital, but not leased capital.

So I crunched the numbers and it very soon became clear that these companies weren’t highly profitable after all. In fact, once their very large rental obligations (also known as operating lease liabilities) were correctly added to capital employed, their returns on capital employed declined from very high levels of around 20% to unacceptably weak levels of less than 10%.

If you want the full details on lease liabilities then please read my article The Hidden Debt of Lease Obligations, and my post-sale review of The Restaurant Group, which I should have called The Three Most Important Things in Retail Investing are Leases, Leases and Leases.

I’ll summarise my findings on lease liabilities here:

Lease liabilities are essentially no different from borrowings. If you wanted to open a retail store you would need to either build, buy or rent that store. In the first two cases you would probably get a loan and pay it off over a number of years. If you decide to rent the store then you’ll sign an agreement to pay the landlord for the period of the lease, which would also typically be a number of years.

In all three cases you have:

  1. No significant up-front cash outlay as the property is funded by (and effectively owned by) your bank or landlord and
  2. a contractual obligation to pay out an agreed amount every month (or quarter, or year) to either your bank or landlord.

In other words, you have a debt to your bank or your landlord, regardless of whether you buy or rent, so why should a purchased property and its related mortgage be on the balance sheet while a leased property and its related lease liability are entirely absent?

The answer is that lease liabilities should be on the balance sheet as a form of debt and a source of capital, and thanks to IFRS 16 (PDF) this is now an accounting standard.

However, that wasn’t the case when I bought Ted Baker, and not taking account of lease liabilities was the single biggest mistake I made with this investment.

Fortunately it’s an easy mistake to fix and lease liabilities have been integrated into my investment spreadsheet and checklist since late 2019.

So Ted Baker’s return on capital employed was weak once leased capital was taken into account, but why does that matter?

It matters because companies with weak returns on lease-adjusted capital employed typically have little or no competitive advantage. If they did have meaningful competitive strengths then in almost all cases they would use them to generate more profit. 

So I now think Ted Baker had no material competitive advantages, and that matters because competitively weak companies are highly exposed to tough competitors and tough economic conditions.

They may sail through one or two recessions if their customers aren’t hurt by the downturns, but when they do eventually face a major challenge, whether it’s the shift to online retailing, a highly promotional environment or a global pandemic, weak companies and their shareholders usually suffer the most. 

In contrast, strong companies with consistently high returns on lease adjusted capital employed usually benefit at the expense of their weaker peers, either by taking market share or acquiring them at fire sale prices.

Problem 2) Rapid growth driven by rapidly increasing debt and lease liabilities

Growth doesn’t happen out of thin air. It needs to be funded, whether that’s to increase stock, fit out of a new store or build a new distribution centre. These new assets cost money and that money has to come from somewhere, and that somewhere is typically either:

  • shareholders (providing equity capital)
  • lenders (providing debt capital) or
  • landlords (providing leased capital).

Ideally, growth assets will be funded with shareholder equity because it’s the lowest risk form of funding. It’s low risk because dividends are optional and equity capital has no set repayment date, so it has far more flexible repayment terms than debt or leases, both of which have relatively fixed repayments in terms of how much and when.

Equity can be raised through rights issues, but the easiest way to raise additional equity capital is to retain some of the earnings generated by the company each year.

However, if a company has weak returns on capital then it has little in the way of earnings to retain in the first place, and therefore little to invest in additional assets to drive growth.

For example, in most cases a company producing returns on capital of 5% cannot sustainably self-fund capital employed growth of more than 5%. Since capital employed growth is the foundation of revenue, earnings and dividend growth, this is a problem. And if that same company pays out half its earnings as a dividend then its retained earnings will be equal to just 2.5% of its capital base, and therefore that will be its sustainable self-funded growth ceiling.

This is a major problem for companies like Ted Baker or The Restaurant Group, which consistently produced returns on lease-adjusted capital employed of around 8% and 5% respectively. They both also paid out dividends, so their self-fundable growth rates from retained earnings were even lower than that. 

But if Ted Baker was retaining earnings equal to less than 8% of its capital base each year, how did it manage to grow by more than 20% per year for so many years?

The answer is that Ted used external funding from banks and landlords to massively increase its growth rate.

For example, in 2016, Ted produced earnings of £44 million using £173 million of equity capital, £98 million of debt capital and £258 million of leased capital. Ted’s return on total capital employed was therefore 8%. About half of the earnings were paid out as a dividend, so retained earnings were about 4% of its capital base.

If Ted had only raised additional capital by retaining earnings then it would have grown by about 4% between 2015 and 2016. But that’s not what happened.

Instead, Ted’s debts that year went up by almost 400% (from £26m to £98m) while its lease liabilities went up by about 50% (from £171m to £258m). This rapid increase in debt and leases helped Ted’s capital base grow more than 50% that year, far faster than its sustainable self-fundable growth rate of 4%.

This is the magic of using other people’s money. If you take on lots of debt and lease liabilities you can grow a company much faster than you could using the “boring” but sustainable method of self-funding growth with retained earnings. 

The risk, of course, is that when things turn bad the company won’t be able to meet its relatively inflexible debt and lease obligations. At the very least, excessive debts and leases may force a company to suspend its dividend and/or carry out a rights issue, and that’s pretty much what Ted had to do.

Problem 3) Excessive debt and lease liabilities

This follows on from the problem of using debt and leases to turbo boost the growth rate of an otherwise ho-hum company. This can work for a surprisingly long time, as long as things don’t spiral out of control. I think through most of Ted’s history it used leases that were either too expensive or too long, but at least it didn’t make the mistake of having lots of debt as well.

Eventually though, management succumbed to the magic money tree of borrowed funds, as debts increased rapidly from zero in 2012 to almost £140 million in 2019. When combined with Ted’s lease liabilities, that left it with financial liabilities of almost £350 million, about 15-times its ten-year average earnings.

My preference is for cyclical companies like retailers to keep debts and leases to less than four-times earnings, or five at the very most, so Ted was wildly overleveraged by thost standards.

Rule of thumb

Only invest in a company if its combined debt and lease liabilities are less than five-times its ten-year average earnings (or four-times if the company’s sector is particularly cyclical).

In summary then:

  • Ted Baker produced weak returns on capital, leaving it with a mid-single digit self-fundable growth rate.
  • Management chose to increase its growth rate by using large amounts of lease capital and, more recently, debt capital.
  • That worked for a long time, but eventually Ted found itself in a market characterised by heavy discounting, and this left it unable to afford its excessive lease and debt liabilities.
  • Ted had little choice but to suspend its dividend and raise additional low risk equity capital via an equity raise, offering new shares at rock bottom prices which massively diluted the holdings of existing shareholders.

How to make sure this doesn’t (or is very unlikely to) happen again

Investing in Ted Baker was a mistake caused by a lack of understanding of the importance of lease liabilities.

As I said when I reviewed Ted Baker in January, the relevant lessons have already been learned and integrated into my investment spreadsheet and checklist. The key changes were to:

  1. Measure lease liabilities going back ten years
  2. Include lease liabilities in the calculation of return on capital employed (ROCE)
  3. Add lease liabilities to my Debt Ratio (ratio of debts and leases to average earnings)
  4. Measure debts over the last ten years so any trend of increasing debt is visible
  5. Add lease liabilities to my Growth Quality score because companies using lots of external growth funding have less sustainable growth

With these changes in place I have a much better understanding of the strengths and weakness of retailers and other property-heavy businesses, and hopefully that will be enough to stop me from making the same mistake again.

As for the model portfolio’s remaining retailers, most are highly profitable and have relatively strong balance sheets, even when lease liabilities are taken into account.

Selling Ted Baker because it isn’t a “special” business

I like to own high quality businesses, or as I prefer to call them, special businesses.

Special businesses:

  1. Generate consistently high returns on lease-adjusted capital employed over long-periods of time.
  2. Retain some of those impressive returns to drive relatively consistent growth, without using dangerous levels of debt or lease liabilities.
  3. Are usually market leaders.
  4. Have entrenched competitive strengths.
  5. Are built around a highly focused core business.
  6. Usually grow by tightening their grip on their core market and by moving into closely related adjacent markets.

I’m now of the opinion that Ted Baker does not have any material competitive strengths and is therefore unlikely to be a special company. I think it was a so-so company which grew too rapidly using too much external funding from debt and leases.

Selling Ted Baker

The only reason I held onto Ted in recent months was to see what the new CEO’s turnaround plan would be, and whether that tied in with my thoughts about Ted’s weak returns and excessive use of external funding.

That turnaround plan has now been announced, and it focuses on capital-light growth with Ted becoming an online-first rather than store-first retailer, with efficiency and cost reduction used to drive higher returns on less capital in the future.

This closely matches my view that Ted’s stores were too lavish and cost too much money for too little return, and that the number one goal going forward has to be an increased focus on return on capital rather than growth.

With the turnaround plan in place I think there is little left to be learned from this investment, so I think now is an appropriate time to sell up and move on.

So I sold my Ted Baker shares earlier this week, and the meagre proceeds will be reinvested into a new holding in the next month or so.

Author: John Kingham

I cover both the theory and practice of investing in high-quality UK dividend stocks for long-term income and growth.

22 thoughts on “Why Ted Baker has been a disaster and a gift in equal measure”

  1. I’ve been a subscriber for 2 years now and still haven’t figured out why you select such clear poor fits for a dividend portfolio. Retail is a fickle business and chasing a unicorn high growth and dividend payer was always a doomed strategy. If the strategy is dividend income you should pick stable. If regular income isn’t an actual requirement, because you’re not near retirement or have a huge pile of cash, then the obsession with dividend can be counterproductive.

    1. Hi Malcolm

      There’s a lot to unpack from your comment, so I’ll take them one by one:

      “why you select such clear poor fits for a dividend portfolio”

      I guess by this you mean putting cyclical companies into a portfolio where steady and growing dividend income is one of the main goals, when it seems obvious that such a portfolio should focus primarily on defensive dividend payers like utilities, food manufacturers, medical suppliers and arms manufacturers.

      While those stocks are suitable for a dividend-focused portfolio, I don’t think they need to be the main focus or even a significant focus. I think diversification of the overall portfolio is a far more important factor, perhaps followed by the balance sheet strength and competitive strength of the individual holdings.

      For example, the FTSE 250 is full of all sorts of companies, from very defensive to cyclical to basket case. However, over the last 30 years its dividend has grown fairly steadily and that’s almost entirely down to diversification. With 250 holdings, it doesn’t really matter if this or that company suspends its dividend or goes bust. Most of the time most companies grow, and that’s more than enough to offset the occasional disaster.

      So no, I don’t focus on holding classically defensive holdings because I’m interested in the performance of the overall portfolio more than I am the ups and downs of any one holding.

      Beyond diversification, balance sheet strength and competitive strength have a huge impact on the prospects of a company and its dividend. You only have to look at companies like Centrica or Vodafone to see that classically defensive companies can be bad investments if they have weak balance sheets and weak competitive positions (I have owned both those companies in the past in the mistaken belief that they were ‘defensive’).

      I would much rather own a cyclical company with a strong balance sheet and strong competitive advantages than a defensive company with neither. Yes, it would be nice to own a defensive company with a strong balance sheet and strong competitive advantages, and there some in my model portfolio, but for me strength trumps cyclicality any day.

      “Retail is a fickle business”

      If you mean fashion retail then yes, it’s very fickle. And that makes a strong balance sheet and a strong competitive position all the more important. Ted Baker had neither of these. Other retailers in the portfolio have much greater strength, although of course strength is no guarantee of success.

      “chasing a unicorn high growth and dividend payer was always a doomed strategy”

      I disagree. I see no reason why investing in a high quality, high growth company is automatically a doomed strategy. Ted Baker was high growth, but it wasn’t high quality as the article hopefully explains. My new focus on self-fundable growth should ensure that future high growth investments are driving that growth with high profitability, not high debt.

      “If the strategy is dividend income you should pick stable [companies]”

      I agree. That’s why all of the companies in my model portfolio have multi-decade track records, have paid dividends every year for more than a decade and mostly have consistent records of growth. Obviously much of that goes out the window during a pandemic, but pre-pandemic I would definitely describe almost all of the holdings as stable.

      There are a couple of questionable holdings (e.g. Xaar and N Brown) but I understand where I went wrong (Xaar wasn’t stable enough and N Brown was going through a transformation from mail order catalogues to online retail), so I agree with you that stable companies are the ones to go for in a dividend-focused portfolio. But stable and defensive are not synonymous and stable and cyclical are not mutually exclusive.

      “obsession with dividend can be counterproductive.”

      I agree. If you’re not interested in dividends then they may be a distraction, although on average dividend stocks have historically outperformed non dividend payers. Personally I like dividends, I like the steady drip of cash into my accounts and I intend to retire on dividend income alone at some point in the distant future, so that’s why I run a dividend-focused portfolio.

      Thank you for the critique. Hopefully I have at least clarified my position on each point but let me know if not.

  2. What a well written, honest article.
    I’ve chanced upon this website and I’m very impressed!

    1. Thanks Tony. If I’m known for anything it’s for honestly analysing my mistakes, although hopefully my mistakes will become smaller and less frequent over time…

  3. The whole point of the article is that something is only a mistake if you respond to it in a negative way.

  4. Interesting honest article.
    It illustrates how a company can quickly get into difficulties with too much debt.

    I also invested in Ted Baker and have lost around 90%,

    Because my holding was worth under £350 I took a different approach and decided no point in selling as bulk of investment already lost. Maybe could improve post Covid as well known brand.

    Furthermore I invested another £120 in the recent cash raising doubling my number of shares in the belief that a small recovery could get some money back

    So far all I have proved is that throwing good money after bad is not a good idea.! I should have sold too!

    1. Hi George

      I think holding on is entirely reasonable, especially when the remaining investment is now so small. I toyed with the idea of leaving Ted in my portfolio for the same reason, but decided not to as I felt there was nothing left to learn and it would just be clogging up the portfolio with an unwanted holding.

      I think if Ted’s going to recover then it’s not likely to happen before this pandemic is over, which could be well into 2021 at the earliest, and the economic impact could last much longer than that. You may need to be very patient!

  5. Reading this article made me very fearful of my current holding in TED (long view holding) It wasn’t until the very end of the article when John revealed he had just sold all his holdings that I thought now would probably be a very good time to top up. 😉 why do people judge the future in such short time frames? It’s only the passage of time combined with a low entry that creates market beating returns and I feel Johns reasons for selling smack of rationalising despairing capitulation – singularly the most reliable buy signal for any long term investor.
    TED has increased its cash, refocused on more profitable licensing activities, totally restructured it’s employment and shifted emphasis to online and still has strong loyalty.. the night is darkest before the dawn and Johns short term emotions have been placated at the expense of a very nice profit in 4-5 years time..

    1. Hi Mark

      “Johns reasons for selling smack of rationalising despairing capitulation”


      “Johns short term emotions have been placated”

      I can understand why you might think that, but neither statement is true.

      If I’d simply sold Ted and said that I didn’t like the company anymore, then perhaps that might be emotional capitulation. However, after more than a decade as a stock picker, I have long since moved past the stage of being emotionally affected by the ups and downs of individual companies.

      In fact, my portfolio is deliberately set up so that individual holdings don’t keep me up at night. Ted Baker, for example, never made up more than 5% of my portfolio, so even if it went bust I wouldn’t have been overly concerned.

      Instead, I would have investigated the reasons behind its downfall and whether there were any lessons that could be applied to other companies. That’s exactly what I did, and my findings are detailed in this article.

      As for judging the future over a short time frame, I’m not. I have looked at Ted’s results over the past 20 years or so and they just do not look like the performance of a high quality, highly competitive business. Instead, they look like the returns of a so-so retailer that opened (leased) as many new stores as it could for as long as it could, until the market turned against it and it collapsed under the weight of those debts thanks to its inability to earn decent returns on capital.

      For the sake of Ted’s employees I hope management can turn the company around, but it doesn’t have the track record of a quality business so I’m not interested in owning it.

  6. Hi John

    “So I crunched the numbers and it very soon became clear that these companies weren’t highly profitable after all. In fact, once their very large rental obligations (also known as operating lease liabilities) were correctly added to capital employed, their returns on capital employed declined from very high levels of around 20% to unacceptably weak levels of less than 10%.”

    I’m not really sure I follow your calculation here in assessing TED’s returns.
    I agree completely that you should consider leases (especially for a smallish retailer like TED that doesn’t own any of its stores and has a circa 100m rental expense each year).
    However, I’m questioning your formula here or rather the way you have calculated returns. If you want to calculate ROIC for instance then you must have consistency in top and bottom lines. So if you want to include lease capital in invested capital (ie denominator) then you must reverse it out of your NOPAT (ie tax effected EBIT) – otherwise you have an apples and oranges calculation.
    When I calculate ROIC on that basis and include leases, I get 22% and 21% for 2018 and 2019. When I exclude leases I get ROIC 17% and 15%

    1. Hi MAB

      You’re right of course. When you’re calculating ROCE or ROIC the standard approach is to have return and capital numbers match up, so return should be EBITR (EBIT before rent) for lease adjusted ROCE.

      However, I like to use net earnings for a few reasons:

      1) it’s easier
      2) it makes ROCE worse for companies that use a lot of debt and leases as the returns (earnings) are reduced by interest and rent payments. This makes them appear less attractive and is a form of ‘risk adjusting’ ROCE.

      If this approach is applied consistently across all companies then I think it’s useful. I realise it’s non standard but that’s fine by me.

      I do indirectly look at debt (and leases) to equity, but I like to factor debt costs into ROCE as well.

  7. Hi John,

    My biggest mistake has got to be AA Plc. To be succinct my failure was to overlook the governance of that company. Governance dictates the success and failure of any company.

    Tobacco is a good example they may produce products that are not socially acceptable but the first priority of management has always been to the shareholders of the company. On the other hand, if you look at corporate failure a lot of it boils down to bad management. Sometimes good management means accepting the reality as it is and making hard choices.

    For example C&A the clothing retailer quit the UK in the late 90s, in hindsight it seems like it was a wise decision. This decision saved the owners a substantial amount of money. However, finding management of that calibre is very difficult. Even Steve Jobs when he returned back to Apple he shrank the company and managed it in a financially prudent manner. Most people think the iPod saved the company but it was his laser focus on mundane activities such as financial management that saved Apple and this heavily leans on governance. Choices like this mean taking ego out of the equation which the management seems to be very susceptible to.

    1. Hi Reg

      I agree that governance is important, but it should still show up in the numbers so that’s where my initial focus is.

      “Steve Jobs when he returned back to Apple he shrank the company”

      This idea of corporate focus and leadership in a given niche is something that has gradually moved to the centre of my thinking on the ‘quality’ of a company.

      As you say, one of the most important steps Jobs made was to re-focus Apple on a small number of core products and markets where it either was or could be the leader. And once leadership is built in a given market, expand carefully from there to dominate adjacent niches.

  8. Unbelievable that most of the liabilities were off Balance Sheet and not in the accounts due to the accounting standards. Can you believe it took 10 years for FRS 16 to happen?

    What else could be off balance sheet when reading accounts? Pension liabilities?.

    1. Hi Tony

      The argument over leases has been ongoing for decades, so at least it’s finally in place.

      And yes, I agree that pension liabilities and assets should be on the balance sheet when the company is liable.

      I still don’t understood why companies think they have any business managing their employees’ pension funds. Far better to offload the whole thing to a proper pension manager or life insurer I’d say. Seems that BAE, Rolls Royce and others at least partly agree, having offloaded billions to a certain life insurer and pension transfer specialist.

  9. Excellent article, but I do struggle with your conclusion, where you say “with the turnaround plan in place I think there is little left to be learned from this investment, so I think now is an appropriate time to sell up and move on.”

    If the new capital-light turnaround plan meets with your approval, why sell now? With this new plan in place, many consider TED to be a good recovery play.

    1. Hi Ian, the issue is mostly one of confidence is Ted’s ability to successfully execute on its new strategy.

      I like the strategy, but it’s a new direction for Ted and the company has zero track record of operating as a capital-light online-first retailer. Instead, Ted’s track record is one of debt-fuelled growth and weak returns on capital.

      I will be happy to invest in Ted if it can successfully pull this transformation off, but I would need to see five to ten years of consistent success before I’d have any confidence in Ted’s longer-term future.

  10. A masterclass in how leases and FRS16 are being used as applied to CINEworld.

    The discount rate sets the present value of the liabilities and many companies like CINE, as they have been given a few years to ‘adjust’ liabilities, have set the rate high, massively reducing the PV of the future liabilities on the balance sheet.

    1. Thanks Tony, very interesting. An 8% discount rate for lease liabilities seems very dubious, especially as it’s much higher than the company’s typical borrowing rate.

      I didn’t look at the company in detail, so it would be interesting to know how they justify not using their borrowing rate to discount future lease liabilities.

      As far as I can see its lease liabilities are off the chart, even with potentially excessive discounting. According to SharePad, Cineworld’s lease liabilities are about £4bn. Combine that with borrowings and its total liabilities are about £7.5bn. The company’s earnings have been up and down over the last few years, partly due to a £3bnn acquisition, but they have never reached more than £300m. Even if I’m very generous and compare liabilities to those peak earnings, the ratio of liabilities to earnings is 25x.

      For context, my general rule of thumb for liabilities is that that ratio shouldn’t be more than 5x, so 25x indicates that Cineworld may be ludicrously over-leveraged, especially given the current environment.

  11. Hi John,

    Given the current valuation of Ted after it’s fall from grace, what are your thoughts on it now being at an attractive entry point? I’m not sure if you are somebody who reenters a position after selling or not, but if you were to come across Ted today without your history what would your thoughts be?
    It’s one that I have come across recently myself as a value investor, based purely on it’s fundamentals, although I have not dived in as much as you have here (which has been a very informative read – so thank you for that), it does look rather cheap now that it has overcome this execptionally rocky period.
    Whilst I think it would be dreamland for anyone to think Ted will return to a value of anything over £20/share, from my own calculations I would expect it to recover to around the £7 point within the next 3-5 years and so I guess I just wondered where you see it going (if you have looked at it at all since you’ve sold).

    1. Hi Liam

      I’m quite happy to reinvest in a company I’ve previously sold as long as I like the company and the valuation.

      In Ted Baker’s case, everything I wrote in the article still stands. It grew too fast using too much debt to roll out excessively lavish and expensive stores. Once lease liabilities were factored in its profitability was mediocre at best, suggesting Ted did nt have any meaningful competitive advantages.

      The new strategy of focusing on online growth and improving ROCE would need to produce tangibly better results for quite a few years before I’d even think of reinvesting. I don’t want to invest in turnarounds and that’s what Ted Baker will be until it has proved itself capable of operating as an online-first 21st century fashion retailer.

      But that’s just my approach and investing in turnarounds is an entirely reasonable strategy if that’s your thing. It can be extremely profitable for those who can spot inflection points and are willing to invest in companies where the current results are truly terrible.

      I’ve done that in the past and I’m not very good at it, so I prefer to stick with very successful companies with very good prospects, and which are facing minor problems at best.

      Unfortunately I don’t have any thoughts on Ted’s value as I’m not interested in the company (for at least the next five years I’d say), but if you do choose to invest then I wish you better luck than I had!


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