Why I’d get my money out of this stock now

What a nightmare Mothercare (MTC) is turning out to be both for shareholders and employees.

Things have got so bad thatthe company won't pay a dividend until further notice. And dividends are not the only thing to be axed...

On top of last year's 110 store closures, another 111 are now on the block. This more or less halves their number of stores and could lead to the loss of 750 jobs.

Try 6 free issues of MoneyWeek today

Get unparalleled financial insight, analysis and expert opinion you can profit from.

Start your trial

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

But in all the guff I've read in the press, nobody mentions the real problem that's caused Mothercare all this heartache.

Yes, the High Street is in decline. Yes, that's got a lot to do with supermarkets hogging most of the sales. And yes, the online beast is ripping shreds off the traditional off-line' players. Hardly any insight in that lot...

But what's really happened at Mothercare is a classic balls-up. For shareholders it's a mistake that's all too prevalent out there, and it's one we really need to be on the lookout for.

Hubris and apathy are a deadly combination

Set up in the early sixties, Mothercare was the fantastic product of the new world of consumerism. Like Habitat (with which it later merged, and then demerged), it filled a niche and was a great success. But come the millennium,its stores were already showing signs of age.

The rot at Mothercare really set in back in 2007. As is so often the case, it involved what looks increasingly like a lazy management team stumping up big money to take over another company.

Another upstart had found its own niche in this market. Early Learning Centre (ELC) had stolen a march on MTC; its focus on toys and the like was doing very nicely, thank you very much. In 2003, ELC won Media Age's award for the best retail website. It had even started up nursery stores' selling pushchairs and cots. Now that was really starting to tread on the toes of MTC.

So what should MTC have done about its rival? Well, I would suggest it should have learned a few tricks and upped its game. It did, after all, have a fantastic brand and the benefit of incumbency.

BUT what did MTC do? Well, it took what looked like a much easier path. It decided to buy ELC.

If you look backat the 2007 report and accounts, you can read all about the wonderful synergistic opportunities. You can read about how this defining deal was going to be earnings enhancing from year one.'

What a load of rubbish. MTC shelled out £85m on this adventure (which, incidentally, is about how much it still owes the banks now).

This was the lazy way out of trouble or so it seemed. In business, as with personal finances, nothing is easier than spending money. And overnight, management would be managing an empire with twice as many retail units... now surely that added responsibility would merit a pay rise!?

Well, it won't be lost on shareholders that this empire is going to be whittled back down to whence it began. Yes, most of those ELC stores will get the chop. It seems they're bringing the ELC toys and paraphernalia into the main MTC shops. Flaming Norah if it wanted to retail all this stuff, it could have done so in the first place under its own brand! But I guess that would have been too much like hard work.

And at what cost! Yes, £85m to buy ELC back in 2007, and with yesterday's announcement, it's having to set aside another £35m towards the cost of shutting the stores down! It costs serious money to fire staff and renege on your rental commitments.

MTC has gone cap in hand to the banks to re-arrange its overdraft. And I dare say it was the banks that told them "No more dividends for those pesky shareholders."

Long-time Right Side readers might remember that I warned HMV shareholders long ago, that it was "now a business working for the banks not shareholders" and now it looks like MTC is in the same boat. Incidentally, HMV got itself into debt problems in exactly the same way. It paid crazy money on acquisitions that looked great on paper, but ended up providing exactly the right yardage of rope for its own noose.

When takeovers spell trouble

I've got no fundamental problem with corporate takeovers, so long as they're done for the right reasons.

Takethe example ofCroda. Croda is a brilliant business that makes oil-based products and ingredients for industriessuch ascosmetics. It's run by a mightily shrewd management team based in Yorkshire. When, in 2006, it was offered the chance to double in size through the acquisition of one of ICI's units, I was convinced it would make a go of it. And it did.

You see, what you had there was a well-run business taking over a poorly run business. You could make the same argument for Morrison's takeover of Safeway in 2004. Yes, there may be hiccups along the way but if management is prepared to put in the effort to turn-around an ailing enterprise, then there's likely to be some bounty in it for shareholders over the long-run.

But when a takeover boils down to taking out a competitor rather than taking on a competitor, it's likely to end in tears. And those tears are more likely to come from shareholders than the management team.

Where does MTC go from here?

I'm pretty sure MTC will survive. Cutting down its store base to 200 seems sensible. Research by estates surveyor CBRE suggests that today, you can reach half the population with as few as 90 stores. I guess that's a product of the out-of-town retail sheds approach.

But as I said earlier, all the while MTC is in hock to the banks, it's the banks that it's really working for not shareholders. I don't see that changing for a long, long time.

MTC has installed a new chief exec (Simon Calver from Lovefilm) who'll take up the reins in May. Perhaps he'll pilot the ship well; but I wouldn't hang around to find out.

Shares were up last week on the back of enthusiasm for this grand hatchet-job. But with dividends axed and a bloody retail playing field, I'd take my money and run.

This article is taken from the free investment email The Right side. Sign up to The Right Side here.

Important Information

Your capital is at risk when you invest in shares - you can lose some or all of your money, so never risk more than you can afford to lose. Always seek personal advice if you are unsure about the suitability of any investment. Past performance and forecasts are not reliable indicators of future results. Commissions, fees and other charges can reduce returns from investments. Profits from share dealing are a form of income and subject to taxation. Tax treatment depends on individual circumstances and may be subject to change in the future. Please note that there will be no follow up to recommendations in The Right Side.

Managing Editor: Frank Hemsley. The Right Side is a regulated product issued by Fleet Street Publications Ltd.

Fleet Street Publications Ltd is authorised and regulated by the Financial Services Authority. FSA No 115234. https://www.fsa.gov.uk/register/home.do