26 September 2019
Thomas Cook’s Final Tour
Natural selection or mismanagement?
By Frank O’Nomics
Remember Radio Rentals and Blockbuster video? One company disappeared because of a change of habits (from renting to buying TVs), the other because of technological changes (anyone want an old video player?). The demise of Thomas Cook could be ascribed to the same phenomena. Holiday buying habits have changed – people tend to book flights and accommodation separately, rather than buying a package holiday, and from a technological perspective the internet has led to spending online, thereby leaving a company owning 544 shops with a very large unnecessary overhead. But was the closure of a 178-year-old company really inevitable? Despite wavering consumer confidence, the bigger demand for holidays must surely be undimmed, particularly from an ageing population. This is a company that had 22 million customers (150,000 of whom were affected this week). So where did they go wrong and what are the lessons for others?
At the outset it must be acknowledged that there were other problems for Thomas Cook, principally the weather and Brexit. When in doubt blame global warming or the government. The hot summer in 2018 did encourage “staycations”, which hit Thomas Cook’s business at the worst possible time, and the blow to consumer confidence from Brexit uncertainty has meant that, even with an average summer, the upturn in demand was disappointing. However, neither of these factors can be seen as long-term issues, and are the kind of demand blips that businesses face all the time. Most companies have contingencies to weather such storms, but they hit Thomas Cook at a time of great vulnerability.
So what really went wrong? The simple answer seems to be an inability to adapt to the changing market place – and debt. The refinancing deal that failed did involve the separation of the company’s airline and tour businesses, which looks to be the right idea but way too late. There had been attempts to cut costs in the past – 2,800 jobs went after a merger with MyTravel (which helped secure a nice bonus for the CEO) – but the main way in which the company tried to service its debts was merely to increase the level of its borrowings. At some point banks shout “enough!” and that point was reached this week. Their major Chinese shareholder, to the tune of £450mn, supported a £1.1bn refinancing, but their group of banks would only agree to commit a similar amount if £200mn was raised externally as a contingency against winter trading. Pleas to the government for the money (somewhat ironic given that one of the dissenting banks was the partly government owned RBS) fell on deaf ears and the plug was duly pulled.
Should we be blaming the government? It is fair to argue that giving Thomas Cook £200mn is a lot less of a hit to the tax payer than the costs of repatriating 150,000 travellers, which it is thought could be as much as £600mn. However, when apportioning blame it is hard to see beyond the company’s management. Three CEOs in the last 12 years is not a recipe for continuity and they took a long time to acknowledge the internet impact – going so far as to actually add 401 Co-op travel agencies before embarking on their cost cutting. The dependence on debt is staggering. When they raised £1.6bn in 2013 only £425mn was equity finance, leading to a current level of debt of £1.7bn. The costs of servicing this debt is eye-watering, totaling £1.2bn since 2012.
It is hard to lay the blame on the banks. They could have stumped up the additional cash this time around, but realistically they might have withdrawn support earlier if they had been presented with a more realistic picture of company finances. The restructuring of the business in response to the disruption caused by the rise of the internet allowed them to cite a large amount of costs as one-off exceptional items, which made the underlying profits look healthier than they were. How long can repeated costs be regarded as “one-off”? Once this had been addressed by a new CFO the restatement of earnings for 2018 was 18% lower than first suggested. This is not to suggest by any means that management were doing anything illegal – but it does point to a head-in-the sand mentality. A similar approach seems apparent in the time it took to take a £1.1bn goodwill impairment on MyTravel.
The loss of Thomas Cook is a very sad event. The lesson for investors is clearly to look at the degree to which a company is being positioned for a changing market place. It is also to take a close look at the level of debt on the balance sheet, the cost of servicing that debt, and the extent to which efforts are being made to pay it down – not to increase it. Many have cited Tui as an example of a company better positioned for the current holiday market, although the debt levels here have also been rising. We should have some sympathy with the Turkish investor who recently took an 8% stake in Thomas Cook; he saw the issues for the company as managerial rather than financial and wanted to get involved in the turnaround process. Sadly, events have developed without that happening. Thomas Cook started his company with teetotal travel excursions, yet its demise seems more likely to drive its frustrated customers to drink.