Agrokor giant brought down by addiction to junk debt

Indicating the depth of the problems at the aggressively acquisitive group, new Chief Restructuring Officer Antonio Alvarez of consultancy Alvarez & Marsal has warned that there is no guarantee it can be saved.

"Time is of the essence. The situation is pretty acute," Alvarez told a press conference on April 4, according to Reuters. "There is no guarantee we will succeed. This is one of the most challenging situations that we are going to face,” he added.

Alvarez’s appointment is part of a standstill agreement struck between the Croatian company and its creditors after it spiralled into serious liquidity problems at the beginning of this year. The agreement, put in place on April 2, was reached after several months of speculation about Agrokor’s ability to repay its debts and reimburse suppliers, as the debt-financed expansion model that has served it well for decades suddenly imploded.

This was the product of a variety of factors, from the failure to gain the expected benefits from the 2014 acquisition of regional competitor Mercator, to increased competition from West European retailers that have targeted Croatia after its accession to the European Union in 2013.

These contributed to a perfect storm of problems for Agrokor. “Debt-financed expansion, lack of strategic efficiency, miserable profitability, huge labour costs (more than 12% to turnover, much higher compared to competitors) as a result of [Agrokor’s] national champion mission in Croatia (and Slovenia), and long lasting economic recession (2008-2016), lack of transparency and proper corporate governance, all of that led to balance sheet imbalances/financial leverage problems,” writes Damir Novotny, managing partner of managing consultancy T&MC Group, in a comment emailed to bne IntelliNews.

Todoric had mainly used debt finance to grow his business from a small flower company founded back in 1976 – one of the many small enterprises allowed to operate when Croatia was part of the former Yugoslavia – into a regional empire spanning the food and retail sectors across the region.

According to Agrokor’s website, the company had become the market leader in the domestic flower trade by the mid 1980s, after which it expanded into the import and export of cereals, oil crops, fruit and vegetables.

Alongside organic growth, Agrokor also expanded through an aggressive acquisition strategy, chiefly in two waves of acquisitions in the mid 1990s and mid 2000s.

The first wave took place in 1993 and 1994, after Croatia broke away from Yugoslavia, and while war was still raging in Bosnia. During this period Todoric snapped up cooking oil and margarine producer Zvijezda (1993), bottled water company Jamnica (1994) and ice cream and frozen food manufacturer Ledo (1994), all market leaders in their segments within newly independent Croatia.

Junk debt expansion

Agrokor’s rapid expansion was also reputedly helped by Todoric’s relationship with Croatia’s then President Franjo Tudjman and other members of the Croatian ruling elite.

“Corporate strategy, as formulated by Mr Ivica Todoric personally, was more or less focused on a rapid inorganic growth strategy with heavy support by the Croatian elite,” writes Novotny.

The second buying spree took place a decade later, during a period of strong economic growth in the pre-crisis years of the mid-2000s. In 2005, Agrokor bought up Croatia’s largest agricultural company Belje, the country’s top meat producer PIK Vrbovec, and Agrolaguna, a producer of wine, olives and beef. Two years later, it also bought a majority stake in the country’s biggest chain of news stands, as well as top tobacco retailer Tisak.

Since Agrokor doesn’t publish consolidated and audited financial reports, its debt instruments have been sold as junk, Novotny says. “For almost a decade the company financed expansion with mid- and long-term junk bond instruments, which led to enormous financing cost.” He also points to Agrokor’s expansion into non-core markets such as leisure, printing, advertising and civil engineering.

Dragan Munjiza, founder of Zagreb-based consultancy Jakov Viktor,  notes that Agrokor has been “financing itself for 25 years with over-premium interest rates, unthinkable for its foreign competitors Lidl-Schwarz and Spar Group”. In addition, “Agrokor had a lot of ‘pet side projects’, which have been occupying its limited resources, especially human and financial,” he tells bne IntelliNews.

Despite its rapid expansion and the size of its operation, Agrokor remains privately held, with Todoric still holding 95% of the group, and to a large extent it is still run like a private company. It is also a family concern; Todoric’s three children - daughter Iva and sons Ante and Ivan - are all involved in the company, from the family’s base at the 16th century Kulmer Castle in Zagreb.

While Todoric reportedly employed Rothschild in late 2014 to prepare for a potential IPO, so far only some of the group’s companies (such as Ledo) are listed on the Zagreb stock exchange.

The group’s most significant deal – and, according to analysts, one of the contributors to its current troubles – was the purchase of Mercator, a Slovenia-based food and retail group. Along with Serbia’s Delta Group, Mercator had been Agrokor’s main competitor in the region. In fact, Todoric had reportedly tried several times to merge all three companies, as well as trying unsuccessfully to take over Mercator, before finally striking a deal with the Slovenian group.

Under the deal initially announced in 2013, Agrokor paid €240mn for a 53.1% stake in Mercator, raising its stake to over 80% the following year. In total the deal was worth €544mn, including the payment for Mercator, €200mn to restructure part of Mercator’s financial obligations and €20mn to finance Mercator’s working capital. At the time Mercator was struggling financially and had to conclude a restructuring deal with its own creditors to allow the deal with Agrokor to go ahead.

The combined business had sales of €7bn at the time of the deal, and around 60,000 employees across the region. The deal was intended to allow Agrokor to scale up its business and turn the group into the undisputed leader in the region’s food and retail sector.

Margin pressure

Unfortunately for Agrokor, it came shortly after Croatia’s EU accession, at a time when West European retail giants were investing in the Western Balkans as one of the final frontiers for retailers on the continent. Three years before Agrokor announced its acquisition of Mercator, Belgium’s Delhaize bought up Serbia’s Delta Maxi. Germany’s Schwartz group, mainly via Lidl, was also active in the region, further saturating local markets and eroding the market share of Agrokor’s flagship retail chain Konzum as well as Mercator.

Spar is also set to become a more important player in Croatia, after announcing in 2016 it would acquire Austrian retailer Billa’s stores in the country. As of late 2016, Mercator was still the largest retailer in Croatia, but data from the competition agency showed that Lidl and local player Plodine were catching up.

“Agrokor took over its largest Balkan rival, Mercator, after four unsuccessful attempts, driven by goals to scale up its business. However, now it is facing margin pressure due to aggressive local discounters like Spar,” says Amman Patel, analyst at global investment research and analytics firm Aranca. “The margin pressure and high commodity prices, although a systematic issue, aggravate the problem for Agrokor due to its high leverage.”

Patel points out that declining ebitda made Agrokor’s leverage “beyond manageable”, pushing its ratio of net debt to trailing 12-month ebitda to above seven, compared to a typical ratio of three for the retail industry.

Elsewhere in the Balkans, Delhaize is now the market leader in Serbia, with a small edge over Mercator according to Euromonitor data, while there is speculation that Lidl, which registered a Serbian entity back in 2010, could finally enter the market this year. In Bosnia, Mercator is now going head to head with local chain Bingo, which has benefited from funding from the European Bank for Reconstruction and Development (EBRD).

Poslovni Sistem Mercator remains the market leader in Slovenia, with a considerably larger market share than next placed Spar, although again it is facing increased competitive pressure. “Mercator’s share has fallen from 45% to 30% in Slovenia post integration and the company is facing delay in realising any efficiency gains as many of its stores are under renovation and being remodelled,” says Patel.

In May 2016, Sberbank announced it had opened a six-year credit line worth €350mn for Agrokor, following a €600mn credit line provided in 2014. Later in the year, Agrokor said it had completed a refinancing exercise, which included the extension of €340mn of existing debt with VTB and a further €500mn with a syndicate of banks including Sberbank, BNP Paribas, Credit Suisse, Goldman Sachs and J P Morgan Securities.

“Since Western banks, including the EBRD, reduced exposure and decided not to finance further expansion without restructuring and business model expansion, Mr Todoric approached Russian banks which offered refinancing under ‘softer’ conditions,” says Novotny. “That supported the illusion that Agrokor could continue rapid expansion without restructuring and a capital increase.”

However, this all came crashing down in the first few months of 2017, when bondholders started selling, prompted by concerns Agrokor would be unable to repay senior bonds due in May 2019.

According to Bloomberg, the bonds backing the Mercator deal dropped from over 80 cents in the euro at the beginning of 2017 to just 20 cents as of March 23.

After weeks of speculation, creditors – including Sberbank, VTB, Central European lenders Raifferisen and Erste and local Privredna Banka Zagreb and Zagrebacka banka – announced a standstill agreement with Agrokor on March 31, which entered into force two days later.

Too big to fail

The agreement is expected to make it easier for the troubled group to “resolve its liquidity requirements, to ensure settlement of trade payables towards suppliers, to ensure its continued operation and preserve the value of the group, as well as to establish a basis for a sustainable restructuring of the group,” said the statement, emailed to bne IntelliNews by Erste. Agrokor did not reply to a request for further information.

As well as Alvarez’s appointment as chief restructuring officer, independent experts will be appointed to other top management positions. Sberbank, which also did not respond to bne IntelliNews’ request for further information, is believed to want Todoric to be removed from the management of the group whose growth he has overseen for the last four decades.

The head of the Russian bank’s Croatian unit, Mario Henjak, told journalists that additional funds will be invested in Agrokor, but did not specify how much, according to Croatian news agency Hina.

Meanwhile, Agrokor’s Croatian suppliers, which are owed around HRK16bn ($2.29bn), have asked the government to step in and help speed up the unfreezing of Agrokor’s accounts, Reuters reported. Suppliers met with Prime Minister Andrej Plenkovic on April 3.

A wide-reaching restructuring of the group is expected in the two years before the €300mn worth of senior bonds are due to be repaid in May 2019.

“I strongly believe that Agrokor’s debt problems could not be resolved without overwhelming strategic transformation, not only with small-scale business model changes,” says Novotny.

Patel does not anticipate significant operational turnaround in the next two years, though he does expect some of Agrokor’s assets to be sold off as restructuring gets underway. “We expect to see asset sales in the next one to two years for deleveraging. Those could be top performers like Jamnica and Zwijeza, as less profitable ones might fetch lower valuations than what Agrokor might expect in a situation where they desperately need to sell,” he forecasts.