Deal Mechanic: Card Factory

British discount card retailer Card Factory was already a strong business when it was acquired by Charterhouse Capital Partners in April 2010. Established in 1997 as a one-store discount retailer, on acquisition it had 485 stores across the country and the process of vertical integration within the business was already well underway. Founder Dean Hoyle had brought designer Stuart Middleton on board, and the company was in the process of buying a printing business.

This vertical integration is a key differentiator for Card Factory; unlike other high-street card retailers, it is not reliant on outside designers and suppliers.

“It captures the whole value chain, which makes it a much more profitable business,” says Charterhouse partner Graeme Coulthard, who led the acquisition and subsequent IPO.
With the fundamentals in place, including a strong management team, Charterhouse focused on key value-drivers to propel the business forward – and generate an impressive return for investors.

April 2010 was a tricky time to complete deals. “The debt markets were pretty much shut,” Coulthard says. “Trying to get a bunch of banks together in a staple finance package was proving quite difficult.”

The auction process, run by KPMG, attracted a number of Charterhouse’s competitors, including Cinven and Permira, but it was Charterhouse’s willingness to underwrite the debt itself that made it the strongest contender. “We came along and said, ‘We will write one cheque for you, we will underwrite the debt and the equity, and then subsequently we’ll sell down the debt,’” Coulthard says.

Charterhouse acquired Card Factory with senior debt of 3x EBITDA, which in January 2010 was £53 million, and sold the debt down less than two months later.

Company founder Hoyle was also keen to roll £25 million of equity into the deal. “Instead of him putting £25 million into the equity, we increased the price by £10 million, so he had £35 million, and then he provided that as a loan to the company at a 10 percent rate of interest on a roll-up basis,” says Coulthard.

Hoyle’s vendor loan note was repaid in 2013 when Charterhouse refinanced Card Factory, taking out its original investment and re-introducing debt of 3x EBITDA.

On acquisition Card Factory was opening 50 new stores every year. A typical store is around 1,200 square feet, requires about £60,000 of upfront capex and rents in the region of £50,000 per annum. Its first year of sales is around £300,000, growing to £500,000 over a five-year period. “The business had a clear track record of this level of new store openings over a number of years and a well-developed pipeline to continue openings at this level,” Coulthard says.

As a value retailer, with 90 percent of cards selling for less than £1, a natural avenue of exploration was increasing prices. On acquisition, the majority of Card Factory’s cards fell into three pricing bands: 59 pence, 89 pence and 99 pence.

“We had a lot of discussions around it, and ultimately we decided not to change the price points at all but to adjust the price mix of cards available for sale instead,” Coulthard says. Adjusting the ratio of less expensive to more expensive cards in favour of pricier offerings helped to increase the average in-store spend.

Card Factory also introduced a “13th row” of cards on the stores’ shelves, priced at £1.49. “That was incredibly successful at just increasing the average price of cards sold as well,” Coulthard adds.

With the roll-out strategy continuing as planned, Charterhouse began to look at creating an online presence for Card Factory. In July 2011 the business acquired online gifts retailer Getting Personal. “We liked it because it was selling personalised cards but also selling other personalised products online,” Coulthard says.

Reluctant to move into the online space as opening new retail stores had been a reliable revenue stream, management was persuaded that the move would pay off in the long run.
“When you exit a business, especially if it’s a retail business, you have to have an online part to it. It’s expected now.”

With cards sorted into three price bands, differentiated by size, management had never felt that an investment in electronic point of sale technology was warranted. However, as the business expanded, Charterhouse saw the potential from such an investment. As well as further professionalising the business – which would improve its valuation at sale – it could also be used as a value driver.

“It gives you so much more data on the business and what’s selling,” Coulthard says. “They can try all sorts of promotions and get real-time information on whether it’s working or not.”

Charterhouse also set about making improvements to Card Factory’s printing facilities and warehouses. “When we invested in 2010 there wasn’t a nice, neat production line,” Coulthard says.

“You’d have cards that actually had to be wheeled from one building to another, outside. We’re talking about paper here, which in the British weather is not a great thing to do.”

The business acquired a 100,000 square foot freehold site in Shipley, West Yorkshire, and set up streamlined production lines with new machinery to increase the annual print capacity. “To January 2014 [Card Factory] sold 285 million cards and the new print facility has a capacity of 400 million cards, so there’s plenty of capacity within the business,” Coulthard says.

The new facilities also allowed the business to begin vertically integrating Getting Personal. Today about 60 percent of its offerings are produced by Card Factory.
Charterhouse also used some of Card Factory’s cash flow to invest in warehousing facilities and a dedicated head office. The warehousing facilities can cater for more than 1,100 UK stores, while the head office has space for 250 people – 100 more than currently work there.

Charterhouse exited the business in four stages. In May 2014 the firm listed Card Factory on the London Stock Exchange, selling 30 percent of its stake at 225 pence per share and bringing its return – including the October 2013 refinancing – to 2x invested capital. Following the expiry of the 180-day lock-up period, the firm sold 40 million shares in December 2014, a further 40 million shares in January 2015, and its remaining shares in March 2015, generating a total gross return of 5.25x.

“Each of our post-IPO sales of shares were done at a premium to the market price on the day,” Coulthard says.

As of mid-July, Card Factory’s shares were trading at 325 pence per share, giving the company a market capitalisation of £1.1 billion.

As Charterhouse continues to raise its 10th buyout fund, targeting €3 billion, another solid exit for Fund IX – which has returned all committed capital to investors – contributing to an average return so far of just under 3x is sure to go a long way to encouraging its investors that they are on to a good thing.