The truth behind the Thomas Cook and Co-op ‘merger’

A very large spanner has been put into the works of the proposed merger of the travel businesses of the Co-operative Group, Midlands Co-operative and Thomas Cook. The Office of Fair Trading wants to consider the merger proposal and has asked the European Commission permission to do so. It might then refer the proposal to the Competition Commission for a full-scale – and time-consuming – investigation.

It is impossible to predict what outcome a Competition Commission investigation would come to. On the one hand, the merged business would become the UK’s largest retail travel agent – leapfrogging Tui (also known as Thomson Holidays). It would create a network of 1,200 outlets and a combined customer base of 4.3 million consumers. In addition, the merged operation would be the second largest high street provider of foreign exchange services, behind only the Post Office. The reality is that the merged business would significantly reduce competition in the market place.

On the other hand, though, there is a serious risk that without rationalisation, the retail travel agency trade will decline to the point where Tui has complete market dominance. We have already seen long-standing independent travel agencies fold. Even larger travel agents are struggling to survive in a market where far more consumers ‘pick and mix’ air travel and accommodation over the internet.

Last year was a particularly bad year for the travel business, affected both by the recession and the Icelandic ash clouds. Thousands of holidays were cancelled by the volcanic ash, sparking refunds, and many holiday-makers decided that domestic holidays were a safer option than air travel.

The financial damage can be seen in the travel agents’ balance sheets. Thomas Cook’s pre-tax profits fell by 7.5%, from £45m to £42m. The situation for Co-operative Travel was much worse: down to a mere £100,000 from £2.5m a year before and £7.5m in 2008. It is obvious that Thomas Cook is in a stronger financial position than Co-op Travel: Cook’s profit relative to its turnover is much higher. With the Co-op facing the prospect of its chain soon becoming loss-making, it is no wonder that the merger is attractive.

It is the risk to the continued operation of Co-operative Travel that persuaded the shopworkers’ union Usdaw to support the merger, despite the prospect of hundreds of their members losing their jobs. Sharon Ainsworth, Usdaw National Officer, said: “This will be a major change for our members, but Usdaw is very positive about the venture and believe it will help secure the long term future of the Co-operative’s travel businesses and maintain their presence on the high street. With the combined knowledge and experience of both companies the venture can go from strength to strength.”

She added: “While there will obviously now be some uncertainty for our members, I do not think the announcement will have come as a complete surprise to them as they are fully aware of the challenges the travel industry has faced over the past few years. Usdaw will have full consultations with the Co-operative Group over the coming months and our key aim will be to secure as many jobs as possible and to support and represent our members throughout this period of change.”

In a combined statement from Thomas Cook and the Co-operative Group – Midlands Co-operative intend to come on board later and is less in the driving seat than the other two businesses – ‘synergies’ of £35m per year were predicted. Synergies, of course, represents the savings achieved by stripping out the duplication of provision that becomes unnecessary after merger. That rationalization will be achieved by closing high street shops where there is duplication and also, in likelihood, through the loss of Co-operative Travel administrative jobs in Manchester.

Most of this information will be widely known already amongst readers of the News. What has surprised me is the lack of awareness of what the deal could mean for the future. In the short-term, the combined business will be jointly owned: 70% by Thomas Cook and 30% by Co-operative Travel. Assuming Midlands Co-operative joins, the joint ownership arrangements become 66.5% for Thomas Cook; 30% still for Co-operative Group; and 3.5% for Midlands Co-operative.

A further sign of where the power lies in the merged business is indicated by who takes the top jobs. Thomas Cook chief executive Manny Fontenia-Novoa becomes chairman; Thomas Cook UK chief executive Ian Derbyshire takes on the role of chief executive of the new business; while Co-operative Travel finance director Paul Hemingway is appointed to the new operation in his existing role.

To my mind, though, the real significance lies in the long-term arrangements. The deal has been “agreed for unlimited duration”. But that does not mean that the same joint ownership arrangements are necessarily in place indefinitely.

Over the first four years, the Co-operative is guaranteed a return of at least £40m – much better than its current annual profit. But if the combined business is by the fifth year delivering strong returns Thomas Cook may then buy the Co-operative Group out.

In a joint statement, the two businesses said: “It is intended that the merger remains in existence for the long-term, although from the fifth year onwards, The Co-operative has an option to put its shares to Thomas Cook for a consideration of 4.0 x EBITDA, whilst Thomas Cook has an option to call the shares owned by The Co-operative for a consideration of 5.0 x EBITDA and in such case Thomas Cook will be able to utilise The Co-operative Travel brand for a further two years after exit.”

To put this into simpler language, the Co-operative Group can require Thomas Cook to buy it out in the fifth year or after, while Thomas Cook has the right to require the Co-operative Group to sell its stake. EBITDA is ‘earnings before interest, tax, dividends and amortisation’ – one definition of a business’s profits. This effectively prescribes the range of prices that would be paid were the sale to proceed.

These proposed details of potential sale make it look as if these negotiations are leading to an exit from the travel business for Co-operative Group. But Group spokesman Phil Edwards says this interpretation is misguided. In any joint venture of this kind it is commercially advisable to have this kind of clause built in to the contract,” he explains.  “However it must be stressed that both businesses are in this for the long term.  This deal is all about strengthening the Co-operative Travel brand in the years ahead.”

It must surely also, though, be about protecting the wider Group business from the potential losses that the travel operation would suffer if the rationalisation were not to take place. If the Group does ultimately withdraw from travel brokerage sector it would be hard to criticise – executive leadership must involve taking tough decisions to protect the organisational whole from the potentially loss-making parts.

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