Can Varteks survive and have a sustainable business model in the event of a creditors’ agreement

Creditors and banks must quickly reach an agreement to prevent the struggling Varaždin textile company Varteks from going bankrupt, which would result in the termination of its 850 employees.

Last week, Hina reported the news of the blocking of Varteks’s account due to the collection of receivables, as well as the halting of part of the production, since some workers refused to work upon returning from vacation until they saw how their next salary would be paid. Meanwhile, part of the debt to the Tax Administration and the City of Varaždin has been resolved, but negotiations among creditors regarding the distribution of funds that could be obtained from the potential sale of land to Kaufland are still ongoing.

Despite this, the president of the Workers’ Council Božica Čiček Mutavdžić highlighted Varteks’s increase in retail revenue compared to 2019 and that the company’s production capacities are filled until the end of the year, as well as that there is interest from global brands for cooperation. Also, believing in Varteks’s success, Nenad Bakić, who invested 10 million euros in the company, in his LinkedIn post calls on 'all creditors to reach an agreement on key transactions and, if possible, leave all the money with the company'.

No one can predict what scenario will occur with Varteks, but Mario Kurtović, an independent credit analyst, presented an overview of the entire situation from a banking perspective in his LinkedIn post, highlighting facts and financial indicators. He pointed out, among other things, negative results such as declining revenues, low liquidity, and strong competition, but also raised the question of whether such companies should be helped.

We are publishing his post in full:

„Let me immediately clarify that I do not justify anyone’s position in this story, as an outsider I do not have all the necessary information. I can only point out some areas that leave room for thought, and as someone with experience in managing credit risk, I will list the questions that arise for me. One thing is certain – the situation is not exclusively black or white, and I hope this perspective will help you form your own opinion.

Imagine for a moment that you are a banker and that a request for further monitoring of Varteks is on your desk, considering these facts and indicators:

– A 33 percent decline in revenue in 2020 and a further decline of 7 percent in 2021

– Presence in the mid-market fashion retail segment, which is the most sensitive in crises due to the reduction of discretionary income of the middle class, as seen in the struggle for survival and the collapse of many stronger global players

– Strong competition from fast fashion retailers (e.g., Inditex) and other foreign brands in the domestic market

– The three largest customers accounted for 35-55 percent of Varteks’s revenue, depending on the year

– Marginally positive EBITDA (5.7 million) only in 2019 with a margin of 3.3 percent, with continuously negative EBIT. In other words, historical results do not indicate the existence of repayment potential, not even for covering interest

– Operational cash flow from 2018 to 2021 cumulatively negative at -139 million kuna, and free cash flow at -166 million kuna. The gap of 166 million kuna was covered by asset sales of 39 million kuna, capital increases of 31 million kuna, and new loans of 98 million kuna

– Inventory turnover over 300 days, consuming significant capital. For illustration, Inditex is at approximately 90 days

– Varteks pays suppliers in about 120 days, which means there is also a de facto debt here

– CAPEX continuously below depreciation, indicating underinvestment

– Adjusted debt at the end of June 2022 at 176 million kuna with a debt-to-capital ratio of 5x

– Liquidity very low with cash of 0.6 million kuna compared to adjusted short-term debt of 97 million kuna

I assume that even those of you who are not bankers conclude that the situation is far from rosy. Banks can represent all sorts of interests, but do not forget that banks are mostly staffed by ordinary people who live off their salaries and whose job is to work diligently and in the interest of their employer, which in the case of banks means minimizing losses. We can be sentimental and empathetic as much as we want, but in such matters, there often cannot be room for emotions. The question of whether, and who, should help such companies is very difficult from a human perspective, as we can all find ourselves as employees or suppliers of such companies. Saving jobs is essential, but how long have the problems at Varteks been ongoing? Would further assistance be better or worse for all involved? A difficult question, and I have asked it at Orljava and Kotka as well.

From a professional standpoint, the question arises – can this be a sustainable model? Remember Kotka, which had no financial debt at all, yet the business was closed because further erosion of capital threatened, which was thus preserved and could be invested in something else that would create new jobs.

After all, which segment should Varteks focus on? Retail, which is capital-intensive and where significant investment in the brand is needed? On contract work, which is de facto renting cheap labor? On special clothing, where the business depends on public procurement where price is often the key factor, which again requires a low labor cost? All of these are segments in which Varteks can be successful, but comprehensive restructuring of the business is necessary, which includes fresh capital and a lot of time. After so many years of poor results, I think no one can blame creditors if they are not willing to support it.

Historical numbers are relentless, and with the information we have, from a professional standpoint, it is likely certain what the majority would decide. Or is it?“

Hard Decision

As Kurtović comments for Lider, the purpose of his post was to question the narrative in which banks are exclusively 'bad guys' and offer the public another perspective, because, as he says, 'the banks themselves will not speak out in public in such cases due to banking secrecy'.

– Making a decision that will shut down a business and leave many people unemployed is never easy, but it must be acknowledged that banks are there to ensure the return of their funds and support businesses that have potential. This applies to both commercial and development banks.

In the case of Varteks, there may be a perspective that has been presented to the banks, I have no knowledge of that, but looking at historical results, the effect of the pandemic, the industry forecast, and the fact that even global, much stronger players/brands are struggling for survival, I fear that even in the case of a creditors’ agreement, Varteks will not be able to say for a long time that it has a sustainable business model. Personally, I am very sorry for that, as well as for any other business in Croatia in a similar situation – concludes Kurtović.

On the other hand, Bakić’s argumentation, which highlights the positive aspects of Varteks’s business, is also published in full below.

"After my investment of around 10 million euros, and serving as CEO, Varteks achieved positive EBITDA (a standard indicator for the most important: cash flow from operations) for the first time in 2019, in 20, and perhaps even 50 years. For the first time in many years audited by Big 4 auditors – no fraud.

Retail revenue growth, mainly from its own brand, 70 percent. I believe everyone will agree that this was ‘impossible’, especially since quality and brand were at the bottom.

So much for the idea that it couldn’t be done, or can’t be done. If there had been more support, this could have been the most incredible turnaround/success. Everyone said it was impossible, especially the people of Varaždin, especially the current mayor.

Although it is completely clear that it is not only incredible that I would want to ‘acquire real estate’ (I think that for 10 million euros one can acquire much more interesting real estate, without such great efforts and risks), but it is also theoretically impossible, we must ask ourselves what the goal of such deceptions is.

Varteks still has a chance. I call on all creditors to reach an agreement on key transactions and, if possible, leave all the money with the company. Not to kill the cow for the steak. I have, as I have every time before, even though I am the largest creditor of the company (!) relinquished any income from that, which of course the company respects to which I transferred my claims, which seems to be even softer, and even unconditionally offered a write-off of 30 percent, if other creditors write off at least a little. No one agreed."

Banks Are Not Interested in the Business Model

However, criticizing Kurtović’s post, Bakić believes that his analysis is completely wrong as it does not take into account the specific situation of Varteks. He also believes that comparisons with Orljava are unfounded.

– No one expected that banks would follow Varteks’s business model nor is it possible that narrow-minded Croatian bankers would assume that such a turnaround could be made that in 2019 a 70 percent increase in retail revenue and the first positive EBITDA after 20, and perhaps even 50 years would be achieved. Thus, the turnaround in Varteks’s business has no similarity to the business of Orljava, especially since it is largely a completely different industry – Varteks has successfully begun to pivot to a predominantly fashion company – the difference is similar to steel production and automobile manufacturing. If they could have recognized that, banks would have followed Varteks, but we did not expect that – explains Bakić.

He adds that Kurtović’s analysis assumes that someone should have justified the crediting with the business model to the banks, while in reality, the banks had already largely written off that inherited credit.

– The problem is completely different. With my investment and business development, banks have saved a failed investment, as even securing real estate would not have helped them in that situation due to the inherited situation that was set up for the vulture real estate, e.g., by some ‘coincidence’ there was no urban planning, and it was not possible to start selling the real estate precisely due to the expected collapse of the company. Thus, banks expected, and we agreed that they would be repaid from the sale of real estate and that in stages proportionate to the coverage rate. They violated that agreement and persistently violated it, often extorting all income from the sale of real estate – says Bakić.

– This means that banks may have unintentionally, being narrow-minded in their thinking, or perhaps intentionally, put themselves in a situation where disproportionate and aggressive collection actions threaten not only the company’s business but also the value of their collateral. A little more understanding in that sense would be extremely productive for all stakeholders, including banks – concludes Bakić.