Follow the Money: what went wrong with the vision at Optical Express?

The few facts in the public domain about press-phobic owner David Moulsdale are well worn enough. Having trained as an optician after leaving school at 16, he started Optical Express in 1991 with one store in Edinburgh's Leith area while still in his early twenties. He had tens of stores by the middle of the decade as part of a wave of modernisers in the sector, and was soon garnering awards for his entrepreneurial acumen.

From there the company kept growing on the back of organic growth and acquisitions, becoming the only high-street optician to bet big on laser eye surgery in the early 2000s when it bought out Boots' business (and getting into dentistry through the same deal). Shortly after, it embarked on an overseas expansion into mainland Europe and North America.

Like many retailers, including those owned by Moulsdale's friend Tom Hunter, OE was also able to fast-forward its expansion in the second half of the noughties by borrowing heavily. Net debt rose from £12.2m in 2005 to £55.3m in 2008, nearly double the growth rate of pre-tax profits. By this time OE had over 200 stores and was talking about opening 60 more in the coming year in its quest to boost its market share from 4% to double figures.

What happened next in the financial world is well documented enough - the music stopped after Lehman and the easy money stopped flowing. It did not take long for OE to feel the effects. By early 2009 the Registrar of Companies gave the company three months to show it should not be dissolved - a sure sign that the creditors were closing in.

RBS threw the business a lifeline on that occasion, agreeing a restructuring deal, but there was not a great deal of blue sky on the horizon.

You would think that optometry would, like many areas of health, be insulated from hard economic times since people still need to solve their eyesight problems. You would think this would be particularly true when some 60% of the public - meaning under-16s, pensioners and those on benefits - get free eye tests and prescription glasses. These groups should spend as much on their eyes regardless of which way the economic wind is blowing, producing a big guaranteed revenue stream for anyone trading in the sector.

Against that, however, the likes of Tesco and Asda have come crashing into the sector in the last 10 years and taken market share by offering bargain basement prices. At the same time, the higher-margin full-paying customers appear to have been deferring purchases or taking cheaper options such as having new lenses put into old frames instead of buying new ones.

Then there is laser treatment, which is top dollar and therefore likely to have been hit harder than most segments. You would do well to get a look at the growth charts that Moulsdale and his lieutenants would have used to tantalise bank managers in the run-up to the crash. Almost certainly the reality has been rather different, however. This explains why OE was left with only one major UK competitor recently when Optimax bought long-suffering Ultralase.

Betting heavily on laser may well have exacerbated the Cumbernauld company's fixed costs, ensuring that it only needed to lose a few percentage points in turnover to suddenly have a crisis on its hands. In 2011, the most recent year for which figures are available, for example, a £16.5m drop in turnover led to a £10.4m drop in underlying operating profits. Whatever expenses OE has, in other words, most of them were there regardless of what it sells.

At the same time, the business has clearly been under heavy pressure from the bank to get its balance sheet in order. In 2011, net debt was still about 3.4 times top-line earnings, somewhat above the circa 2.5 times that is seen as acceptable these days.

Hence when former PWC Scotland boss Frank Blin was appointed to the board last summer, there was speculation that he was installed to do the bank's bidding (which is almost certainly correct). This debt problem presumably also explains OE's announcement last autumn that it had put a subsidiary into administration, closing 40 stores and then buying back the remaining 40 - a move that supposedly eased the problem of high fixed costs.

This ailing subsidiary, which was responsible for almost half of turnover, made a top-line loss of about £5m in 2011. Without it, the remaining business would have been much more profitable. The fact that it was not put out of its misery until after Blin arrived might be a sign that Moulsdale was resisting swinging the axe. Turnover is vanity but profit is sanity, as they say.

This move came parcelled up with a debt restructuring agreement with RBS that appeared to relate to the whole of OE. Here comes the mystery I mentioned at the start. On the back of this agreement, OE finance director Stewart Mein was quoted in a rare interview with The Herald, talking about plans to invest £1m in laser eye clinics and open 40 new consultation centres in the UK and Ireland. He said: "We are now in a strong position to build the business going forward."

Yet just 10 months later, RBS allegedly refused Moulsdale an emergency loan to pay staff. It appears he was told he could either arrange for the debt to be bought out or the bank would push his company into administration. Moulsdale, who is estimated to be worth £60m, bought the debt at a substantial discount and came up with a package for capital investment, saving some 1600 jobs.
Some sources familiar with the deal say that this happened in just a few days. OE sources are indicating that it took several months.

Whatever the case, the question is this: why did RBS decide to renege on a debt deal that ought to have been good for a few years? Did the picture deteriorate for OE in 2013 compared to what everyone was expecting at the time of the 2012 deal? This is possible, but not evident. The UK retail market has been growing weakly. Industry sources do not point to any big recent downturn in optometry. And even if OE had been underperforming, it would surely have to be drastic for the bank to volte face so soon after reaching a deal.

There are suggestions that RBS did not feel it had been kept sufficiently well informed of the tightness of the cash situation at OE. If so, it brings Frank Blin's role into question. He would have been at every monthly board meeting, giving the bank eyes and ears around the table. But even if you set aside any question of integrity, this sounds unlikely. The truth would presumably out sooner or later, and it's hard to imagine anyone taking such a risk with such an important client as RBS.

An alternative view is that OE's position did not greatly change in the past 10 months. On this rationale, it was a victim of the fact that banks are finding it easier to find buyers for ailing assets now that the economy is improving (at least in some people's opinion). Certainly there has been talk that someone was waiting in the wings to buy OE.  

It is also the case that the banks are keen to reduce their exposure to certain sectors at present in order to put more into sectors that they regard as more profitable. If retail has a history of producing lower returns for RBS than other sectors, it may have decided to take advantage of the changing economic picture and cut Moulsdale loose.

We can't say for sure that this happened here, but I'm assured it is happening to countless otherwise viable businesses at the moment. So much for the purity of market forces.

Whether OE turns out to have been one of them, keep your eyes peeled for future statements from the company. Further store closures - or the lack of them - would certainly give a hint, since OE is unlikely to be able to maintain the status quo if trading has deteriorated drastically in the past few months.

OE is indicating there will not be further closures, however. If so, it will not look good for RBS. If the bank has just played fast and loose with the future of one of Scotland's best known retailers so soon after giving them stability, it ought to have a compelling explanation.

This online article originally wrongly referred in the title to Vision Express rather than Optical Express. We apologise for this error, which has now been corrected.