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July 5, 2007

New Coles owner looks to reassure investors

The long-running battle to buy Australian retailer Coles Group looked to have reached a conclusion earlier this week when the company accepted a bid from local conglomerate Wesfarmers. However, as Ben Cooper reports, the market remains unconvinced that Wesfarmers is the right owner for Coles – which could open the door for last-minute rival offers.

The long-running battle to buy Australian retailer Coles Group looked to have reached a conclusion earlier this week when the company accepted a bid from local conglomerate Wesfarmers. However, as Ben Cooper reports, the market remains unconvinced that Wesfarmers is the right owner for Coles – which could open the door for last-minute rival offers.


The success of the largest takeover in Australian corporate history could depend on Australian conglomerate Wesfarmers finding the right leadership to turn around the struggling Coles Group retail empire.


Since Wesfarmers, a conglomerate with interests in sectors including chemicals and insurance as well as retail, had its A$22bn (US$18.8bn) bid accepted by the Coles board on Monday (2 July), its share price has tumbled, suggesting that the market needs convincing that the company’s turnaround strategy for Coles will work. Analysts had been forecasting a slight adjustment in the Wesfarmers share price, given the dilutive effect of the transaction and the fact that the shares were being traded at a record high. However, the scale of the fall has been surprising.


Moreover, the drop in the Wesfarmers share price is more than an indication of a lack of confidence. The fact that the bid comprises a substantial share element means that the effective purchase price is going down too. The offer comprises A$4.00 in cash and 0.2843 of a share in Wesfarmers for each Coles share. The A$21.9bn valuation of the deal was based on the Wesfarmers closing share price on 29 June of A$45.73. The bid agreement has a clause that allows either party to pull out if the Wesfarmers share price falls by more than 10% from that level. At the close of trading on 5 July, Wesfarmers was trading at A$41.89 or, as one analyst put it, “perilously close” to that point.


This leaves Wesfarmers in a delicate position. Wesfarmers managing director Richard Goyder has been visiting institutional investors during the week in an effort to reassure them of the bid’s merits but amid the doubts being raised, there is a prevailing sense that the market has reservations about Wesfarmers expertise in the supermarket field. The company’s credentials at turning round businesses are very good, and it has solid retailing experience too, with its DIY operation, but as FW Holst analyst David Spry told just-food, the supermarket sector is a different proposition.


“While Wesfarmers is involved in hardware retailing, that is slower moving,” Spry points out. “The supermarket sector does require fairly experienced operators just to handle the pace of it and the logistical side of it and Coles are behind in that area at the moment.”


Like some other analysts, Spry feels that the recruitment of supermarket expertise could make the difference in Wesfarmers winning over investors and staving off the possibility of a last-minute rival bid, possibly from a private equity-led consortium. “They (Wesfarmers) have a lot of work to do,” Spry says. “They will be looking globally to source some good people.” Spry also suggests that a big name in retailing may relish the challenge of involvement in the Coles turnaround.


Interestingly, during the weeks of speculation leading up to the Wesfarmers bid being accepted, the conglomerate had been linked with Archie Norman, who led the transformation of the UK supermarket chain Asda in the 1990s. It is quite possible as the bid hangs in the balance that shoring up a big appointment such as Norman might tip the balance for Wesfarmers.


On the other hand, if Wesfarmers fails to convince investors, whether by articulating its prepared strategy for Coles or announcing a major recruitment, the possibility of a renewed bid from a consortium led by a private equity group cannot be ruled out. Goldman Sachs suggested in a research note that there remained an “outside chance” that a private equity group would make another attempt to acquire Coles.


As the Wesfarmers share price has tumbled, Australian supermarket giant Woolworths has heaped on the pressure, publicising its plans to invest heavily to head off any challenge from a reinvigorated Coles. While Woolworths itself has never been considered a viable bidder for Coles’ supermarkets because of competition constraints, the company remains a potential participant in a consortium, as it would be interested in acquiring the Coles-owned Office Works, Target and possibly its K-Mart operations.


It has been suggested that if the Wesfarmers takeover falters, Woolworths could yet emerge as a partner in a consortium led by a private equity group.


In the meantime, Goyder continues to stress the merits of the Wesfarmers bid over a possible private equity-led takeover. “The recommendation from the Coles board is a big step towards helping end the uncertainty for shareholders, employees, suppliers and customers surrounding the company’s ownership review,” Goyder said on Monday. “With the resolution of the ownership issue now in prospect, employees will be better able to focus on their key task of improving business performance in a very competitive marketplace.”


Goyder said that investors in the combined company would “participate in the substantial benefits and uplift in earnings expected to flow as the planned Coles simplification, transformation and revitalisation programmes take effect”, adding that he believed it was important that this deal allowed Coles to remain an Australian company. This is one aspect to the Wesfarmers bid that should appeal to investors, and certainly gives it an edge over a private equity group, but the last few days has shown that the market will not be convinced by flag-waving alone.

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