Opinion: Disciplined by design

JB Hi Fi Home 1Having acquired The Good Guys, JB Hi-Fi is eyeing a future as one Australia’s largest retail brands. However, it certainly hasn’t happened overnight, and all that success can be put down to JB Hi-Fi’s gritty long-standing discipline.

JB Hi-Fi’s remarkable success can be attributed to the fact it is one of the most disciplined retailers in the country.

JB Hi-Fi has one of the most recognisable and admired brands and is second only to Bunnings Warehouse as the best performed retailer over the past decade – quite a feat in a retail category that has had a number of high profile casualties.

Until now, the retailer has grown organically, save for two bite-sized acquisitions, the $15.2 million 2007 purchase of the 11-store Hill and Stewart chain in New Zealand and the 2004 acquisition of a controlling stake in the Queensland-based Clive Anthony chain.

Last week. JB Hi-Fi departed from its playbook and struck an $870 million deal with the Muir family to buy The Good Guys’ 101 stores after a rigorous due diligence process and some hard-nosed negotiating that typified the retailer’s discipline.

The price was well short of the $1 billion plus expectations of the Muir family, but was a realistic value for The Good Guys and a more certain return than was in prospect for a float on the Australian Stock Exchange, notwithstanding the spruiking of advisors to the family.

JB Hi-Fi ran a ruler over The Good Guys seven years ago when the Muir family first decided to sell the business they had built up from a single electrical store opened in 1952 into the largest privately owned electrical chain in Australia.

JB Hi-Fi and a number of other suitors passed on the opportunity because of the price tag the Muir family had put on the business and concerns about its franchise business model.

The Muir family has received a much lower return with the JB Hi-Fi deal than it had wanted over the past seven years given the $1 billion plus as the notional sell price.

In a bid to extract a higher price from trade buyers, the Muir family engaged financial advisers to prepare for a public listing and had begun an investor roadshow.

The Muir family advisors claimed that there was strong interest in the float, justifying a sell price above the $800 million to $900 million value estimated by market analysts. But apparently the sums and the share market’s volatility tipped the scales for the trade sale to JB Hi-Fi.

Demonstrating just how disciplined its approach to the deal was, JB Hi-Fi scotched media speculation about its interest in The Good Guys acquisition while undertaking an exhaustive analysis of the opportunity that included shadow shopping of around 50 stores to observe consumer interactions with staff and to assess store environments.

JB Hi-Fi also developed a financial strategy to fund the acquisition by extending its debt facilities to $500 million and a $394 million share issue that was snapped up in record time by institutional investors.

The $870 million purchase price is less than 12 times the $74.2 million earnings before interest and tax booked for the 2016 financial year. However, the profit figure for the period would have been diluted by restructuring costs, including the buyout of franchisees.

RichardMurray

Richard Murray, JB Hi-Fi CEO

Removing a competitor
Richard Murray, JB Hi-Fi CEO, claims the acquisition of The Good Guys creates a “best in class retailing combination with a strong strategic rationale”.

The acquisition certainly adds up in terms of sales and market share gains, with The Good Guys’ $2.09 billion sales and 26 per cent share of the home appliances market taking JB Hi-Fi revenues above $6 billion and market share to 29 per cent.

JB Hi-Fi has effectively taken a major competitor out of the market and leapfrogged Harvey Norman in sales and market share in a major category shake-up that also involved the Dick Smith exit earlier this year.

In home appliances, JB Hi-Fi and The Good Guys combined now have 29 per cent market share to Harvey Norman’s 24 per cent, while in consumer electronics the merged entity has a 24 per cent market share to Harvey Norman’s 15 per cent.

Murray has indicated that The Good Guys brand will be retained and Michael Ford will continue as CEO, overseeing an expansion program that had been developed as one of the key planks of a growth strategy underpinning the prospective public float.

Murray said JB Hi-Fi and The Good Guys would have independent go-to-market strategies and would maintain separate support offices.

The Good Guys currently has 101 stores in Australia, while JB Hi-Fi has 179 stores in Australia and 15 in New Zealand. Both brands have a similar revenue profile of around $20 million a store.

The size of The Good Guys stores is also a reasonably good fit with the JB Hi-Fi Home store format, which currently has 55 locations with seven new sites and five existing store conversions planned for the current financial year.

Murray says there is potential to open four or five new stores under The Good Guys brand over the next three years, and JB Hi-Fi expects to boost sales through online platforms.

One of the strengths of JB Hi-Fi has been a balanced portfolio of stores across locations and the combined brands will now have 30 per cent of stores in homemaker centres, 41 per cent in shopping malls, and the remaining 29 per cent in standalone sites.

Risky business?
Currently, JB Hi-Fi generates around $119 million from online sales, representing three per cent of total sales, while The Good Guys has $111 million, or five per cent of its revenues, from its online platform.

While JB Hi-Fi will face integration costs, Murray estimates there will be synergies of between $15 million and $20 million for the combined business after a three year period, primarily from support function, buying, logistics and supply chain efficiencies.

The integration costs have been estimated at $10 million to $12 million for the first 12 months, which seems on the low side but is apparently based on the due diligence assessments.

Good Guys 2One of the key short-term risk factors associated with the acquisition is maintaining the motivation of staff in The Good Guys stores after buying out the franchisees and now operating as corporate outlets under managers.

Some of the franchisees that were bought out by the Muir family are on one-year management contracts to June 2017, while others have already left. And, either way, the process has created a management challenge for Ford and JB Hi-Fi that might hinder the planned new store rollout for The Good Guys brand.

Murray said the two businesses have complementary customer profiles, product offerings and store locations, as well as aligned retailing philosophies and customer value propositions with a focus on, “great value everyday and exceptional customer service”.

Murray said the acquisition will provide JB Hi-Fi with increased scale to optimise its supply chain and leverage the value from the investment of the two brands in digital assets over time.

JB Hi-Fi is continuing its own sales momentum with revenues for the first two months of the 2017 financial year up 11.6 per cent, with comparable sales up 7.7 per cent.

Murray said the closure of the Dick Smith chain has contributed to the early sales gains of FY17, but will moderate as results cycle against the collapsed retailer’s declining performance in the latter months of 2016 and receivership in January of this year.

Dick Smith execs staring down the barrel
While JB Hi-Fi looks to the future as one Australia’s biggest retail brands with sales almost double those of the venerable but lumbering Myer and outpacing Kmart, the courts and Australian Securities and Investments Commission are picking through the entrails of the Dick Smith collapse.

ASIC has yet to make any public move following receipt of information from Ferrier Hodgson as receiver managers and liquidators and McGrathNicol, the firm appointed as administrators by the Dick Smith board, but it is closely following proceedings in the New South Wales Supreme Court that are attempting to recover $400 million for creditors of the collapsed retailer.

In testimony that could galvanise legal action by ASIC, the court has been told by a former director, Jamie Tomlinson, that Nick Abboud, the Dick Smith CEO, was out of his depth and had not provided the board with accurate information on the company’s trading and debt position.

Tomlinson said the retailer failed because of a poor strategy and leadership as well as a breach of trust, with one example cited of a $50 million loan obtained from Westpac by Abboud and Michael Potts, the chief financial officer, without board approval.

Tomlinson said Abboud had no credibility with suppliers, shareholders and management within the company, while Lorna Raine, another former non-executive director, told the court that inventory levels had blown out while only 62 stocktakes were conducted for 350 stores.

The court was told the retailer continued to open new stores and buy more stock while borrowing money to overcome cash flow difficulties and to pay dividends, despite a sharp 7.5 per cent fall in sales in the first quarter of the 2015 financial year – just eight months after Dick Smith floated on the Australian Stock Exchange.

Ferrier Hodgson has claimed that directors and management of Dick Smith breached their duties in misrepresenting the retailer’s sales and earnings results, in part, through booking supplier rebates derived from bloated inventory levels as profits.

Ferrier Hodgson has called 10 former directors and executives, including Abboud and Potts, to provide evidence in the Supreme Court proceedings that are seeking recovery of the $400 million owed to creditors, including $140 million owed to the National Bank.

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