Opinion: Woolworths, Lowe’s in messy Masters divorce

Lowe'sThe Masters Home Improvement chain joint venture partners, Woolworths and Lowe’s, are embroiled in a legal action over the value of the one-third stake held by the North Carolina-based home improvement chain.

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Lowe’s contends that Woolworths’ management and strategic decisions had a deleterious impact on the value of the Masters Home Improvement, significantly reducing the returns to the American company from the closure of the venture.

Lowe’s sought the appointment of a liquidator in the Federal Court to examine the failure of the joint venture and to take control of the wind up processes.

Woolworths has staved off a decision on the appointment of a liquidator with Federal Court Judge Lindsay Foster directing the parties to a formal arbitration process.

Lowe’s had earlier indicated it was prepared to participate in an arbitration of the dispute, which revolves around the fairness and equity of the wind-up of Hydrox Holdings, the joint venture company that Woolworths and its American partner used as the platform for the Masters Home Improvement chain.

At issue is the apportionment of costs associated with the exit that Woolworths might claim against the funds generated from the sale of the Masters Home Improvement chain ahead of a distribution of the funds released to each of the joint venture parties.

Brad-Banducci-WoolworthsCEOThe legal dispute between the joint venture partners is not expected to disrupt the $165 million sale of the Home Timber and Hardware chain to Metcash, the publicly listed wholesaler, which also owns the Mitre 10 hardware chain, or the $835 million acquisition of the Masters Home Improvement property assets by the newly formed entity, Home Consortium.

Announcing the exit sale package from its failed hardware venture, Woolworths had indicated that Lowe’s’ agreement would be required to the deal with Home Consortium because it involved the acquisition of Hydrox Nominees along with the properties.

It is understood Lowe’s is not opposed to the deal and Home Consortium claims it has a binding contract, which would trigger further pain for Woolworths and Lowe’s in the form of legal action if the deal fell through.

Woolworths estimates that the gross proceeds of the Metcash and Home Consortium deals, along with settlement of all trading obligations including staff entitlements, supplier invoices, tax and customer gift cards laybys and product warranties, the liquidation of stock and some internal property transfers will be around $1.5 billion.

The $500 million value of the stock liquidation appears somewhat optimistic notwithstanding the improved customer traffic flow in stores since closure sales have commenced, especially if the Dick Smith stock liquidation process is any guide to consumer expectations and behaviour.

In any event, Woolworths has estimated that it will have just $500 million in net proceeds from the wind-up to distribute between itself and Lowes on a two-thirds to one-third basis, respectively.

That sum represents a massive loss of more than $2.5 billion on the funds invested by the two joint venture partners since launching the ill-fated hardware venture with high hopes of securing a large slice of the Australian market in 2011.

Lowe’s legal action is targeted at the $500 million net proceeds from the wind up of the venture in a fractured partnership that is now replete with recriminations.

Lowe’s’ input lacking?

Before departing a short-term consultancy role with Woolworths in June, former CEO, Roger Corbett, indicated the company had been disappointed with the support provided by Lowe’s to the joint venture, given that they were supposed to be the experts in the category.

Woolworths and Lowe’s acquired the publicly listed Danks Holdings as a platform to launch their joint venture hardware chain, in part, because the wholesaler provided expertise and knowledge of the local market.

Danks Holdings owned and operated the Home Timber and Hardware and Thrifty Link independent retailer chains and had thousands of wholesale customers.

While the Masters Home Improvement venture bled money in its short existence, the former Danks Holdings operations remained profitable under the Woolworths-Lowe’s ownership and is the business asset that has been acquired by Metcash.

The Danks expertise and knowledge was either quarantined from the Masters Home Improvement management team so as not to upset regulators or lose independent retailers as customers, or was ignored in favour of the mass merchant thinking of the Woolworths project team and Lowe’s know-how.

The Lowes input to the conceptual development and operational systems for Masters Home Improvement was led by former Texan, Don Stallings, who had previously led the American retailer’s expansion into the Canadian market for a two-year period up to September 2009.

Stallings came to the joint venture with around 35 years experience in the hardware industry and hands-on store operations roles in Payless Cashways and Hechinger Company before climbing the ranks in Texas, one of Lowes strongest regional markets.

Stallings joined Melinda Smith, who had been a rising star in Woolworths’ supermarkets and Big W businesses, before being selected to head the Masters Home Improvement venture.

Stallings and Smith formed a co-management team for Masters Home Improvement, reporting to a joint-venture board, comprised of both Woolworths and Lowe’s executive, initially under Woolworths CEO, Michael Luscombe’s, leadership and later the oversight of his successor, Grant O’Brien.

They were both replaced by the British retail executive, Matt Tyson, in January 2014 as Woolworths tried to fix the problems in the Masters Home Improvement stores and salvage its sinking investment in the joint venture.

Tyson, who is now advising Bunnings on its entry into the United Kingdom via its Homebase acquisition earlier this year, had overseen a restructure of the Kingfishers B&Q business’s Asian operations,  and had a two-year stint as CEO of the Russian Castorama chain as part of a 25-year career with Kingfisher plc, the largest home improvement retailer in Europe.

Smith admitted to investors six months before Tyson’s appointment and shortly after Stallings was vanquished that the joint venture had made crucial mistakes in developing the business, including overestimating sales and gross margins, underestimating labour costs, the impact of seasonality and getting the product range wrong.

Smith might have added that the store design concepts were also a major problem for the chain when she conceded to analysts that the management team, “didn’t know a lot about this business” when we setting its budgets for the 2013 financial year.

Tyson set about revamping store layouts, reconfiguring product ranges and resetting pricepoints, overhauling marketing and stalling the store rollout program. And while new stores and organic growth for stores that were already trading, but still in their infancy, did boost sales, losses continued to balloon.

MastersComing apart at the seams

Under the joint venture agreement for Masters Home Improvement, Lowe’s had an option to sell its one-third stake to Woolworths at various milestones and no doubt laments now that it didn’t bail out of the venture earlier.

Lowe’s decided to exercise its option to exit the joint venture in January of this year and promptly wrote down the book value of its investment in the Australian chain by around $A695 million, but was no doubt at the time aware that Woolworths was carrying a contingent liability on the put option in its books of $886 million.

Following Lowe’s put option, Woolworths announced its decision to abandon the Masters Home Improvement business through a sale or closure – a course of action that potentially left Lowe’s facing a return on its $1.3 billion one-third stake in the joint venture of, perhaps at best, $166 million if its return is dependent on the proceeds of the asset sales concluded by Woolworths in August.

Provided Lowe’s does not appeal the decision, the former High Court judge, Murray Gleeson, will now oversee the confidential mediation process ordered by the Federal Court, which also provided relief to Woolworths on some of its legal costs in recognition that the court proceedings were outside a previously agreed framework for arbitration of disputes between the joint venture partners.

The arbitration process will focus substantially on a fair return to Lowes for its one-third stake in the venture and could potentially see Woolworths forced to pay a large sum to prevent further legal action that would revolve around the timing of the Lowes put option and Woolworths decision to close the business completely as well as the management of the closure.

Continued legal action could also address concerns by Lowe’s that Woolworths and Masters Home Improvement management failed to provide full disclosure on plans they had developed or, at least considered, to abandon the joint venture from August 2015 or before.

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