Private equity move on Woolworths

Woolworths, supermarket, wooliesThe rumour mill is running hot on the possibility of a private equity takeover of Woolworths, Australia’s largest retailer, but it is difficult to fathom the value of such a move.

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While Woolworths currently has its problems and seems to be undermanned in senior executive ranks, the retailer would seem to be too big an outlay and too small a return for a private equity investment.

But if the rumours are correct and a takeover bid is in the offing, the private equity play would almost certainly be premised on a break up strategy that would assume the divestment of the business divisions would unlock more value than is available in the total business.

An investor could conceivably divest the underperforming Masters Home Improvement and Big W discount department store chains, an option that Woolworths itself may assess when a new CEO takes over from Grant O’Brien in November.

Despite the poor initial results from the Masters Home Improvement business, largely the result of poor execution of a business plan and store concept and product ranging, the market opportunity in a fragmented hardware and home category that Woolworths identified is a genuine and potentially lucrative one.

Big W provides less blue sky in a crowded, fiercely competitive and – over a number of years now – a flat growth category, but the chain has a national footprint of around 180 stores that could attract a buyer, such as the South African retailer, Steinhoff International, which currently owns Freedom Furniture, Harris Scarfe and Best & Less in Australia.

A more lucrative spin off from Woolworths would potentially be the hotels and gaming division, which has more than 300 sites and annual sales of around $1.5 billion.

Selling off the hotels division might require some re-engineering of business structures to keep the Dan Murphys outlets in the Woolworths camp, but it is not an unrealistic proposition to dispose of the gaming division, particularly with growth in the on-premises gaming venues slowing markedly and subject to higher taxes that are squeezing earnings. The hotels division could be sold to a trade buyer or listed on the Australian Stock Exchange.

The New Zealand supermarkets are a separate division within Woolworths’ structure and could also be divested or floated as a public company. There are more than 180 supermarkets in the NZ business, generating around $A5.2 billion, and it is Woolworths only current retail investment outside Australia.

The volatile fuel and convenience business could also be divested, a business that racks up around $7 billion in sales, but is arguably not a core business for Woolworths – and certainly less attractive since competition regulators cracked down on cross-promotions involving fuel discounts for supermarket shoppers.

Non-core business divisions

Divestment of some or all of Woolworths’ non-core business divisions would potentially allow a private equity investor to bank the returns from the break up and then on-sell a leaner supermarket and liquor operation with annual sales of more than $40 billion to an overseas retailer wanting to enter the Australian market, or to re-float the business as a public company.

Private equity investors usually work to a three to five year investment timeframe, and they could well look to improve the trading performance of the various divisions ahead of any divestment in a bid to improve returns. It would be likely that a staggered sale program would be adopted depending on the sale readiness of each business.

Given that all of Woolworths major businesses are now under new leadership, private equity investors would believe their own management expertise and resources could be pivotal in effecting improvement in each of the businesses, including the supermarkets and liquor business that is still achieving growth, but at a slower rate than rivals Coles, Aldi and Costco.

Obviously there would be costs associated with a breakup of the Woolworths group, and some synergy savings of the conglomerate would be lost. But streamlined and focused businesses might well prove more effective, agile and, ultimately, profitable.

The rumour mill that has Woolworths as a takeover target suggest that the US-based private equity firm, Kohlberg Kravis Roberts, is evaluating a bid.

KKR previously tried to acquire the Coles Group but lost out to Wesfarmers, which has re-energised the supermarkets business under the Coles brand and has lifted the performance of Kmart but has seen Target’s sales and earnings go backwards and its liquor business continue to struggle. It is understood KKR’s intentions with the Coles Group was a break-up strategy.

Woolworths has a market value of around $34 billion, with the lion’s share of its value in the core supermarket and liquor business. Woolworths shares have been trading down around 20 per cent on its watermark value and the fall in the Australian dollar and cheap interest rates in the US would underpin a takeover.

Thomas Dux divestment

Woolworths’ own management has embarked on a series of reviews, staff cuts and re-structuring of its capital investment in a bid to improve results.

While Woolworths has indicated it has no plans to divest or close the loss-making Masters Home Improvement or to sell off Big W, the retailer has apparently decided to sell its 10 store gourmet food business, Thomas Dux.

It is understood that Woolworths has sought expressions of interest from potential buyers with a price tag upwards of $10 million.

The decision to sell the business follows the sale of the Dick Smith chain to private equity investors, who promptly floated the business on the Australian Stock Exchange at a handsome profit that left Woolworths CEO, O’Brien, and the retailer’s board of directors red-faced.

Woolworths, which opened the first Thomas Dux store in Lane Cove in Sydney in 2008, has declined to comment on the sale of the upmarket Thomas Dux fresh food retail concept stores.

This story first appeared in Inside Retail PREMIUM, issue 2051.  To subscribe, click here.

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