The takeover bid by Woolworths of South Africa is excellent news for shareholders of David Jones but not such good news for rival department store operator Myer.
Slapping Myer and David Jones together made sense for Myer.
Now, way out of left-field, Woolworths SA has bobbed onto the scene and the David Jones board has accepted its offer at $4 a share.
Overnight, DJs shareholders are 25 per cent better off than they were at the last closing price. Myer chief Bernie Brookes – who had been endeavouring to engineer a scrip deal with David Jones earlier this year – waved the white flag this morning.
“While we believe in the strategic merits of our proposal and the potential value accretion for both sets of shareholders, we have always maintained a disciplined approach to valuation, and as a consequence we will advise David Jones today of the withdrawal of our proposed merger of equals,” said the release to the ASX.
Now that the DJs directors have accepted the rival pitch – a clean cash bid – it is too great an ask for Myer to get traction for a scrip merger. At the release of its last profit, Myer’s balance sheet was showing just $14 million in cash so a cash offer was out of the question.
Myer shares up
Brookes is an invidious position. Interestingly, Myer shares popped up 4 per cent in early trading, perhaps on speculation that it too might be taken over. Clearly, the South Africans see value in Australian retailing.
Without the arrival of another takeover pretender however, Brookes and co are left with listless growth prospects. Myer needs a panacea for its decline. Since 2010, operating revenues have fallen from $3 billion through $2.78 billion, $2.73 billion to $2.74 billion.
This sales decline has stabilised over the past year, as has the earnings decline. Earnings before interest tax depreciation and amortisation (EBITDA) fell from $336 million to $307 million in three years and there is $500 million in debt.
Brookes has run a tight ship but his predicament is tricky because, if he runs it any tighter, he risks putting a further squeeze on sales.
Flat isn’t growth
David Jones, also beset by the incursion of online shopping, has suffered similar torpor in sales and profits. And like Myer, its earnings decline has stabilised over the past year.
But stable earnings and flat sales growth are hardly an attractive investment option. There is little margin in sales and little margin for management error.
“Myer remains fully committed to continuing to progress our well-established five-point plan with a number of new initiatives to drive sales and profitability while continuing to invest in the growth areas of the business,” said Myer’s ASX release.
“As we move into FY2015 we expect to benefit from a number of strategic initiatives including new stores, major refurbishments, growth in exclusive brands and the online business. Myer remains Australia’s largest full-line department store business, and will continue to be a robust competitor.
Mixing it up
For consumers, the South African takeover should entail some change to the product mix and retailing strategy though it is too early to tell what will change, and to what extent.
The chief executive of the South African retailer, Ian Moir, has a deep knowledge of the Australian market having been CEO of Country Road, the upmarket clothing and homewares group in which Woolworths Holdings commands an 88 per cent stake.
Moir was appointed a director of Country Road in October 1998, and served as chief operating officer before assuming the top job in November 2000.
His strategy is likely to affect Myer. The department stores both operate in the same shopping complexes and if DJs goes upmarket or expands its food offerings for example (Woolworths SA is big in food) it will beg a competitive response from Myer.
The Woolworths SA bid values DJs at $2.15 billion. Its own market capitalisation is $5.5 billion and its annual revenues are $4 billion, compared with DJs revenues at $1.8 billion.
The two parties are said to have been in talks since March, following the change in the chairmanship at David Jones.
For DJs chief executive Paul Zahra, who is expected to stay running the business, the takeover is vindication. Zahra had faced opposition on the DJs board and, without the support of previous chairman Peter Mason, his position was increasingly tenuous until the imbroglio over directors’ trading earlier this year.
When two David Jones directors were found to have been buying DJs shares – with Mason’s permission – before a positive sales announcement to the market and before news of the Myer merger approach became public, the board came under pressure and Paul Zahra’s leadership was subsequently cemented.
David Jones and Myer had been in discussions over a $3 billion proposed merger. The deal was made public in late January, since then David Jones shares have jumped more than 10 per cent, while Myer shares have risen close to 10 per cent.
Paying a premium
Myer approached David Jones with a merger offer of 1.06 of its shares for each David Jones share, but the bid was rejected because DJs did not believe it represented sufficient value and had no premium.
The South African bid, although shy of the 30 per cent rule-of-thumb takeover premium for the average value of the target shares over the past three months (it is pitched at a 25.4 per cent premium to the closing price of David Jones shares on April 8), represents a 39.4 per cent premium to the price of David Jones shares on January 30, which is the last closing price prior to the Myer proposal becoming public.
The earnings multiple is 20.8-times the reported FY13 earnings per share of 19.2c per and 23.8 times the estimated FY14 EPS of 16.8c based on consensus broker estimates.
These PEs of almost 21 and 24 are pretty solid considering the hitherto unimpressive prospects for earnings growth.
Interestingly, Goldman Sachs increased its stake in David Jones just two weeks ago, from 8.15 per cent to 9.17 per cent.
Rothschild is advising Woolworths SA and David Jones is being advised by Gresham Partners and Macquarie Capital.