Buy one, get one free

The protracted process of the sale of Coles Group is about to enter its final week, with the big rebound in Wesfarmers' share price over the past 10 weeks making the prospect of embracing Wesfarmers' bid far more palatable than it once was.

With Woolworths abandoning any ambitions of gate-crashing the bid, the outcome of next week's scheme of arrangement meeting appears a formality. The strengthening in Wesfarmers' share price from its nadir of $37.39 in August to more than $44, pushing the value of the scrip and cash offer towards $17 a share, will make the transaction a somewhat more pleasurable experience for Coles shareholders than once appeared likely.

Given that they will retain a significant continuing interest in the merged group, it will be some time, perhaps years, before definitive judgments can be made about the merits of the transaction and the value it ultimately delivers to Coles' shareholders.

They don't have to look far, however, to find a compelling illustration of what new management can do to a perennially disappointing retailer. If the rest of the Coles group is in anything like the state of its former sibling Myer, there could be a lot of unrecognised but latent value to be released.

When Myer released its 2007 results last month the big story in its accounts, remarkably, wasn't reported.

The Texas Pacific-led private equity consortium that bought Myer and its key Bourke St property for $1.4 billion last year was expected to move quickly to grab any low-hanging fruit, and it did. In fact it discovered an entire orchard.

In the accounts lodged with the ASX, Myer revealed that as a result of the $160 million of cash it raised through the "history making clearance'' and the $605 million released from the sale of its flagship store, it had been able to return "surplus'' capital to shareholders.

When the TPG-led group -- which includes the Myer family and management -- bought the business, the buy-out was funded with $428 million of equity and just over $1 billion of debt. Subsequent a further $20 million of equity has been added to the group's capital base.

So, how much surplus capital did the private equity investors receive? Through a combination of $196 million of dividends and a capital return of $364 million, $560 million flowed back to the investors – in their first year of ownership they not only extracted every dollar of capital they had invested but also a further 25 per cent return on that capital.

They still own a business with $3 billion of turnover -- through which Bill Wavish and Bernie Brookes are driving massive change -- and effectively now have a free exposure to the upside. No wonder TPG's Ben Gray was so frustrated at being forced out of the auction process for Coles by the unhappy timing of the sub-prime implosion.

Coles Group may not provide quite as immediate a bonanza for Wesfarmers as Myer has been for its new owners. However, while Myer was a neglected business within the Coles group, it is telling and disconcerting that Coles' management left so much easily realisable value on the table.

Wesfarmers and Coles shareholders alike will be hoping that the new management Wesfarmers has introduced to Coles is as adept at recognising and harvesting the fruits of poor management as the new team at Myer.