How Woolworths snatched DJs from Myer's grasp

It was Myer’s overtures for a largely scrip-based "merger of equals" and its own boardroom tensions that put David Jones into play and led to the $2.15 billion agreed takeover by South Africa’s Woolworths. A Myer counter-bid looks unlikely given the big price-tag the bid places on its department store rival and the comments Myer made as it withdrew its ‘merger of equals’ proposal.

With the South Africans offering a premium of almost 27 per cent to David Jones’ three-month volume-weighted average share price -- a whopping 39.4 per cent premium to the price at which David Jones shares were trading before Myer’s proposal became public -- the $2.15bn valuation of David Jones looks too much of a stretch for a group with a market capitalisation of $1.35bn.

Unwittingly, however, Myer’s approach to David Jones has led to an outcome that, if completed, would significantly strengthen its direct competitor. It would cut off its only obvious option for a transforming transaction in what is otherwise likely to be a low-growth and increasingly competitive landscape for department stores.

The only obvious vulnerability to Woolworths bid is that it is to be executed via a scheme of arrangement, which leaves it open to a rival -- perhaps Solomon Lew’s Premier Investments -- to grab a blocking stake on-market.

Lew has a history with the South Africans. He has held a stake of just under 12 per cent in Country Road since 1997, frustrating Woolworths’ efforts to achieve 100 per cent ownership. He doesn’t, however, have any history of willingly over-paying for an asset. Woolworths is paying a very big price for David Jones.

The consolation prize for Myer is that the size of the price-tag for a rival with a smaller retail business than its own ought to cause the market to reappraise its own value. In fact, the value of David Jones established by the bid does raise the question of why Woolworths didn’t target Myer instead.

That may reflect a view that David Jones’ boardroom instability made it more vulnerable to an approach, but it could also relate to its market positioning in the premium end of department store offerings.

Woolworths is a $5.7bn company, operating in the same hemisphere and with a similar market position to David Jones and therefore will have the ability to bring its supply chain and procurement capabilities in particular to bear on David Jones.

It is talking about $130m of synergies from bringing the two groups together but, unlike Myer where much of the $80m to $90m a year of estimated benefits of a merger related to costs, its synergies are largely revenue-related.

Woolworths already has a meaningful presence in Australia through Country Road, Witchery and Mimco. Its chief executive, Ian Moir, is very familiar with the market, having presided over a dramatic turnaround in Country Road’s fortunes when he was its CEO.

At present, less than 20 per cent of Woolworths’ revenues are generated in Australia. Adding David Jones would lift that proportion above 40 per cent and, according to Woolworths, lift the combined group into the top 10 department store groups by revenue in the world.

Woolworths says it has been looking at David Jones for more than a year and that the acquisition of the venerable retailer would be a ‘’natural progression’’ of what it had itself been doing in South Africa and through its purchases of Country Road, Witchery and Mimco.

Moir said David Jones was a ‘’perfect match’’ and a ‘’mirror image’’ business for his group, with similar customers, brands and values. The takeover would create a southern hemisphere group with the scale, the same seasonality and the speed-to-market to create a competitive advantage over the northern hemisphere retailers now entering Australia, he said.

There was a significant opportunity to lift David Jones’ private label offering, now less than 3 per cent of its sales, to something closer to Woolworths’ 20 per cent. Woolworths has about 25 times as much private label product as David Jones, which has been a key factor in a five percentage point increase in its margins on clothing in recent years.

Woolworths also sees an online opportunity for the enlarged group. David Jones has only about 2 per cent of its sales online and, while Woolworths itself has only a modest online presence, Country Road has more than 10 per cent of its sales online.

The bid, and the price Moir has been prepared to offer, underscore his view of the value of the ‘’southern hemisphere advantage’’ the combination will create as well as his conviction that ‘’the department store isn’t dead, mediocrity is dead’’.

Certainly, the performance of Woolworths in recent years would suggest that it is a very good retailer: it has been growing revenue at more than 10 per cent per annum and earnings by more than 20 per cent. If it executes its retail strategies well, it can justify the price it has been prepared to offer for David Jones.

If it does that, of course, it will put considerable pressure on Myer, which has been better-managed and better-performed than its rival in recent years in a recessed retail environment.

If the merger proposal Myer put to David Jones (which it withdrew today) was a response to Myer’s view that its future was less-than-exciting without a structural change to its business, then the disappearance of that option will leave Myer looking for a different strategy to respond to the rapidly intensifying competition from online and northern hemisphere retailers.