Private equiteer should hang on to shares in Myer sale

Myer's earnings before interest and tax in the year to July were $236 million, up from $165 million in 2006-07, the first year Myer was under the control of the TPG consortium. In the same period, Myer's own sales actually fell, from $3 billion to $2.8 billion.

The group forecasts that sales will rise to $2.937 billion in the current year and EBIT will rise to $261 million as the new Myer Melbourne store opens, and as Brookes introduces new point-of-sale software and a CCTV anti-shoplifting network that represents the final phase of restructuring that has also modernised and simplified Myer's supply chainand given the group the ability to make bespoke retail offers in some stores.

The changes have driven Myer's costs down and its earnings up even as sales have slipped, but it is a finite exercise, and Myer is approaching the end of it.

Brookes says sales growth will be driven from here on by an expansion of new, higher-margin selling space as Myer adds 15 new stores to its 65-store network in five years  five of them inserted between existing stores in the city centres and suburbs, five in regional hubs, and five in new urban growth corridors.

He announced three new sites yesterday, in Tuggerah on the NSW Central Coast, Coomera on the Gold Coast and Woden in Canberra, and says he now has 12 of the 15 locations identified.

The target is for the new stores to return at least twice their cost of capital, and to generate sales of $30 million-plus after two years from a capital outlay of about $6 million each. Brookes says Myer can now supply and support 100 stores, a total it might reach about 2020.

Brookes argues that the risk Myer will expand itself into low-margin competition with discount merchandisers is minimised by its ability to tailor its offer for local demographics, and the MyerOne card, which generated 63 per cent of sales last year, is a key source of demographic intelligence for store locations because it shows where customers are travelling from.

The bottom line, however, is that the sales-led second-phase expansion is promised, not delivered: and the execution risk is reflected in the decision to offer Myer shares on a lower earnings multiple than David Jones (the mid-range price-to-earnings ratio is 15.8 times forecast 2009-10 earnings, and David Jones is trading on 17.4 times).

It's enough of a discount to get the sale away, but it's not generous. TPG owns 84 per cent of Myer, and says it will sell between 80 per cent and 100 per cent, depending on investor demand, which will be known shortly.

It should forget that, and show faith in Brookes by committing to stay. The overhang created by the private equity group not cashing out completely would matter less than the vote of confidence a decision to hang in conveyed.

STILL KEENNufarm's earnings slumped from $138 million to $80 million in the year to July, as the global economic downturn undermined the price of one of Nufarm's main global products, Glyphosphate weedkiller. The Glyphosphate price fell by about two-thirds in the year to

July, and by 50 per cent in the

final six weeks.

Despite that, the Chinese state-owned Sinochem is going into due diligence with a view to buying the group through a scheme of arrangement for $13 a share, with shareholders also banking the 15 cents-a-share final dividend.

Late in 2007 another Chinese group, ChemChina, teamed with Blackstone and another private equity group to propose buying Nufarm for $17.55 a share. The deal fell through as the global financial crisis accelerated, and while the new deal isn't as rich, times have changed, asset values have fallen and it still puts a solid price on Nufarm, which is a genuinely global business, sourcing more than 70 per cent of sales outside Australia.

The 2007 deal was priced at 13.3 times Nufarm's earnings

before interest, tax and depreciation. The new one from SinoChem is pitched at 18.5 times this year's depressed bottom line EBITDA, and at 11.8 times EBITDA before abnormal charges.

Remembering that EBITDA is a proxy for cash flow, 11.8 times "normal" EBITDA is still a high multiple. In similar deals, Germany's Bayer group bought Aventis Crop Science in 2001 for 10 times EBITDA, and sold one of its own businesses, Fipronil, to BASF in 2003 at 10.6 times.

Sinochem has been negotiating with Nufarm for a year, and throughout the talks Nufarm's profit outlook was weakening as the Glyphosphate price fell.

Nufarm's managing director, Doug Rathbone, and his adviser, UBS, and Sinochem and its adviser, RBS, were able to agree nevertheless because China is looking past cyclical issues as it invests in commodity production chains around the world  and because Rathbone was still in a position to ask for a top price to depart. With an 11 per cent direct holding and an estimated 30 to 40 per cent of the register behind him, he was in a powerful negotiating position despite the profit slide.