Less surprising than David Jones’ forced disclosure that it was approached by Myer last year with a merger proposal is its admission that it had rejected the overture “shortly after it was received.”
That Myer should have approached David Jones isn’t in itself revelationary – the market has canvassed that prospects and its merits in recent years as the two big department stores have struggled in the post-financial crisis period.
Nor is the timing. With both companies looking for new chief executives – David Jones had announced Paul Zahra’s intention to resign only a week before the approach and Bernie Brookes will retire from Myer this year – there was an opportunity for both groups to take a fresh look at their futures.
David Jones, in the confirmation of the approach that was flushed out by a “speculative” media article, said that Myer’s proposal was for a zero-premium exchange ratio of 1.06 Myer shares for each David Jones share, based on the previous volume-weighted average share prices of the companies over the previous 12 months.
It said its directors had decided that the proposal didn’t have sufficient merit for David Jones shareholders to warrant engaging in discussions with Myer and providing the access and information Myer had sought.
“The execution and implementation of any such transaction would have substantial commercial, market, business and regulatory risks, including the ACCC review process. It would involve the diversion of company resources over a lengthy period, with great uncertainty as to the final outcome, and the potential to result in diminution of value of the David Jones business,’’ the company said.
That’s all true, to a point. There would be commercial risks in trying to put together two department store groups with overlapping footprints and overlapping ranges of merchandise, particularly as their key stores tend to be virtually co-located. That would constitute a major challenge for management.
The ACCC could be an obstacle, although the intense and intensifying competition from both physical and virtual retailers probably diminishes that risk.
One suspects that “cultural issues” might have been a factor, given the lengthy and proud histories of both companies and, after Myer gate-crashed David Jones’ home market with its acquisition of Grace Bros in the 1980s, historic rivalries might have also played a part.
The potential benefits of a merger, however, would be very significant for shareholders of both groups if the transaction could be executed effectively and the combination managed well.
There would be obvious and highly meaningful cost synergies in management and administration, buying, marketing and IT – to the tune of $85 million annually, according to Myer. There would be greater leverage with landlords. There would be an opportunity to create a stronger delineation of the brands, which currently do overlap and compete, assuming both were retained.
The concept would at least be worth pursuing and investigating thoroughly, given the potential value that could be created for two sets of shareholders whose experiences in recent years have been less than positive and given the breadth and scale of the threats both groups face.
When like businesses are involved, zero premium all-scrip mergers are the most attractive way to create the combination. Neither set of shareholders pays a premium to the other and then takes a disproportionate share of the risks for a lesser proportion of the rewards.
The vital element of such mergers is to get the exchange ratio right. Whether or not Myer’s proposed 1.06:1 ratio properly reflected the contribution each group would bring to a merger could only be assessed after the kind of extensive discussion, analysis and information-sharing that David Jones’ board rejected.
It may be that David Jones was concerned that if it engaged with Myer it would actually put itself into play. Nil-premium mergers are completely vulnerable to the entry of a third player willing to make a conventional offer with a premium.
Retail attracts private equity but David Jones would also know that Solomon Lew’s Premier Investments is out there with a $1.5 billion balance sheet containing more than $200 million of net cash. Premier’s retail businesses are run by former David Jones’ chief executive Mark McInnes, who has recruited a flock of ex-David Jones senior retailers.
If David Jones did engage with Myer it would be acutely aware that Lew and private equity groups around the world would dust off their files on both groups.
Without a permanent CEO, with institutional shareholders that appear to have a very strained relationship with the board and with a business that has performed poorly since the crisis – and which is about to take a hit as the American Express deal that has underwritten the profitability of its financial services business ends – the possibility that engaging with Myer might invite other approaches might have been appealing to shareholders.
The concept of the merger, given the rapid structural changes occurring in retail, including the invasion of Myer and David Jones’ turf by world class retailers, is strong enough to attract the attention of both companies’ institutional shareholders, which may behind the belated leaking of the news of the approach.
It is possible that Myer might have a second crack, perhaps with a more conventional and more difficult to dismiss offer. It is also possible, if David Jones’ shareholder agitation deepens, that someone else might decide to move.