Vulnerable DJs gets first knock at the door

It was probably only a matter of time before someone knocked on the doors of beleaguered department store operator David Jones – and now it has happened.

David Jones today disclosed that it had received an "unsolicited letter from a non-incorporated UK entity about which no usual public information is available" indicating its interest in making an offer for the company".

David Jones subsequently revealed that the approach had come from EB Private Equity, which apparently focuses on property investment, and was said to be a $1.65 billion bid for 100 per cent of the company.

The offer, if it eventuated, would be funded by $850 million of EBPE-sourced equity, $450 million of debt funding and $450 million of "residual equity" for David Jones' existing shareholders, some of which would be underwritten.

For months speculation of a private equity tilt at the venerable retailer has swirled around the market, fuelled recently by reports that property consultants have been asked to value the four key retail properties it owns in Sydney and Melbourne.

David Jones is vulnerable. While it isn't the only retailer experiencing difficult conditions – Myer recently issued a profit downgrade, saying earnings could be 15 per cent lower than last year's – David Jones has forecast a nasty 35 per cent to 40 per cent earnings slump this year and outlined quite a bleak medium-term outlook.

With the guaranteed 7.5 per cent a year increase in its earnings from its credit card alliance with Amex falling away, its financial services earnings will halve next financial year.

Exacerbating its vulnerability, unlike Myer, which leases its flagship stores, David Jones owns its CBD stores in Sydney and Melbourne.

The stores – two in the Bourke Street mall in Melbourne and the Elizabeth and Market streets properties in Sydney – generate about a quarter of its sales and a bigger proportion of its earnings but have a book value of less than $500 million. Analysts' assessments of their market value vary, but some have put it at up to $1 billion.

That suggests a buyer could reprise what the TPG-led private equity consortium did when it acquired Myer in 2006 for $1.4 billion. It quickly on-sold its flagship Bourke Street store for more than $600 million and entered a long term lease arrangement.

While Myer's share price performance has been a disappointment since it was re-listed, that period of private equity ownership did improve the fundamentals of its business, with heavy investment in its supply chain and systems that is also now enabling Bernie Brookes to rapidly roll out an omni-channel offering. David Jones is pursuing a similar strategy but is hampered by the need to put in place a new IT platform and point-of-sale system.

David Jones' share price had fallen nearly 40 per cent over the past year before the news of the approach from the mysterious UK would-be suitor saw it spike this morning. It was valued, at yesterday's close, at about $1.2 billion – which provides some perspective on the significance of the properties it owns.

If David Jones does come into play, there's another obvious potential bidder.

Former David Jones chief executive Mark McInnes now manages Solomon Lew's Just Group and has been assembling a high-powered team of former senior David Jones and Myer executives. Only recently he lured one of the key executives during his time at David Jones, Colette Garnsey, after she had spent only a year at Pacific Brands.

Lew's Premier Investments is sitting on more than $300 million of cash and he has made no secret of the fact that Premier was keeping tabs on David Jones. Lew made his fortune in the 1980s when he bought into Myer and then was a key player in the merger of Myer into Coles. He knows department stores retailing intimately as, of course, does McInnes.

Having moved on Just Group too early, just as the retail environment suffered a second and more powerful downturn, Lew probably wouldn't want to take a shot at David Jones until conditions were more stable and David Jones' response to them was more advanced. If the contest is initiated by another party, however, he may not be able to continue just watching and waiting.