Country Road’s independent expert has come to the unsurprising conclusion that South Africa’s Woolworths is paying a premium in a bid for the outstanding shares in Country Road that values that business at about $1.89 billion. At face value, that would appear to suggest Solomon Lew is getting paid over the odds for not derailing Woolworths' $2.2bn bid for David Jones.
It isn’t, however, quite that straightforward. Therefore, the report by Lonergan Edwards doesn’t provide definitive support for the view that Lew is being paid a massive premium for his 11.8 per cent Country Road stake in return for not carrying out his threat to block the David Jones bid, which David Jones shareholders voted for last week (with Lew abstaining).
Lonergan Edward’s core conclusion was straightforward. The offer of $17 a share is fair and reasonable because it was clearly above the form’s valuation of Country Road at between $14.92 and $16.22 a share.
While that’s a long way short of the $4 to $14 a share that Justice Kathleen Farrell of the Federal Court said could be the size of the collateral benefit to Lew if numbers were picked out of the air, it would still appear to give Lew between 78 cents and $2.08 a share, at roughly $10 million to $12m. That's more than the analysis of Country Road’s value would suggest it’s worth. (Justice Farrell’s comments were made during a hearing at which the Australian Securities and Investments Commission raised its concern that Lew would receive a special benefit not available to all David Jones shareholders.)
What the Lonergan Edwards analysis doesn’t factor in, however (because independent experts are not allowed to factor it in) is the value to Woolworths of achieving 100 per cent ownership of Country Road if it successfully takes out the 12.12 per cent held by other shareholders, almost all of it by Lew.
Earlier this month Country Road released a trading update that showed Country Road’s sales had grown 20.3 per cent for the year to June. It provided profit guidance that showed Country Road expected earnings before interest and tax of between $92.9m and $100.9m for the year, an increase of between 53 per cent and 66 per cent on the 2012-13 result.
Woolworths has said that full ownership of both David Jones (which it now has locked up) and Country Road would generate benefits of at least $30m a year of increased earnings before interest, tax, depreciation and amortisation.
Those benefits/synergies would flow from sourcing (lower costs and increased timeliness), supply chain efficiencies, rationalisation of service and administration functions and increased negotiating clout with landlords and would be unique to Woolworths.
Lonergan Edwards said that Country Road’s management had given it a detailed analysis of the share of the benefits that would accrue to Country Road only and had estimated them at $27m of EBIT. They would be largely due to increased same store sales growth in Australia, South Africa and online.
That potential uplift in Country Road’s earnings of 25 per cent to 30 per cent, while some of it might be available even if the bid for Country Road failed because of the impact on Country Road of Woolworths' full ownership of David Jones, isn’t fully factored into Lonergan Edwards’ valuation.
If it could be it would more than justify the premium that Woolworths is offering. Perhaps Lew should have held out for more, which he could do if he was prepared to ignore the current offer and the $200m or so of cash it would release and wait for Woolworths to come back in future at a higher price.
The Lonergan Edwards conclusion, if the benefits Woolworths expects from fully owning both David Jones and Country Road are factored in, could be interpreted as Country Road shareholders (Lew, primarily) being offered a modest share of the very substantial synergistic value the South Africans expect to extract.
While not as sexy as the argument that Lew is getting an exorbitant price in Country Road from greenmailing Woolworths with his threat of blocking its bid for David Jones, that would suggest the collateral benefit arguments may have been over-stated, and that the outcome for both Lew and Woolworths is somewhat more balanced than had been perceived.
He is being offered a pretty attractive exit price for a shareholding that has been locked in since 1997, but Woolworths gets to unlock a lot of value if it can execute its strategies well.