Coles, Wesfarmers Marriage Looms

By Glenn Dyer | More Articles by Glenn Dyer

They will be line-ball businesses: Coles under the ownership of Wesfarmers and its rival, Woolworths.

But in terms of the bottom line, they will be chalk and cheese. Woolies will still be the one to beat.

Based on the latest results, both will have around $41 billion or so in revenues from retailing. Wesfarmers will have around $4 to $5 billion extra from its non-retail areas of operation, such as insurance, coal, energy, industrial gases, insurance and safety.

The combined Wesfarmers and Coles retail businesses would have earnings before interest and tax of around $1.2 billion to $1.3 billion by the end of the 2007 financial year.

Woolies would have EBIT close to $2 billion, and that's the difference and the risk in the huge, $22 billion takeover of Coles by Wesfarmers.

For all the size the deal gives WES in terms of revenues, it will be an earnings-light business.

Besides the $4.3 billion or more in cash WES will have to find to pay Coles group shareholders, another $600 million or more will have to be found to try and transform Coles into a competitive retail giant, not what it is now: a business slowly dying.

WES's other businesses won't really matter. Wesfarmers has managed to find a structure that replaces debt with its high priced-shares as the principal currency in the takeover.

Getting a return on the 308 million WES shares to be issued will be vital, but not as vital as paying the interest bill on $14 billion in bank borrowings and other debt.

Earnings from the Coles business will be the only metric analysts and investors will focus on: how WES is going in revamping and making Coles into a profitable retailer.

Wesfarmers' earnings from its other businesses, especially coal and energy, will be seen as valuable extras, but a source of capital for the Coles turnaround and for keeping shareholders happy.

With Bunnings accounting for almost half Wesfarmers' revenues and more than 40 per cent of EBIT, the company is already dominated by its existing presence in Australian retailing.

Now it will be under pressure to float, or spin-off its non retailing businesses; not to raise cash, but because they will absorb valuable management time and capital that's needed to turn Coles into the sort of retailer that Woolies is: profitable and growth driven, not struggling and defensive.

WES earned just over a billion EBIT in 2006, Woolies, $1.7 billion. Woolies earnings will have momentum, even without the bits of Coles it tried to buy, WES will have up to two years of hard work to reverse the damage done by the Coles board and management in its ill-fated 2006 revamp.

Coles shareholders will be a major part of WES. At $22 billion, with a huge proportion of that in shares, there would be no other outcome.

Wesfarmers won the approval of the Coles board with a $21.9 billion cash and share offer that values the retailer at $17.25 a share. That includes a bid of $17 a share in cash and shares and the 25c final dividend.

The decision to give shareholders the dividend they are entitled to and not cut the offer price by its amount again highlights the parsimonious decision of the Macquarie Bank-led and Qantas board approved offer of $5.45 a share for the airline. It was plain dumb.

Wesfarmers managing director Richard Goyder said the takeover represented an opportunity for Coles shareholders to hold onto an ongoing interest in the company, for Coles to stay Australian-owned, and for staff and consumers to benefit from a revitalised major force in retailing.

"The recommendation from the Coles board is a big step towards helping end the uncertainty for shareholders, employees, suppliers, and customers surrounding the company's ownership review," Mr Goyder said.

Wesfarmers said Coles' shareholders would receive a premium for their shares under the bid, an anticipated increase in annual dividend income and the prospect of capital gains tax rollover relief for a substantial proportion of their shareholding.

Under the bid, to be carried out by scheme of arrangement, Wesfarmers is offering $4 cash and 0.2843 Wesfarmers shares for each Coles share.

Shareholders will also be entitled to a final dividend of 25 cents a share.

"Based on the closing price of $45.73 on Friday 29 June, the offer values each Coles share at $17.25 per share inclusive of a final dividend of 25 cents per share," Wesfarmers said.

Wesfarmers is offering Coles shareholders a minimum of 75 per cent of their holding in Wesfarmers shares at the record high of $45.73 on Friday.

The Perth-based conglomerate said both companies shareholders would be able to take part in the substantial benefits and earnings uplift expected as Coles' planned transformation process took effect.

Coles chairman Rick Allert said the offer represented a good outcome for the company's shareholders, and the board believed it to be fair and reasonable.

"This is a good outcome for Coles shareholders, which recognises the significant turnaround of the company over the past five years, and the future opportunity of the company's new growth strategy," Mr Allert said.

"It provides an attractive premium now, as well as an opportunity to share in the future value upside from the Coles businesses, as part of the broader Wesfarmers group."

He said the proposal had limited conditions to completion, with no conditions relating to factors such as financing, approval from the Australian Competition and Consumer Commission approval, or landlord consents.

Wesfarmers was forced to make a stand-alone bid for Coles after its private equity partners, Pacific Equity Partners and Permira Holdings, pulled out at the last minute.

The fourth member of the Wesfarmers bid, Macquarie Bank pulled out on Friday.

The planned takeover would r

About Glenn Dyer

Glenn Dyer has been a finance journalist and TV producer for more than 40 years. He has worked at Maxwell Newton Publications, Queensland Newspapers, AAP, The Australian Financial Review, The Nine Network and Crikey.

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