16/01/2007 - 22:00

Crunch time for Wesfarmers?

16/01/2007 - 22:00

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Has Wesfarmers become just another tired, diversified industrial, destined for the knacker’s yard, or is it one of the best investments on the stock market, destined to disappear in a glorious ‘big bang’ that will shower cash on everyone aboard?

The latest thoughts about what to do with Wesfarmers have come largely in stockbroker reports, suggesting that the company would be a difficult takeover target for a private equity fund interested in a smash and grab raid.

The reason, which Briefcase finds a little silly, is that Wesfarmers is said to be ‘loved’ by its army of 34,000 faithful shareholders who would never sell their shares, partly because Wesfarmers has been such a good investment in the past, and partly for fear of capital gains tax obligations.

The financial merit of that argument is easily understood.

Less easily understood is the apparent rejection by the brokers of the seductive aroma that comes from a fistful of dollars being waved under your nose.

The real question about Wesfarmers is not whether it is loved (can you actually love a business?) but whether it might attract a ridiculous price from a private equity fund being run by a 20-something merchant banker desperate to do a deal – any deal – by spending someone else’s money.

Briefcase knows a number of Wesfarmers shareholders who would gratefully take the money, especially if there was lots of it.

And he knows a number of Wesfarmers managers who have shown an equal willingness to take the money when the price is right – or why else did CEO, Richard Goyder, sell the rural division, once the heart-and-soul of Wesfarmers, to AWB when an offer too good to refuse was made.

Money, money, money – just like the old Abba song – is what Wesfarmers is all about, and Mr Goyder has already said he is struggling to make any big-ticket acquisitions because the private equiteers are paying silly prices and he can’t compete.

Well, if you can’t compete, and you’re a perfect break-up target because of the neat and easily saleable compartments that make up your corporate structure, then perhaps soliciting a big, fat, bid is actually in the best interests of the shareholders.

That’s unless you prefer to drift along as a yield stock for as long as private equity rules the capital roost (which is, itself, a rather interesting question).

Perhaps now might actually be the perfect time to make a glorious exit and catch the private equity tide before it recedes.

•••

According to what Briefcase has seen, the brokers are valuing all of Wesfarmers at somewhere between $14 billion and $16 billion, largely by assigning values such as $6.8 billion to the home improvements (Bunnings) division, and $1.6 billion on coal.

These are conservative estimates based on traditional investment thinking and bear no resemblance to how a private equiteer with a deep love of debt sees some of the Wesfarmers divisions.

Consider a few alternative thoughts, starting with the Wesfarmers you see today, with shares attracting a zero premium as shown in the way the stock is priced at a prospective price-earnings (PE) ratio of 17. This is spot on the average of the top 200 listed stocks – because Wesfarmers is a totally average industrial stock, owning bits and pieces of what make up the All Ordinaries index with divisions that cover retail, chemicals, mining, energy and insurance.

•••

To understand why Wesfarmers might be heading for a takeover bid (or a self-managed auction of its divisions), look at a possible sum-of-the-parts valuation through the eyes of a private equity fund.

As a first step, imagine that debt, great big dollops of the stuff, will cause you no concern whatsoever – which is not something Briefcase can do, but is a prerequisite in this latest incarnation of the game known as leveraged debt.

At Wesfarmers, according to broker estimates, the company will end the current financial year (to June 30 2007) bearing a debt load of $2.6 billion, up from nil debt in 2005 and $1.7 billion in 2006.

The changing debt profile was acknowledge by Wesfarmers itself last week when it quietly reinstated its dividend reinvestment plan, by which shareholders can take additional shares in lieu of cash.

But prudent debt as seen by Wesfarmers is nothing to the way debt is seen by private equity funds, which would load the different divisions with mountains of the stuff.

Imagine what a private equity fund would do with Wesfarmers Energy (coal, gas and electricity), which posted an EBIT result of $627.2 million from revenue of $1.68 billion.

Given the astonishing level of interest in energy assets today it is easy to imagine someone offering a very high price, perhaps somewhere between $8 billion and $10 billion, and then gearing the business to the eyeballs.

The home improvement division reported EBIT of $420.5 million, and must be worth at least $5 billion to $7 billion. Profit from insurance was $124.8 million, which implies a business value as high as $2 billion to $3 billion. Profit from industrial and safety was $96.8 million (another $1 billion to $2 billion business) and profit from chemicals and fertiliser was a depressed $81.4 million, but still a potential $1 billion to $2 billion business.

Add the potential values of the component parts, as seen through the eye of someone immune to concern about debt or spending someone else’s money, and it is easy to concoct a sum-of-the-parts value for Wesfarmers of anywhere from $17 billion to $24 billion.

And all that’s available today on the market as a complete package of $14 billion to $15 billion.

At these notional Briefcase divisional estimates, Wesfarmers shares could trade as high as $50 or $60 each – surely enough to buy-off every one of those 34,000 love-struck Wesfarmers shareholders

In fact, the more Briefcase looks at the potential for such a deal, the more it wonders whether Macquarie would lend this column the funds to do the deal – or perhaps it’s already talking to Wesfarmers management.

•••

Resignations have been pouring in at Alinta, but the silence, so far, from the federal government on the question of management making takeover bids for companies they are employed to run is deafening.

While professional critics, and casual observers like Briefcase, recoil in amazement at the management-led buy-out proposals for Qantas and Alinta, the government, which administers corporate law, seems to have been struck dumb.

Hopefully this will not be the case for much longer because this really is an example of shareholders being treated as something even lower than a mushroom.

To test that claim, ask a simple question: Does Joe Average shareholder know as much about the internal workings, and future growth prospects, of a company as the chief executive? Of course he doesn’t.

Another simple question: Is the chief executive employed to work for the shareholders, or himself? Another no-brainer. The CEO’s sole duty is to enrich the shareholders – with corollary function being to look after the employees.

What the CEO is not supposed to do is make an offer to buy the business – unless he first ceases to be the CEO.

Bob Browning, somewhat belatedly, has done the right thing. Geoff Dixon at Qantas will probably have to follow.

But what Briefcase would really like to see is some clear distance put between a CEO quitting, and being allowed to use the knowledge gained in his job to be part of a bid for the business.

It happens with some governments whereby ministers and senior civil servants are not allowed to use their knowledge in a lobbying position.

So why can’t it happen in business?

Surely a change in the law is essential if these management-led buyouts are to become more common.

•••

“Take my assets, but leave me my organisation, and in five years I’ll have it all back.” Alfred Sloan

STANDING BY BUSINESS. TRUSTED BY BUSINESS.

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