Opinion Piece on Wesfarmers/Coles demerger (May 2018)
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Opinion Piece on Wesfarmers/Coles demerger (May 2018)
Wesfarmers demerger of Coles – still “half–pregnant”?
Robyn Rodier
Supermarkets are tough, low margin businesses. Whilst Wesfarmers failed to transform Coles
and lift it from the mire of paper thin returns of this industry, its board at least has
acknowledged past errors and with their decision last month have acted decisively to exit the
status quo.
Admitting mistakes though is the beginning, not the end of the decision making required. The
full outcome will only emerge as implementation decisions are made. Deciding what terms to
impose on the NewColes, including where assets should end up, are the stuff that can make or
break a demerging NewCo when cut adrift. So questioning whether implementation decisions
satisfy the best interests of the shareholders test is neither churlish, nor diminishing the praise
for the primary exit decision.
With implementation decisions “the devil is in the detail”. The worthiness of the decision to
exit should not therefore preclude examination of subsequent decisions on the implementation
phase that now follows. Many zero-sum decisions need to be weighed and made. “Wouldn’t it
be nice to have such-and-such a business/division/asset move to the residual parent” - when
rationally it might be much more defensible if it was passed to the NewCo. Such ruminations
will not cut the mustard in this era of transparency, and accountability required of boards for
their decisions.
This approach though gets tested immediately, indeed in the initial announcement – with their
first three implementation decisions (see Side Bar 1).
Side Bar 1
Wesfarmers’ Foreshadowed Three Implementation Decisions
1. Wesfarmers to retain up to 20% in NewColes
2. Wesfarmers to bestow NewColes with a cadre of Wesfarmers nominee
directors. (Unspecified in number, but “determined by Wesfarmers
independently of the size of Wesfarmers retained stake”, according to new
CEO Rod Scott in a recent interview).
3. FlyBuys; a “keeper” for Wesfarmers
A first blush response concludes that all three of these decisions are incongruous and
inconsistent with the fundamental decision to quit the business. These initial impressions don’t
improve on second blush. The clearly delusional choice of being in a half-pregnant state is the
objective it seems. By half-pregnant I simply mean that these decisions are clearly aimed at
continuing control of the NewColes business to Wesfarmers’ advantage, despite notionally
having decided to quit the business. And, to do so despite an 11-year, sustained
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Wesfarmers demerger of Coles – still half–pregnant? Robyn Rodier Opinion Piece May 2018 Page 1 of 5underperformance, reflected in Wesfarmers’ inability, even with 100%, to raise returns to
acceptable levels.
I suggest that Wesfarmers ongoing presence in the NewColes post demerger is especially
unhelpful to the NewColes on several fronts (see Side Bar 2)
Taking the opposite tack, what reasons might have been advanced against this 20% stake that
the board would have had to ignore or reject en-route to their curious decisions? My
suggestions here are summarised in Side Bar 2;
Side Bar 2
Adverse Impact of Wesfarmers’ Implementation Decisions
a) The substantial minority holding (up to 20%) will be a weighty overhang on the
NewColes share price until Wesfarmers, eventually, exit the register.
In past examples, ill-fitting, large minority shareholdings have undoubtedly
done just that (For those with long memories – recall the influence of the BHP
stake (37%) in Fosters post John Elliott’s demise in the early 1990s).
b) The proposed arrangements would likely put a brake on what NewColes could
seek to do with restructuring.
Wesfarmers clearly won’t be interested in agreeing to any demands for
large licks of capital going forward. Undoubtedly some compromising of an
obvious need for a longer term strategic plan for NewColes will result.
c) FlyBuys natural home – NewColes is the obvious place for management of this
loyalty program.
Coles clearly delivers most of the volume. It seems equally obvious a
commercial arrangement for shared access could be negotiated to the benefit
of both parties post demerger.
Wesfarmers board clearly has a different view.
d) Preferential advantage to one or other entity by way of misplaced assets –
this potentially comes at a cost to the strength of the entity that loses that
revenue.
e) Blocking Stake - Whilst in the event of a future takeover there is potential
value in a blocking stake, there is currently no white knight on the horizon
f) 20% of capital tied up in New Coles (amounting to in the order of $20 billion)
could be better used by Wesfarmers elsewhere in their higher yield businesses.
The demerger also begs the question of retailing more broadly as part of the Wesfarmers
portfolio.
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Wesfarmers demerger of Coles – still half–pregnant? Robyn Rodier Opinion Piece May 2018 Page 2 of 5Side Bar 3
Coles performance under Wesfarmers and likely future
• For the first half of the period Wesfarmers owned Coles, Woolworths
“ate their lunch”.
• More recently, Coles turned the tables for a period (that largely
coincided with Woolworth’s troubles with a faltering Masters initiative
and the distractions that caused for their other business segments). In
fairness Coles CEO until recently John Durkan, managed to increase
performance strongly for a period
• Despite the improved performance period, it was short-lived
compared to Woolworths who have regained top dog status by
grinding back on top of Coles again even more recently.
• Tellingly, this reversal was delivered despite Coles supremacy in the
advertising space in the past few years (the irritating, but effective
“Red Hand & the Down, Down” advertising and the tie-up with
celebrity chef Curtis Strange), seeming to be more effective than the
Woolworths package in this area.
• The “Down, Down” program has run its course?
Interestingly, departing Coles boss, John Durkan, indicated recently
that this campaign might have run its course and that Coles now plan
to give this campaign, with its exclusively price competitive, discount
orientation, a rest. Its replacement is a new focus encapsulated in
“Good things are happening in Coles”.
• No longer Top dog
It remains to be seem how effective this change will be but, in any
event, despite this arguably superior advertising package over the past
couple of years, Woolworths still retain ‘top dog” status at present, in
delivering returns.
The bulwark defence of Wesfarmers’ retail performance throughout this time has been the
catch cry - “Bunnings” – which has been a sustained, stellar performer for Wesfarmers. Based
on the US Home Depot model, Wesfarmers are rightly lauded for stealing a march on the local
hardware retail industry and quickly establishing this long term, premier retailing model in that
sector. Despite this history in Australia the model failed miserably in the UK (no doubt an
unpleasant surprise for Wesfarmers board and management after the ever-upward Australian
experience with Bunnings over the past decade to have to face up to an exit cost by way of
write down of around $1.7 billion.
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Wesfarmers demerger of Coles – still half–pregnant? Robyn Rodier Opinion Piece May 2018 Page 3 of 5Notwithstanding these recently surfaced travails, the message out of the West has essentially
been – “Trust us, we can be top class retailers (and chemical manufacturers and agricultural
suppliers and insurers and coal miners – as well as retailers) – look at what we have done with
Bunnings – especially as we have sent Woolworths packing with their ill-fated Masters
adventure. We will get the Coles business winning again”.
The directors were right to conclude that this was not a credible expectation. “Times up” for
prior management’s promises of improved performance of Coles (See Side Bar 3) and the
future looks bleak (Side Bar 4)
Side Bar 4
Why Wesfarmers’ NewColes Will Struggle to Deliver Returns Acceptable to
NewWesfarmers:
• If Wesfarmers learnt nothing else over the past 11 years, it must have dawned on
them after the first blush of acquisition passed, that Coles is in a very different
market segment to Wesfarmers other businesses.
• Coles’ domain is an all too competitive market place here in Australia with one
large competitor and a bundle of well-funded, major overseas players itching to
join the fray (Costco and Aldi already here and growing; and Kauflands has its toe
in the water and clearly demonstrating that it wants to win down here as well as
being a sustained performer in Europe).
• The duopoly of gorillas is not enough - especially with an even bigger gorilla as
the other duopolist. Despite the duopoly there has been little “rational” market
behaviour apparent in recent times that normally characterises advantageous,
mature duopolies – just real, head-on, zero-sum, price competition -
commendably consistent with the regulatory best-case outcomes but unlikely to
survive the onslaught of the newcomers.
• Multiple aspirant young gorillas are circling, chafing at the bit to chance their
arm and to grab a bigger slice of this market; Costco, Aldi, IGA and Kaufland and
Amazon in various forms shortly - four with deep pockets.
• The bricks and mortar assets are being challenged by encroaching technology
that is seeing increasing focus on customer service via growth in internet order
and delivery – with more to come one would expect
• The overall strategy was just too hard to deliver – especially returns on the
capital employed (currently only 34% of Group Divisional earnings).
• There is no light at the end of the tunnel for Coles; only more competition,
higher customer expectations, more costs of technology; even tighter margins
and ongoing lower returns.
• A conglomerate discount has plagued the arrangement - around a 6.3% increase
in share price resulted immediately on the demerger announcement.
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Wesfarmers demerger of Coles – still half–pregnant? Robyn Rodier Opinion Piece May 2018 Page 4 of 5There is no getting away from it; having bitten the bullet with the exit decision, the three initial
execution decisions are genuinely difficult to fathom. It is to be hoped the board will include in
its Scheme Document, explanation beyond the “digital cooperation” story etc., as to why this
20% continued holding, and ongoing effective control of NewColes via it and board
representation, is really “in the best interests of shareholders” – of either the continuing
Wesfarmers or the New Coles. Shareholders would also like to be convinced decisions over
valuable support service components, like FlyBuys, are dealt with objectively, with commercial
common-sense, and to the benefit of both companies and thus shareholders of both
NewWesfarmers and NewColes. Shareholders are looking for value in both surviving entities to
be maximised.
So, my conclusion is in two parts – praise for the overall exit decision but a withholding of
judgment on the implementation decisions, beyond observing that they need explaining as,
Prima Facie, these implementation decisions are a worry for shareholders. The wisdom of
these decisions needs to be explained to shareholders. And, to “jump off the page with
persuasiveness and overwhelming force of logic” - and thus silence naysayers (like me).
Failing this, the board should revisit and change their initial implementation decisions.
Shareholders therefore anxiously await a Scheme Document that, hopefully, pays genuine
homage to the “in the best interests of shareholders” test, and demands “QED” as the
inescapable verdict. I must say though, if past practice is the best indicator of future
performance, and if I was a betting woman, I would not put the house on it.
Robyn Rodier is Senior Fellow at Melbourne Business School and a PhD candidate at RMIT
University in the School of Accounting.
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