King's ransom in Coles partsPaul Kerin Paul Kerin teaches...

King's ransom in Coles parts


Paul Kerin Paul Kerin teaches strategy at Melbourne Business School.

The Australian Financial Review | 21 Aug 2006

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The retailer should chart its own course, writes Paul Kerin. Investors and commentators have failed to pick the real reasons behind two critical recent events. First,
why did Coles Myer's share price really plummet after CEO John Fletcher's announcement on July 31 of
his new strategy? Second, why have potential bidders for Coles really emerged now? The real answers
to these questions give Coles's long-suffering shareholders reason to smile.

Within three days of Fletcher's strategy announcement, Coles shares plummeted 9.4 per cent, wiping out
more than $1.1 billion of shareholder value. The drop was generally blamed on the poor strategy that
Fletcher announced. And it was appalling. Fletcher said it took nine months to construct but, frankly, it
could have been written on the back of a napkin over lunch.
He defended his new strategy by saying, "We know our vision is seen by some as being too bold". Too
bold? What planet is he on? The problem was that it contained nothing bold at all! But the strategy's
nothingness did not spook the market - after all, it had learned not to expect much. Rather, sensible
investors were spooked when they realised this strategy, if implemented, would cut off extremely
valuable strategic options.
Sensible investors have long realised that a full Coles break-up would create substantial value - although
this seems to have escaped its board and management. Some hoped that the successful sale of Myer
may have made Coles reconsider the merit of a break-up.
Several years ago, I criticised Coles Myer's decision to re-brand Grace Bros stores to Myer (Coles takes
wrong step, AFR, February 2, 2004). The reaction of Dawn Robertson (then Myer's managing director)
would have put Hezbollah to shame. But my point was that divestment of Myer was clearly the best
option and that re-branding was costly - in direct outlays (at least $10 million to $20 million), but more
importantly in dumping a brand that would have been very valuable to potential acquirers of Myer.
Dumping the Grace Bros brand made a valuable option more difficult to realise.
Potential acquirers have emerged now because the re-branding and integration elements of Fletcher's
"new" strategy will cut off valuable options. They are trying to rescue very valuable businesses and
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King's ransom in Coles parts
Paul Kerin Paul Kerin teaches strategy at Melbourne Business School. Earlier this year, he
advised
brands from the value destruction that would happen under the new strategy. If acquirers do not have a
well-known brand to build on - and, even worse, have to spend money re-branding an acquired business
- they have less reason to do the deal. They realise they must act now before the new strategy gets too
far down the track.
Coles's closing share price of $13.45 last Friday put its market capitalisation at just over $16 billion - up
$2.8 billion (21.2 per cent) for the week. Analysts bids at present generally range between $13 and $15;
Citigroup estimates that a private-equity bid could not exceed $15.70 ($18.7 billion). I firmly believe
that this understates the potential for value creation.
The last time Coles semi-seriously considered a break-up was in mid-2002, when Swiss investment bank
UBS conducted Project Gold. Shareholders missed out on substantial gains then; they should hope
Coles does a better job now.
UBS's work contained at least two glaring furphies. First, the claim that Myer could not be sold - or be
viable - on its own. What hogwash!
Second, UBS argued that shareholder tax implications put the kybosh on a full break-up. This implies a
false assumption: that without a break-up, shareholders will never sell! Yet the average holding period
for Australian shares is about one year; therefore, on average, existing shareholders will sell them within
six months. Though a break-up does have a tax cost, it is far smaller than break-up opponents have
claimed
Interestingly, UBS has now switched sides, supporting the Kohlberg, Kravis and Roberts-led consortium.
Substantial value gains are available, but the extent to which existing shareholders capture them
depends on how Coles plays its hand. It should set up an open auction, inviting bids for any Coles
business or combination of businesses. This will flush out the best bids from trade buyers interested in
parts but not the whole. Rather than repeat the mistake of pre-judging what value-maximising business
combinations to offer, let the market decide.
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