Wesfarmers’ left-field bid for Australian Pharmaceutical Industries (API) is a somewhat risky investment move for the Perth-based conglomerate. On the plus side, the health sector has the growth potential that Wesfarmers wants to pursue and API could provide a platform on which Wesfarmers could build a health division. On the flip side, the acquisition of API would take Wesfarmers into a fragmented, highly government-regulated business sector against significant large competitors. Moreover, th
eover, the business model is based on wholesaling, supplying and supporting franchisees and independent retailers, some of whom may well shift to other wholesalers and pharmacy retail brands if the Wesfarmers takeover succeeds. Wesfarmers’ greatest retail success has been in building the Bunnings business, a mass merchandise category-killer. While Wesfarmers will now gain some exposure to franchisees through Bunnings’ recent acquisition of Beaumont Tiles, the company’s retail comfort zone is in company-owned and controlled chains with dominant market shares. Think Coles, Kmart, Officeworks and, while both have relatively underperformed compared to competitors, Target and Coles’ liquor business. There are few companies that have been able to successfully integrate corporate and wholesale business channels as Woolworths found in grocery wholesaling and more recently in supplying independent hardware retailers and hotels. Even hybrid corporate and franchise business models have found it difficult to create successful chains. Wesfarmers divested the Coles food and liquor group in November 2018 to pursue opportunities that would offer stronger future growth prospects and is certainly sitting on a substantial war chest to fund the purchase and development of new businesses. The health sector, particularly since Covid-19, has clear potential but it is a very different proposition to Bunnings, Officeworks, Kmart or Target. Indeed, a bid by Coles, Woolworths or Metcash for API would offer significantly more synergies than the Wesfarmers acquisition, unless that company plans to also make a bid for Sigma Healthcare and create a more scalable business. As a standalone proposition, industry observers contend that API requires considerable capital investment to ensure it remains competitive in its wholesaling operations and reinvigorates its retail brands. Wesfarmers wants to acquire 100 percent of API’s shares in a $1.38 cash bid through a scheme of arrangement, valuing the Sydney-based wholesaler at $687 million. Listed on the Australian Securities Exchange, API is locked into a network of around 470 smaller mall and neighbourhood pharmacies with a health and beauty offer and generates annual sales of around $4 billion. API’s brands are Priceline Pharmacy +, Priceline, Clear Skincare, Soul Pattinson Chemist, Pharmacy Advice and Club X Premium. The API-supplied pharmacies compete with Sigma Healthcare retail formats, such as Amcal and Guardian, Discount Drug Stores, Chemist King, PharmaSave, Wholelife Pharmacy and Healthfoods, as well as the aligned Terry White and Chemmart brands and My Chemist, the Chemist Warehouse mall store format. Wesfarmers has previously shown interest in API, just as Metcash some years ago canvassed the acquisition of Sigma Healthcare, while API itself proposed a merger with Sigma Healthcare in 2018. Merger discussions between API and Sigma Healthcare are understood to have been revisited recently, with both businesses adversely impacted by Covid-19 disruptions and wary of the yet-to-be-finalised ASX listing of dominant market leader, Chemist Warehouse. The revived merger talks may have triggered the decision of Washington H Soul Pattinson and company (WHSP) to quit its long standing shareholding in API and strike a deal with Wesfarmers. The largest shareholder in API, WHSP has committed its 19.3 per cent holding to Wesfarmers, giving the suitor a strong advantage over any other potential bidders that may emerge in the weeks ahead. Other potential bidders could include cashed-up private equity firms or any of the supermarket chains which are also currently in strong cash positions. An API and Sigma merger is also a live option and quite likely the favoured option of most pharmacy owners. Interestingly, anticipating pushback from independent pharmacy owners, Wesfarmers has indicated in its takeover announcement that it is strongly committed to community pharmacy. API shares have jumped to their highest levels since 2019, with the expectation of many investors that other suitors will emerge and that a higher bid will be on offer. There is certainly a view that the Wesfarmers bid, while at a premium to recent share prices, is opportunistic with Covid’s impact on API and industry uncertainty about government policies and the impending Chemist Warehouse ASX listing. For Wesfarmers, the purchase of API only makes sense as a platform for further acquisitions that would provide operational scale.