Metcash must decide whether it will follow Woolworths’ lead and divest its hardware business to return to its core business in food and grocery or, in contrast to Woolworths, to stay the course in hardware.
There is a potential buyer in Anchorage Capital Partners, the private equity firm that also presents as a potential joint venture partner bringing a capital injection and business integration experience to the table.
The business integration skills are an important consideration, as a decision by Metcash to continue in the hardware category means negotiating with Woolworths on the purchase of its Home Timber and Hardware independents chain.
Anchorage Capital Partners represents a threat as much as an opportunity because it could potentially take a hostile spoiling position on the purchase of the Woolworths hardware assets and push Metcash to exit the business.
Metcash has tacit support from the Australian Competition and Consumer Commission to acquire the Woolworths hardware assets and support from financial analysts and suppliers, who recognise the most attractive scenario would be a merger of the Mitre 10 and Home Hardware businesses.
However, if Anchorage Capital Partners could snap up the remnants of the Woolworths misadventure in hardware, financial analysts would be more pessimistic about the outlook for Metcash’s Mitre 10 division and prefer the wholesaler quit the category.
Financial analysts and investors generally favour Metcash and Anchorage Capital Partners or another private equity firm teaming up to buy out the profitable Home Timber and Hardware business and, possibly, some of the better performed Masters Home Improvement stores.
Suppliers would prefer a go-it-alone play by Metcash because of the bad smell of the Dick Smith collapse that is being substantially blamed on Anchorage Capital Partners and unsupportive banks.
The private equity firm acquired Dick Smith from Woolworths in 2012, investing just $10 million of its own money on its way to a $520 million payday after just 13 months ownership.
Anchorage Capital Partners has been talking to Metcash about merging the two independent hardware chains and Inside Retail Weekly understands there may be interest from other private equity firms, possibly including Pacific Equity Partners, where Metcash grocery executive, Steven Cain, was a senior executive.
If Pacific Equity Partners is interested in a joint venture with Metcash, Anchorage Capital Partners would likely find the wholesaler less hospitable, albeit any deal will ultimately come down to structure and dollars.
The structural outcome could be an across the board hardware joint venture or a private equity firm acquiring both Mitre 10 and Home Timber and Hardware and merging the retail businesses while striking a long-term wholesale supply contract with Metcash.
Metcash has previously considered floating Mitre 10 on the Australian Stock Exchange, possibly retaining a sizeable, if not majority, stake in any new public entity. So a sale of the retail operation based on continuing supply contracts is a live option.
Metcash acquired Mitre 10 in a two-stage deal struck in 2010 with the directors and shareholders of the iconic independent hardware business and Anchorage Capital Partners were the under-bidder six years ago.
For Metcash, the deal was about leveraging its wholesaling and logistics expertise into a new retail category and securing the business by controlling the retail brand.
Mitre 10 was forced to surrender its own independence after a disastrous foray into Mitre 10 Mega stores, a big footprint format designed to allow its retailers to take on Bunnings.
With that experience in mind, as well as the failure of the next big box contender to step up in Woolworths, Metcash would be wary of acquiring any of the Masters Home Improvement sites, whereas a private equity firm may be keen to pursue a flagship strategy.
What to do with Masters?
The opportunity to sell some of the Masters Home Improvement stores rather than to bear the costs of closing them down could be an important factor for Woolworths in any deal its strikes on the Home Timber and Hardware business.
Woolworths is desperate to retrieve as much money as possible from its exit from the hardware business, meaning the retailer will not be nearly as benign as it was when it struck what has been called the ‘deal of the century’ in selling a streamlined, profitable and asset solid Dick Smith to Anchorage Capital Partners in 2012.
The private equity firm, Blackstone, and Bunnings Warehouse are already circling the Master Home Improvement property assets, with Woolworths still owning around half of the stores as well as a significant landbank.
Interestingly, the amount of retail floor space that would be created by the closure of all Masters Home Improvement stores would equal four years supply of new large format or bulky goods retail floor space while some of Woolworths’ landbank includes planning permits.
Woolworths is currently embroiled in a dispute with its joint venture partner, Lowes, over the value of the one-third stake held by the American hardware retailer.
Woolworths wants to settle payment to Lowes for its stake before proceeding to sale negotiations on what’s left of the failed Masters Home Improvement chain. However, Woolworths have been talking to potential buyers of the assets, including Metcash, talks with the wholesaler that have been both sweet and terse.
Woolworths is currently caught in a balancing act trying to retain the value of its Home Timber and Hardware business so that it can retrieve some value for its disgruntled shareholders.
Arguing competition law obligations, Woolworths recently threatened Metcash for making overtures to Home Timber and Hardware retailers, inviting a group of them to the Mitre 10 annual conference.
It would seem a hollow threat – and quite laughable, given how Woolworths itself plays hardball and shows little mercy to competitors. But the move demonstrates the retailer’s concern that the defection of any of its independent Home Timber and Hardware retailers to Mitre 10 would erode the sale value.
With the threat approach a double edged sword for Woolworths, the retailer has more recently changed tack and offered incentives and sweeteners to its hardware customers to stay.
There are 44 company owned Home Timber and Hardware stores and around 250 bannered independent stores and another 100 plus wholesale account customers. The business lifted profits by 43.3 per cent in the latest half-year to $12.9 million on an 8.7 per cent lift in sales to $525 million.
Beware the profitability of the businesses being readied for sale, however, the Home Timber and Hardware business has been profitable since Woolworths bought it from Danks as a platform to develop its Masters Home Improvement business.
For the 2015 full financial year, Home Timber and Hardware lifted earnings by nearly 200 per cent to $20.9 million on a 20.9 per cent increase in sales to $937 million, albeit earnings were no doubt assisted by the operational scale of the Masters Home Improvement chain and would likely be lower going forward.
Mitre 10 has around 380 stores with just over 300 under its own brand and in the latest half to November 30, 2015, the hardware business increased its earnings by 22.1 per cent to $11.6 million on a modest 1.2 per cent lift in revenues to $530.7 million.
In the 2015 full financial year, Mitre 10 topped $1 billion in sales for the first time and lifted earnings by 7.5 per cent. The profits were reported in a combined figure of $57.9 million, with the subsequently divested automotive division of $57.9 million.
Metcash suffered a $384.2 million loss for FY15 after significant writedowns in its core food and grocery business and, while it was in the black for the latest half, earnings before interest and tax were down by 22.9 per cent to $91.9 million.
Metcash contemplates its future
Metcash has been beefing up its management ranks as it executes a business transformation strategy that aims to reboot sales and earnings growth as a headline ambition but, perhaps more realistically, to defend market share against Coles, Woolworths, Costco and Aldi.
New executives include George Saoud, former CFO at Fantastic Furniture, Algy Pereira, who left Woolworths to join Dick Smith just as it crashed, and Mel Patel from Aldi.
In a recent structural change, the hardware division now reports along with the food businesses to Andrew Clark as national GM, but the strategic direction for hardware has not been as clearly outlined by Metcash, as has the blueprint for food and liquor.
In large part that could be due to the uncertainty in the category before Woolworths decided to abandon its Masters Homer Improvement venture and to the urgency of remedying the core operations in food and liquor that generate more than 90 per cent of total sales and the lions share of earnings.
Metcash now has an opportunity to more clearly assess its position with Bunnings’ move into the United Kingdom a concession that it is unlikely to be able to generate the same level of growth in Australasia in the future in terms of store rollouts as much as the remarkable sales and earnings figures it achieves.
The Bunnings move and the certainty that no other major new hardware player is likely to enter the Australian market after the failure of Masters Home Improvement has peaked interest in a Mitre 10 and Home Timber and Hardware merger.
Metcash must now decide whether to be a buyer or a seller and whether its future is more promising owning and running a merged hardware wholesaler operation serving independent retailers by itself or with a joint venture partner, or by quitting the retail side and concentrating on what it knows and arguably does best – wholesaling.
Access exclusive analysis, locked news and reports with Inside Retail Weekly. Subscribe today, and get our premium print publication delivered to your door every week.