Why Wesfarmers is cutting Coles loose

Coles7After spending a decade turning Coles around, Wesfarmers announced the demerger of their $20 billion supermarket business.

The new and separately ASX listed company will include over 800 supermarkets, nearly 900 liquor stores, 700 service stations and 88 hotels.

The move by the conglomerate will have private equity groups and international supermarkets taking note.   

What is a conglomerate?

A conglomerate is a large corporation that owns several smaller businesses. Businesses in a conglomerate are often unrelated and very different from one another in terms of the products or services they offer. The Wesfarmers group currently owns a diverse range of business in retail, chemicals, energy, fertilisers, safety products and coal. There is a strategic reason for this.

Unlike Woolworths that essentially runs a ‘retail company’, a conglomerate model allows Wesfarmers to spread the risk for themselves and their investors. If coal prices fall, they lean on their retail companies. If their hardware business loses $1 billion in the UK, they can rely on their industrials and energy companies to deliver a $915 million in profit. Wesfarmers is very good at entering and exiting markets, and identifying opportunities – and getting into food and groceries a decade ago was a smart move.  

Cows, Dogs, Stars and Question Marks

These two pie graphs explain Wesfarmers decision to spin-off their supermarket division. As it stands, Wesfarmers has 61% of working capital invested in a business that is contributing 34% of the conglomerates profit (EBIT). In simple terms, as a property investor, would you continue to leave 60% of your cash in one property, if it only returned 30% value to your overall portfolio?  

Most first year business students deal with these conundrums and often reply on simple models like the classic Boston Consulting Groups Matrix. Businesses move around in these quadrants, depending upon external, macro-level impacts. A stronger Kmart, will push Target from a ‘Star’ into the ‘Dog’ category very quickly. Wesfarmers has successful moved Coles from ‘Dog’ status 10 years ago, to ‘Cash Cow’. However, with a 14% slide in profit down to $790 million, it is evident the cow is no longer milking. Like any good conglomerate, Wesfarmers will continue to merge and demerge businesses, enter and exit markets constantly seeking new opportunities.

Getting out of Dodge

It is evident that Wesfarmers saw an opportunity to enter the food and grocery sector when they purchased an ailing Coles in 2007 and pulled together a new management team, led by Ian McLeod . However, that was over a decade ago and the sector has changed dramatically in relation to intense competition, the growth of discounters like Aldi and the emergence of price conscious shoppers – who simply shop across multiple brands of supermarket each week.

This month, Fred Harrison, chief executive of Ritchies, Australia’s largest chain of independent supermarkets, called for an end to the price wars. While at the same time Coles signalled a move away from a purely price focussed strategy. Metcash’s half yearly results attest to the negative long-term consequences of the drawn out price wars, delivering loss in their food and grocery business. With the entry of German discounter Kaufland imminent, and possibly their other business, Lidl, it is suggested, Wesfarmers are getting out of Dodge.

Knowledge is power

Other than potentially cash back on the balance sheet, the move creates two long-term revenue streams for Wesfarmers. To begin with, Wesfarmers will aim to a hold 20% stake in the new company – thus, continuing supermarket generated revenues will flow back to Wesfarmers.

More importantly, Wesfarmers will retain FlyBuys data management. The value for Wesfarmers in continuing to collect, analysis and disseminate shopper information is best highlighted by Woolworths move to purchase a 50% share of data mining firm Quantium in 2013 for almost $20 million. Retaining control over this data will allow Wesfarmers to boost its customer analytics capabilities, tailor promotions, ranging and store layouts across all of their other retail businesses. Further, any potential new owners of Coles will be eager to access this information.

Private equity groups and international players

While Wesfarmers will remain a minor shareholder of the new company, it will be interesting to see which companies will be casting an eye over the books as the new and separate Coles business lists on the ASX.

Taking over from John Durkin (current MD) will be ex-Metcash Chief Executive – Food and Grocery, Steven Cain. Cain is no stranger to Coles, being dumped by the retailer in early 2000 and Cain has a long history working for private equity groups like Pacific Equity Partners.

Putting a food, liquor and convenience business comprising over 2500 locations onto the market becomes a very attractive proposition for international players to enter, like Walmart or Carrefour. Walmart has a long of international market entry via acquisition. Wal-Mart entered Canada through an acquisition. In Mexico, due to cultural differences, they used a 50/50 joint venture with Cifra, Mexico’s largest retailer. Entry into Brazil was also accomplished through a joint 60/40 (in favour of Walmart) with Lojas Americana. French retail giant Carrefour too has adopted different approaches to international expansion, including joint ventures and acquisition

Potential relationship impacts

The new ownership – be it a private equity group or international player – will have impacts on existing relationships, none more important than the relationship between the supermarket and suppliers. While the nature of these relationships have regularly been criticised and investigated, a new owner will bring these matters back to the forefront. Ultimately, private equity good and global businesses only purchase companies and enter markets where considerable return on investments can be made.     

A new Coles company will become a more agile business, no longer constrained by a conglomerate ownership model and this will present challenges for a newly refreshed and profitable Woolworths. This will lead to faster innovation, greater investment and potentially another battle for market share between the two big supermarkets.  

Gary Mortimer is an Associate Professor in Marketing and International Business, Queensland University of Technology.

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