Consumer discretionary

I’m not talking about the front cover.

The current owners, including TPG and the Myer family, plan on raising $1.9b to $2.8b to exit the business. (Yes, the Myer family indicate on Page 33 that they may sell 100% of their shares).

$315 million will be used to pay down debt and $100 million odd are frictional costs associated with the float. The rest will go to Private Equity and the Myer Family.

Upon listing, the business will trade with a market capitalisation of somewhere between $2,282m and $2,768m.

What, however, is the business worth?

With all the relevant data to value the business now available and using the pro-forma accounts supplied in the prospectus, I value the company at between $2.67 and $2.78, substantially below the $3.90 to $4.90 being requested. It appears to me that the float favours existing shareholders rather than new investors.

Investing safely in the share market requires a wonderful business and a rational price. Myer is arguably now a much better business than it was, but the price being requested is even hotter than the cover.

By Roger Montgomery, 28 September 2009

by rogermontgomeryinsights Posted in Consumer discretionary.

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Like me, your Myer One card entitles you to pre register for a prospectus for the forthcoming float of Myer. Should you take the next step and buy the shares?

The answer to that question depends on three things. First, does the business have bright prospects? Second, what is the business worth? Third, at what price is it being offered?

Clearly, Bernie Brookes is the talk of the town, and his work in turning Myer around is fast becoming legend.  But is the talk about Bernie’s ability to improve returns on sales from 2 cents in the dollar to 7 cents, or is the talk because a private equity firm bought a business with $400 million of equity and $1 billion of debt then, in the first year, paid themselves back their equity – essentially getting the business for free and then a few years later still, floated the business for what many analysts believe will be $2.5 billion?

Myer may be a better business than it was and it may be that earnings next year will be higher again, but this is not a JB Hi-Fi, able to roll out another 100 highly profitable stores with short payback periods. This is a department store.

It is, I confess, now a highly profitable business and highly profitable businesses are the sorts of businesses to own. But what should you pay for it?

To value a company, we need to know a few things. How much is reasonable to expect the company to earn on its equity going forward? What will be the equity going forward? And what will be the policy for the distribution and retention of earnings? In other words, what portion of its earnings will the company pay in dividends?

The company earned $109 million on beginning equity of about $300 million. That is a return on equity of 36.3%. If we assume the company and its management earn another 30% next year, pay half out as a dividend, and if we assume that we require a twelve percent return, the business is worth about $2.4 billion.

But there’s a catch, the company will not earn 30% on its equity, particularly if its equity keeps growing as half the profits are retained. In reality, if the company kept retaining profits, the equity would rise and the return on equity would fall. As the business matures, it will have to pay an increasing proportion of its earnings as a dividend.

Now that probably means that the business’ value will not grow significantly after about three to five years.

Investors who are considering buying shares in the float need to consider what the true value of the business is and what it will do in the future. And also keep an eye on how much goodwill is added to the balance sheet and how much tangible equity is taken out prior to the float.

By Roger Montgomery, 17 September 2009

by rogermontgomeryinsights Posted in Consumer discretionary.

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It seems the profits to be made by TPG on the re-listing of Myer will be outsized beyond what has been reported thus far. When a TPG-led consortium purchased Myer and the Bourke Street store, they paid $1.4 billion. Of that total, just shy of $450 million was equity – the contribution by the new owners and $1 billion was debt. Here’s the interesting part… in the first year of ownership, the owners held what you might recall was a massive clearance sale. They also sold the Bourke street store. The sale of the store netted around $600 million and the clearance sale, about $160 million. With the excess cash generated by these activities, the owners received a dividend of almost $200 million and a capital return of $360 million and hey presto, the owners bought Myer and got all their money back in the first year effectively buying Myer for nothing! Whatever the company lists for, subtract a billion to pay down the debt (assuming Myer is listed debt free) and the rest goes straight to the vendors – an infinite return on equity. What will be even more intriguing is whether the company is IPO’d with any debt. The more debt left on the balance sheet, the more of the float proceeds go to the vendors and remember they bought Myer for free.

By Roger Montgomery, 9 September 2009

by rogermontgomeryinsights Posted in Consumer discretionary.

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