Australia | Jul 02 2012
– David Jones receives unsolicited approach
– Flagship properties highlight gearing opportunities for an acquirer
– Structure of approach unclear
– Brokers remain cautious about value in David Jones at current levels
By Chris Shaw
Last Friday David Jones ((DJS)) announced it had received an unsolicited approach from EB Private Equity of the UK, valuing the department store group at $1,650 million. Details regarding the proposal are limited at present, to the extent Deutsche Bank notes it is unclear whether the value implied by the proposal is enterprise value or equity value.
In the view of Credit Suisse, David Jones offers the usual gearing opportunities to a financial acquirer. This reflects the potential of achieving full value for the group's flagship Sydney and Melbourne properties, which are on the books at David Jones at a combined book value of $460 million. This compares to Macquarie's estimate of market value of around $750 million on a cap rate of 8%, while Citi is more cautious and sees potential for the properties to achieve a price of around $600 million.
Achieving a good price for the properties would be a key to private equity creating value in the view of Credit Suisse, as the broker remains of the view there is downside risk to the sustainability of current department store earnings.
This reflects the expected negative impact of investing significant amounts in systems and operational changes over the next couple of years. In Credit Suisse's view such investment is needed as David Jones is currently uncompetitive when compared with online specialty peers.
A sale of the credit card business would also deliver some returns to any acquirer, as Citi values the business at around $250 million. One issue may be the joint venture with American Express, which could restrict any deal in Citi's view.
Another issue for Credit Suisse is the structure of the proposal, as it seems to require existing shareholders to maintain an interest in David Jones. The proposal implies existing shareholders will receive $2.27 per share for their existing holdings, while retaining $0.85 per existing share in the equity value of the new entity.
Deutsche estimates the internal rate of return from the proposal would be around 21% over a five-year time frame, which includes the benefits of property sales. This is not large in the broker's view given the structural and cyclical risks associated with Australian retail.
In contrast, Citi's model suggests a bidder could pay $3.00 per share for David Jones and achieve an equity internal rate of return of 25%. This factors in $850 million in asset sales and a recovery in underlying department store margins.
While Citi suggests the approach to David Jones is a signal of value in retail, it is also recognition of the particular attributes David Jones offers via the ownership of its flagship properties. This limits this element of appeal to David Jones and Harvey Norman ((HVN)) in Citi's view as both hold significant property assets.
On news of the approach to David Jones only Deutsche Bank has to date adjusted its rating, upgrading the stock to Hold from Sell. This reflects the fact the risk/reward appears evenly balanced at current levels, allowing for the uncertainty given no concrete offer for the company has yet been received.
The upgrade by Deutsche means David Jones is now rated as Buy once, Hold three time and Sell four times, with valuation the issue for those brokers retaining more negative views on the stock. The consensus price target according to the FNArena database has increased to $2.26 from $2.19.
Having rallied last Friday on news of the proposal shares in David Jones today are weaker in a stronger overall market and as at 11.15am the stock was down 15c at $2.44. This compares to a range over the past year of $2.10 to $4.14 and implies downside of around 6% relative to the consensus target in the database.
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