KEY POINTS:
Supermarket giants Foodstuffs and Woolworths will today go head to head with the Commerce Commission in the High Court at Wellington, appealing a decision barring either from taking over discount chain The Warehouse.
In June the commission said if either Woolworths or Foodstuffs bought The Warehouse it would harm competition and strengthen an existing supermarket duopoly.
But the supermarkets will argue that company's grocery strategy, which so far consists of three underperforming Warehouse Extra stores, is hardly competition.
Key in the appeal process is whether the removal of present competition at the three existing Warehouse Extra sites and potential competition at future sites can amount to a substantial lessening of competition.
Market watchers say it will be tough for the Commerce Commission to prove that The Warehouse ever intended to be anything other than a bit-player in the grocery market.
One observer, who asked not to be named, said The Warehouse simply did not have the scale to compete against the two dominant players.
Foodstuffs has about 56 per cent of the grocery market, Woolworths 42 per cent and The Warehouse 2 per cent.
"To win 10 per cent of the grocery market, The Warehouse would [have to] risk drowning the rest of its operations in losses."
The company would have to allocate at least one third of all its floorspace solely to grocery, he said, or convert some stores completely to groceries.
"That's not a strategy they'll take because their underlying business is general merchandise. [Introducing groceries was] a way of increasing foot traffic and helping drive the business."
Some stores, such as the Newmarket outlet, were surrounded by carparks and streets making expansion "impossible".
The Warehouse would not expand upward, the observer said, because shoppers preferred single-floor shopping, unless in a mall.
In August The Warehouse also appealed the commission's decision, indicating it has taken the supermarkets' side. It will have to explain to the court its grocery strategy and whether it intended to become a major player.
It has already indicated it did not.
Chief executive Ian Morrice said at the group's annual meeting in September that the Whangarei Warehouse Extra store had proved a disappointment and that the company shelved plans to rollout the rest of its planned 15 Warehouse Extra stores.
The supermarkets, both of which snatched a 10 per cent stake in The Warehouse this year, will also have to show that by buying The Warehouse, consumers will benefit.
To do that it could point to Australia where the two dominant players, Coles and Woolworths Australia, have performed well and consumers have benefited from the supermarkets' growth by getting economies of scale.
The Commerce Commission is expected to argue that there is limited scope for the supermarkets to grow organically in New Zealand because new sites will be hard to find, and resource consent tough to get.
The Herald understands that any new information, such as that The Warehouse Extra stores were not performing well, can be introduced to court, but if the decision goes to another appeal, no new information can be introduced. This means each party will be offering extremely detailed submissions.
Investment director of Macquarie Financial Services Arthur Lim pointed to a similarity between this case and one in 2001 when the commission rejected Progressive's bid for Woolworths New Zealand, then owned by Hong Kong's Dairy Group International. Progressive subsequently won its appeal.
This time the commission has said that until The Warehouse started its grocery offering last year there had been no new player in the market in 20 years, and Woolworths and Foodstuffs had operated in a duopoly. The Warehouse was "uniquely placed" to compete with the two supermarkets because of its property portfolio, extensive distribution networks and established brand. Of the two supermarkets, Woolworths is seen as the more likely buyer.
In June last year Foodstuffs bought 10 per cent of the Warehouse for $5 a share, but the move was viewed as purely defensive.
In September founder and 51 per cent owner Stephen Tindall announced plans to privatise The Warehouse by buying out the other shareholders in a scheme backed by Australasian Pacific Equity Partners. The $5.75 a share Tindall said he would offer was widely seen as a low bid.
Two weeks later Woolworths killed off the Tindall offer by paying $6.50 a share for 10 per cent of the group in an overnight raid.
The appeal will be heard by Justice Jillian Mallon and is set for nine days. Due to its commercial importance the decision is expected to be given priority over other judgments.
Most market observers canvassed expected the losing party to appeal, meaning the issue could drag on for months.
THE APPEAL
* Woolworths (Progressive Enterprises) and Foodstuffs are appealing the Commerce Commission's June decision rejecting their applications to take over The Warehouse.
* The Commerce Commission said a takeover would strengthen the supermarket duopoly.
* The supermarkets will argue The Warehouse's grocery strategy - Warehouse Extra - is no competition.
The Warehouse
* Has 85 big box outlets in New Zealand, three of which are Warehouse Extra stores.
* 43 Warehouse Stationery shops.
* The Warehouse annual sales account for 8 per cent of all non-food retail expenditure in NZ.
* Is the third largest retailer in New Zealand, behind Foodstuffs and Woolworths owner Progressive Enterprises.
Foodstuffs
* Owns New World, Pak'nSave, Four Square.
Progressive
* Owns Woolworths, Foodtown, Countdown.
WORKING OUT THE ODDS
Citi Investment Research is giving Woolworths and Foodstuffs a 75 per cent chance of being successful in their appeal.
In a research note released last week the analysts break down the odds on the future of The Warehouse. They give a 56 per cent probability one of the supermarket chains will buy The Warehouse at a price of $6.60 to $7.10 within six months.
And they see a 33 per cent chance that an unsuccessful appeal will be followed by a new initiative from Stephen Tindall to take the company private. That will see him buy out the company at a price of $5.85 to $6.35 within six to nine months, the note suggests.
The prospect that a status quo is maintained gets an 11 per cent chance. That would mean unsuccessful appeal and no new Tindall initiative with the shares being worth $5.14 within 12 months.
Factoring in the odds on all three outcomes, Citi gives a weighted average target price of $6.40. The shares closed on Friday at $5.45.
