The Warehouse drops its swag

Ian Morrice

A five-year foray into Australia will leave The Warehouse with little to show for it but a sense of relief, after the company yesterday struck a deal to sell its Yellow Sheds for A$92 million ($98 million).

Shedding the troubled operation will force The Warehouse to write off a further $80 million to $90 million this year - the difference between the price received and the operation's recorded value - while the proceeds are earmarked to pay off about A$80 million in debt linked to the Australian operation.

Warehouse chief executive Ian Morrice said the impact of the transaction was "fairly neutral". But that had to be set against the cost of remaining in Australia.

"We'd have to spend probably in the order of $100 million more of investment in Australia over the next few years to get the scale required," said Morrice.

It's a far cry from the discount retailer's high hopes in 2000, when it announced the purchase of 115 Clint's Crazy Bargains and Silly Solly's stores for A$105 million. In the end, adjustments for items like working capital meant The Warehouse paid $114 million, plus around $35 million of debt.

Initially, the discount retailer said Australia would contribute 30 per cent of its profit within three years. Instead, the operation reported a string of losses culminating in a $37 million blowout in the 2004 financial year, making a small operating profit just once in 2002.

It is believed to have invested a total of more than $200 million into the business during its five years of ownership.

"You just have to look at the numbers to conclude that clearly we haven't had an acceptable return on those investments," Morrice said yesterday.

Last month, he predicted the unit would break even this year, having narrowed its operating loss to $5.8 million in the last financial year. But the deal - a joint sale with the discount variety operations of rival Miller's Retail - will instead see it handed to private equity firms Catalyst Investment Managers and Castle Harlan Australian Mezzanine Partners.

The $98 million price-tag is still likely to be a bargain if those buyers can bring the business closer to its full potential. Earlier in November, Deutsche Bank analysts estimated the Yellow Sheds had a value of about $180 million at their full potential - although they thought it would sell at a discounted $90 million.

The write-off taken by The Warehouse doesn't include losses the business may make before it is handed over. But Warehouse chief financial officer Luke Bunt said the result for the four-month period would be an improvement on the comparative period, although he would not give more details.

While the possibility of the sale has been supporting the share price of The Warehouse since it confirmed discussions with Miller's in June, they still fell on the news. Initial gains were quickly eroded with the shares finally closing 5c lower at $4.04 each, having traded as low as $3.93 a share.

ASB Securities head of advisory Stephen Wright said it was a "buy on the rumour, sell on the fact" reaction.

"They didn't quite get the $100 million so after the initial euphoria it became a 'so what' announcement," he said.

But analysts welcomed the sale.

"This is the removal of a massive millstone from around The Warehouse's neck," said Macquarie Equities retail analyst Warren Doak. "The price is not really even in the equation: they're getting out for strategic reasons."

He said some might not have understood what the consequences would have been if the company had remained in Australia.

"A year ago we would have all clapped if they had walked away and written off hundreds of millions of dollars," he said.

Instead, Morrice and Warehouse Australia boss Ian Tsicalas had turned the operation around and brought it close to profitability, ensuring they recovered some value.

Doak said it was hard to quantify the upside, because it was strategic: the board and management would be able to focus on growth rather than spending time on a business losing money.

Morrice said growth plans would unfold over the next few years. "The reality is we have got just over 4 per cent of total retail spending, including food but excluding cars," he said.

"When you look at the market like that and when you consider we have got a first-class store base in The Red Sheds ... you've got to conclude there are significant opportunities for growth."

The company's initial focus will be on extracting better returns and greater sales from existing New Zealand stores by bringing customers in-store more frequently.

The company has already said it intends to launch stores with full grocery offerings at the end of next year and plans to sell liquor.

Morrice said the company had already seen good responses from customers having improved its advertising and introduced a wider range of products including more upmarket, branded goods. That had been evident in apparel and homeware sales.

"We only began this strategic journey in March and we're eight months into it. We're pleased with the progress we are making but we have a long way to go," he said.

Surprisingly, the Australian experience hasn't put Morrice off overseas expansion - in time.

He said the company had made a mistake trying to replicate its New Zealand model of stand-alone, big box stores, in an Australian environment favouring mall-based shopping.

"I think at some point in the future we may well consider expanding again beyond New Zealand.

"I think any market beyond New Zealand needs to remain on the agenda in future, including Australia." 

  
Counting the cost 

*The Warehouse has sold its Australian operation for $98 million.
*It paid $114 million, plus $35 million of debt for the business in 2000.
*The discount retailer is believed to have poured more than $200 million into its Australian foray.
*In September, The Warehouse wrote $33 million off the value of its Australian business.
*It will write off up to another $90 million in this financial year, as the price achieved was less than the book value of the Australian business.