Steinhoff recently announced its intention to purchase the outstanding shares of London-listed discount retailer group Poundland. Steinhoff acquired 23% of the issued shares through the market, which in turn forced it to acquire the rest of the issuance shares (76.4%) by law.
Steinhoff is offering shareholders 222 pence a share (which includes the two pence dividend per share payable on 23 September 2016.) This is a premium of 40.3% to the price the day before it bought its first 15% stake from Warburg Pincus (a private equity venture.) This was Steinhoff’s third attempt and first successful bid to acquire an offshore business since listing on the German DAX stock exchange early December 2016.
Poundland management has recommended the offer to its shareholders for approval, which will become effective by mid-September 2016. The total consideration for the shares in issue is around £597m. This deal still falls on the smaller scale for Steinhoff as it only makes out 3% of the company’s £18bn market capitalisation. The profitability perspective is that it will add ~3% to Steinhoff’s current earnings.
Steinhoff raised capital through a €1bn convertible bond issue at a coupon rate of 1.25% in April this year. This was with a net debt to equity ratio of 17.7 times at the end of February 2016 (the ratio over 50 times when Conforama was bought in 2011.) Steinhoff is in good standing for further acquisitions and possible further corporate action will not be a surprise.
Brexit played into Steinhoff’s hands with the resultant 14% depreciation of the sterling against the euro, which I believe provided the sweetener that enabled it to make the offer at a premium to the Poundland-traded share price. On the other hand, Steinhoff management has made it clear it does not pay for synergies and has walked away from transactions when it felt the price was not right. In the case of Darty, a French electronic wholesaler, Steinhoff was in a bidding war against FNAC but succumbed when FNAC raised the bid price for the third time. Steinhoff recently sold its stake in Darty for a €40m profit – not a bad deal having being invested for just over four months. Recently some activist hedge funds acquired shares in Poundland (13%) - with the hope to unsettle the apple cart for a higher bid price.
Steinhoff has always been superior in purchasing distressed assets or quality assets at distressed prices during the downturning cycles. The company uses relatively inexpensive capital and then adds value to these businesses by utilising synergies with business within the current Steinhoff portfolio. This is very similar to Poundland’s strategy in its acquisitions of 99 pence, a distressed UK discount retailer for more than 250 stores. Poundland is currently converting those acquired stores into the Poundland brand.
The combined purchasing power provides stronger bargaining power and harmonisation in buying terms, with Poundland as the larger of the two businesses having better cost prices and buying terms. The low-cost discount retail business is based on increasing sales volumes rather than price, complementing Poudland’s strategy of a large footprint in its stores across the UK and Europe. With the potential to successfully enter the Spanish markets, Poundland management envisages achieving the 1,300-store mark by end of 2017. In fact, when Poundland listed in 2014 at £3 per share, it was half the size it is today, while the price today is 27% lower.
Within the Steinhoff stable, one would believe this deal would be a great opportunity for Pepco, a very successful Eastern European fast-growing and cash-based discount retailer of clothing and housewares, to enter the UK market and possibly even Spain and Ireland. Poundland’s current business model is focused on fast-moving goods and about 30% on foods, which could complement the businesses.
Steinhoff has been one of SPW’s core investments in clients’ portfolios for over three years and it has become a true stalwart by returning in excess of 300% since 2012 (if all dividends and rights issues have been invested.) We maintain a positive view on the business. Although we are cognisant that it’s trading at a slightly higher valuation to its European peers, this is probably justified, as it’s consistently gained market share across all of its European businesses and management has been able to improve the profit margin year after year.
We believe that with its strong balance sheet, Steinhoff will be looking at expanding the business even further and possibly could be looking at other geographic areas as potential targets. Another potential value-add for the share price in the near future is to be included in the DAX 30 in Frankfurt. Steinhoff is already included in the MDAX index, and is currently the 25th largest listed company on the DAX in terms of market capitalisation. Trading liquidity restraints have thus far prevented it from being included in the Top 30, and it’s currently in 58th position on the stock exchange. The reason for this is that most of its traded script is still held in South Africa. The opportunity to increase its offshore liquidity can be improved with further expansion into overseas markets.
Steinhoff offers a great rand hedge opportunity for South African investors as more than 75% of its earnings are derived outside of South Africa. Management needs to be credited for its ability to build the business and gain market share in tough market conditions at times when consumer spending has been under pressure. As long as management is not paying too much for acquiring other businesses, it looks on track to becoming a giant within the global integrated retail space.
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