On the Watson trail: The case for Pacific Retail Group!

By FRANK FERNANDEZ

Sunday 21st May 2000

Eric Watson

The pearl in Eric Watson's stable of companies must surely be his Pacific Retail Group for it was only last year that the mercurial acquisition/merger maestro turned down a $1.60-per share offer for his 63.4% stakeholding in PRG - a deal which would have netted him a quick $10 million had he taken it.

Watson's shareholding is held through his Logan Corporation while other PRG majority shareholders include New Zealand Central Securities Depository (15.2% - of which AXA holds 12%), Platinum Retail (8.6%) and Gordon Marketing Ltd (3.3%).

With only a meagre 9.5% held by 'small' investors (with shareholdings ranging from 400k down), it is therefore not surprising there is hardly any daily movement in this stock but by the same token, volatility is pretty non-existent too.

The biggest 'plus' for small investors, intuitive enough to buy into PRG, must however be the potential capital gains that can be expected when Watson's inevitable expansion plans for this last jewel in his crown is announced to an expectant marketplace.

PRG, made up of Noel Leeming, Bond & Bond and Computer City, is New Zealand's largest appliance retailer with sales of nearly $400 million a year. Sitting on the PRG Board of Directors are Eric Watson, Maurice Kidd, Nick Gordon, Mark Hotchin, Jock Irvine, Richard Reilly and Stefan Preston.

Under former Whitcoulls head, Stefan Preston, PRG's sales and margins have improved out of sight - so much so that the company will announce an expected pre-tax profit of around the $14.5 million mark in the next few weeks. In its last third quarter results, PRG announced a staggering 163% increase in profit.

Preston reminded investors recently that the market must not lose sight of the fact that traditional businesses are still expanding in New Zealand at an encouraging rate. Data from Statistics New Zealand shows that the retail sector swallowed more than $41 billion of consumers' money last year - a $2 billion increase on the previous year.

For the purists, here are some of the fundamentals on PRG:

KEY DATA
Market capitalisation	$77 million
Shares issues	45 million

EARNINGS FORECAST	2000	2001	2002
Profit ($million)	6.9	8.0	8.5
EPS adjusted (cents)	15.4	17.8	18.9
EPS growth (%)	19.1	15.5	6.1
PE ratio	11.0	9.6	9.0
PE ratio relative (%)*	76.5	76.1	65.3
DPS (cents)	10.0	11.5	12.5
Net yield	5.9	6.8	7.4
Gross yield	8.8	10.1	11.0
Book value (cps)	92.2	98.5	105.3
Price/BV (%)	1.8	1.7	1.6
EV/EBIT	7.6	6.5	6.0
EV/EBITDA	5.0	4.5	4.2
EV/EBITDA Relative (%)*	64.4	63.2	56.9

*to core NZ market

Since Watson's acquisition of his major shareholding in Pacific Retail in early 1999, there has been considerable speculation as to how the company would fit into his overall investment plans. Analysts however believe that PRG would be transformed into a conglomerate of retail and financial interests.

Watson himself has reinforced expansion expectations by the appointment of his right-hand man and former finance director of the Blue Star Group, Maurice Kidd to chair PRG not so long ago, and also that of restructuring guru Greg Kay to his management team.

Sources close to the Watson camp believe that some of the potential acquisition or merger possibilities under consideration may include

Previously Watson-owned book chain Whitcoulls, part of the Blue Star Group, and which has been facing a tough year. Whitcoulls has recently been undergoing a revamp under Fran Stanley whose position has been redesignated as general manager of Blue Star consumer retail in internal restructuring.
This move has strengthened market views that the chain is for sale with some industry sources picking that it will be bundled into a retail group such as PRG. Analysts and company heads have conceded the possibility of the Eric Watson "mega-retail" grouping but say there is nothing official on paper. However Stanley herself has admitted that "It is a possibility."
Adding grist to the mill, Ord Minnett has said that a grouping would tidy up the technically inter-related affairs of the companies while divesting US Office Products of its retail Blue Star assets as it had signalled it would do last year. It would also capitalise on the growth of book sales on Flying Pig.
Watson himself has declined to comment on the possibility of a more formal grouping of Pacific Retail and Whitcoulls - a response many analysed as being indicative of an extremely likely possibility.
Farmers Deka whose share of all department store sales has dropped from 47% to 37% over the past five years. In the last nine months, Farmers Deka revenues have been dropping steadily and the company's group parent, Australian Foodland Associated, is concerned about the continued downslide.
Foodland's Managing Director Barry Alty is also a good friend of Watson and there has been persistent talk that Foodland itself could be the subject of a takeover and carve-up. To add to the jigsaw, Farmer Deka's head Wayne Waldren, who has been at the helm for many years now, has also indicated a possible move to greener pastures.
Should there be a merger of PRG and Farmers Deka, the new company would control nearly half of all appliance sales in New Zealand - a very tempting prospect indeed for Watson. Farmers Deka also has potential operating synergies with Pacific Retail through its Retail Financial Services arm.
The Hill & Stewart chain of which a buyout would add to PRG's overall retail appliance market share. The chain has some 12 appliance stores dotted around the North Island with an annual turnover of around $30 million but an operating loss of about $2 million a year.
Acquiring Hill & Stewart (or Farmers for that matter) would also give PRG access to an exclusive and much sought-after whiteware dealership arrangement with Fisher & Paykel. At present, PRG is denied the dealership arrangement which is only enjoyed in New Zealand by Hill & Stewart, Farmers and Harvey Norman.

While all indications are that PRG would eventually be turned into a conglomerate of retail companies, a concurrent and more immediate move is expected to be the grouping of Watson's financial interests under the PRG umbrella.

When Watson bought into Pacific Retail early last year, he made no secret of the fact that the company's then $130 million finance book was one of the main attractions. Prior to buying into Pacific Retail early last year, Watson and business partner Mark Hotchin bought a 30% stake in Elders Finance. Early this year, the pair took that to 100%. Hotchin, who himself holds an 8.6% stakeholding in PRG through Platinum Retail, was appointed to the PRG board of directors last September.

Elders Finance has assets of about $115 m, putting it just ahead of Marac. About 40% of its book is lent in the rural sector with most of the balance in commercial property. Over the past few years, Elders Finance has been achieving profit before tax of around $5 million annually.

It is Watson's expressed intention to double the size of the company which would then make it the ninth largest finance company in the country. An interesting aspect of those expansion plans is the intended move into consumer finance. PRG is already a well-established player in the hire purchase field with its retail finance book currently worth around $150 million.

Under the terms of the sale of Elders Finance to the Watson camp, the company can continue to use the Elders name for up to three years but will ultimately have to find a new identity and name. All of Elders Finance's funds are also sourced from retail deposits so it will have to move quickly to achieve a high profile for whatever new name is chosen for it.

Under such circumstances, a formal grouping of Elders Finance, Pacific Retail Finance and BSG Finance (financial arm of Watson's Cullen Investments) will be a mere formality - with PRG offering the ideal NZSE listing vehicle for this.

Already Watson has set in place the first of his expansion plans in the finance area through the establishment and listing (on the NZSE and ASX) of the Receivables Management Group (RMG) into the Frontier Petroleum shell.

As investors now know, RMG will be Australasia's biggest receivables management company and is currently valued as a NZ$122 million business. It will also be the first business to be operating on both sides of the Tasman to offer a range of receivable debt management and credit reporting services under one umbrella.

With Watson holding a 27% stakeholding in RMG through Cullen Investments, Pacific Retail Finance's receivables and credit information business (currently handled through Baycorp) will go to RMG.

In recent times, considerable publicity has been given to the appointment by Watson of high-profile restructurer Greg Kay to reshape his empire. Kay is there for an expressed purpose - to expand the Watson empire. Lately he has been putting the finishing touches to the transformation of Frontier into RMG - which will soon start trading on both the New Zealand and Australian stock exchanges.

Kay's next task will be to complete expansion work on the last jewel in Watson's crown - a restructured Pacific Retail Holdings Group which is expected to incorporate expanded retail and financial arms. The market waits with interest!

(Disclosure: Hold FRO and PRG shares)

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