Supermarket wars - coming soon to a counter near you

Friday 10th August 2001

The future of Woolworths New Zealand's 81 supermarkets will be decided within the next month. While the Commerce Commission has stood back from the action consumers have more than a passing interest in the outcome.

The next stage of the process will take place on Monday when the Court of Appeal considers Foodstuffs' attempt to stop Foodtown operator Foodland Associated Ltd (FAL) from buying WWNZ, thereby turning a three-player market into a two-player market.

The court will consider whether the High Court erred in upholding a Commerce Commission decision to allow FAL to bid for WWNZ.

Shoeshine isn't sure what arguments Foodstuffs has put forward but its position doesn't look too hopeful.

Foodstuffs' position is that the commission should have considered FAL's application under the new Commerce Act rules, not the old ones.

The new Australian-style rules shift the competitive analysis of takeovers from "gaining or strengthening dominance" - which an FAL/WWNZ merger clearly wouldn't do, with Foodstuffs holding 55% of the market - to a "substantial lessening of competition" test.

The new rules make it much harder for the second- and third-ranking players in a market to merge. Even so, competition lawyers reckon FAL would have a pretty good chance of getting a merger through under the new rules.

In any case the appeal court won't be revisiting the issue of which rules should have been used, just the way in which the High Court hearing was conducted.

The commission received the application while the old act was in force, therefore it considered the application under the old act. Although the act's introduction date was more or less arbitrary it's hard to see how the commission could have justified acting any other way.

Even so the decision hasn't been a good one for the consumer, whose interests would undoubtedly be better served by the current three-player market than by the "cosy duopoly" Macquarie Equities foresees if FAL buys WWNZ.

In a research paper reported last week by the Australian Financial Review Macquarie analyst Martin Duncan argued a second WWNZ suitor, Woolworths Australia, should stay at home.

His argument, as reported by the AFR, is that "if Woolies buys its namesake the result is a three-way tussle in a mature market that will result in margin pressure and sub-optimal returns."

This, of course, is the status quo and it's not clear why Macquarie thinks a three-player market with WWA owning Woolies NZ will be any more competitive than a three-player market with Dairy Farms owning Woolies NZ.

WWA boss Roger Corbett's interest in the local group is explained by the simple fact that WWNZ is profitable - much more profitable, in fact, than FAL's New Zealand operations - and is considered by the industry to be well-run. So if WWA wins the bidding it's hard to think why it would want to make big changes.

Cosy duopoly or three-way tussle, both groups have been losing ground to Foodstuffs in recent years.

According to Coriolis Research the three Foodstuffs companies' market share grew by more than 7% between 1995 and 2000 while WWNZ shrank by 7% and FAL's local unit lost 2%.

FAL's submissions to the commission argued Foodstuffs' market share could grow to 70% if clearance to buy WWNZ was declined.

A further reason for Roger Corbett to stay home, the AFR speculates, is that WWA would have to raise capital to fund a WWNZ acquisition.

WWA reports for the June year on August 27 and the market will get a better picture then.

But it's not clear the company will have any problems funding an acquisition.

The AFR argues the ratio of debt to equity is 64% and will rise to 110% when it settles the $A229 million ($286 million) purchase from Dairy Farms International of 67 Franklins supermarkets and a couple of warehouses.

But those gearing figures depend on how you treat the $A583 million ($729 million) of "Woolworths Income notes" sitting on the balance sheet.

The notes are "quasi-equity" perpetual instruments with no maturity date.

The noteholders are entitled to interest payments at 2% above the 90 day bank bill rate, provided the money's there. And their entitlement ranks ahead of ordinary shareholders' right to dividends.

It's unclear how this arrangement will appear to bankers' eyes if WWA does want to raise further capital. If the notes are quasi-equity they're also quasi-debt and the AFR reckons WWA's bankers will see them that way and insist more equity is raised to fund any WWNZ bid.

Even if the banks think the notes are "gearing" it's still unclear WWA needs fresh capital to mount a bid. Lenders tend to judge a company's creditworthiness less on a crude measure of debt-to-equity than on the number of times free cashflow covers interest payments.

According to the AFR this ratio is still a healthy seven to nine times.

WWA can well afford it. Now it's down to who'll pay the most.

FAL has the synergies so on the face of it it will be in a position to bid more for the asset. But WWA will presumably find some synergies too.

In the meantime WWNZ's owner, Dairy Farms, is in no hurry to sell.

The local chain has officially been taken off the market but it's understood J P Morgan has been appointed to talk to interested buyers - rumoured to include Britain's giant Tesco chain - and conduct a limited tender.

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