Property dilemma complicates Woolworths’ escape from Masters

There is an interesting tension between Woolworths’ desire to minimise the losses flowing from its exit from the disastrous Masters home improvement joint venture with its partner Lowe’s of the US and the longer term implications for its continuing businesses of how it manages that exit.

The fate of the Home Timber & Hardware business isn’t of particular concern, given that Woolworths is withdrawing from the home improvement sector after Masters racked up about $1 billion of operating losses.

Woolworths has provided for impairments of the value of the Masters business and its inventories of $1.9bn, with a further $1.3bn of provisioning for the cost of breaking leases and other costs associated with closing down the Masters store network and dealing with the property portfolio.

The simple objective of the liquidation process will be to maximise the sale price, as well as to extract as much value as possible from the hundreds of millions of dollars in inventory associated with the business. Metcash is the obvious frontrunner, albeit perhaps not the only interested party, for the Home Timber & Hardware business, given its existing Mitre 10 operations.

Of greater potential consequence is how Woolworths deals with the properties within the Masters business and the 63 stores that it either owns (about 39) or leases.

That’s a more sensitive issue, with long-term strategic implications, and one that is complicated by Woolworths’ inability, so far, to be able to agree the terms of its original plan to buy Lowe’s out of the joint venture.

When Woolworths announced the closure of Masters early this year, after the partners had invested more than $3bn in the failed attempt to compete with Wesfarmers’ Bunnings business, it said Lowe’s had exercised a “put” option it held over its one-third share of the joint venture and that it would then exercise its own “call” option over Lowe’s stake to ensure it could maximise the value recovered from a sale or liquidation of the home improvement operations.

Despite a lengthy and quite structured attempt to agree the value of Lowe’s interest, which analysts have estimated at anywhere between $500m and $1bn, the partners have yet to agree a price even though Woolworths said in its third-quarter sales update earlier this month that Lowe’s remained supportive of the sale and had indicated it would do all it reasonably could to facilitate it.

While Lowe’s remains in place within the joint venture, Woolworths has an obligation to extract the highest possible price for all its assets, which is where the potential complications in how it disposes of the property portfolio lie.

Woolworths has been garnering expressions of interest in both the home improvement operations and the property portfolio and is reported to have now short-listed the group of prospective buyers.

If obtaining the highest price weren’t the only consideration in the process, Woolworths would balance the potential value it could receive against the likely destinations of the underlying properties and what that might mean for its food, liquor and Big W discount department store operations.

The biggest barrier to new entrants and to expansion in Australian retailing is access to suitable sites. The Masters sites represent a large portfolio of very large “big box” format sites across the country and therefore a unique opportunity for either existing retailers or aspiring entrants.

Bunnings has made no secret that it would like to get its hands on 15 of the sites. Harvey Norman is interested, as is Super Retail Group. While it might prefer not to see Bunnings expand its footprint and strengthen Wesfarmers’ businesses, Woolworths probably wouldn’t feel too threatened by those groups.

It mightn’t be quite as comfortable if key sites are acquired by Costco, or Aldi, or giant South African group Steinhoff, or Ikea or any new entrant whose offering might overlap with elements of its own continuing operations. It would be even more anxious not to see sites acquired by Coles or Kmart.

If it had full control of the Masters liquidation it would be able to trade immediate value against the longer term implications for its own businesses, sacrificing value today to protect its core franchises’ futures by ensuring that key competitors weren’t given the opportunity to turbocharge their growth.

But, in the absence of an agreed deal with Lowe’s, it has a fiduciary and moral obligation to its partner to maximise the value generated/minimise the losses from the liquidation of the home improvement businesses.

How the Masters’ portfolio is dealt with has the potential to subtly but meaningfully alter the shape of the big end of the Australian retail sector, depending on who ultimately gets their hands and their brands on which sites. It will be fascinating to see how Woolworths manages, or doesn’t, the outcomes.