Timing could not be better for API to revive merger talks with Sigma

API will be dealing with new leadership at Sigma as it seeks to revive merger plans and fend off a $687m takeover from Wesfarmers.

Sigma Healthcare chairman Ray Gunston is known as a pragmatic operator. Picture: Stuart McEvoy

Priceline owner Australian Pharmaceutical Industries faces one key difference as it seeks to revive merger talks with bigger rival Sigma Healthcare and fend off a $687m takeover bid for the company from Wesfarmers: the resignation of Mark Hooper.

API initially courted Sigma three years ago with a $727m takeover bid, which Sigma chief executive Mark Hooper firmly rejected, declaring he could deliver better value for shareholders by allowing him to pursue his growth strategy.

“We are economically rational people … if there is a logical deal for shareholders that is fine but it needs to be one where I put my hand on my heart and say I think it’s better to take an offer rather than continue with the existing business,” Mr Hooper said at the time.

“We just don’t feel that is what we have got at the moment.”

But now, as API seeks to drum up more value following its takeover bid from Wesfarmers, it faces a different Sigma board under new chairman Ray Gunston, who was appointed last year, while Mr Hooper is leaving the company in October after more than 11 years in the top job.

The timing could not be better for API to revive its talks with Sigma about a merger, which if successful would create a behemoth in pharmaceutical distribution, and bring leading pharmacy brands including Amcal, Guardian and Priceline under the one roof.

It is understood that Sigma’s board is open to considering such a merger, which would not doubt rattle Chemist Warehouse founder and richlister Jack Gance, who has built a pharmacy empire after exploiting a loophole in pharmacy ownership rules for years.

Mr Gunston is known as a pragmatic operator. He was chief financial officer at Tatts Group for more than 12 years, and after he left the organisation did not oppose its $11bn merger with Tabcorp four years ago, providing clear rationale, leaving emotion at the door.

“The consolidation of tote operators is long overdue -the historical structure of the

wagering industry is not optimally economic or efficient in the current wagering environment,” Mr Gunston wrote in a statement to the Australian Competition Tribunal in 2017.

“Indeed, Australia‘s federal system, whereby each state or territory government was responsible for legislating and regulating wagering and lotteries, produced a fragmented and ultimately inefficient model of state-based wagering products.”

Rob Scott’s Wesfarmers has deep pockets when it comes to the API bid. Picture: Colin Murty

As for Sigma, it is now in a stronger position than when API first approached the company, having resumed paying dividends after swinging back into the black in March, reporting net profit of $59.76m in the 12 months to January 31, versus a $12.33m loss the previous year.

The earnings result benefited from the first full year of Sigma resuming its contract with Chemist Warehouse, which Mr Hooper said “remains on track to achieve $800m” in annual sales.

Sigma had been weakened significantly when it lost a third of its revenue in 2018 after it ­walked from its exclusive pharmaceutical distribution deal with Chemist Warehouse, which Mr Hooper branded a non-profitable arrangement for Sigma’s shareholders.

Chemist Warehouse has since reinstated half of its contract with Sigma - and on better terms. Sigma’s shares have increased 21 per cent to 62c from when it rejected API’s initial takeover offer, but they’re still trading below API’s cash and scrip bid, which was worth 68.3c at the time.

Meanwhile, API’s shares, while surging from $1.14 to $1.38 - Wesfarmer’s offer price - in the past two days. The Wesfarmers takeover offer also overshadowed a trading update from API, which warned it would its full year earnings before interest and tax would fall by $1m a week if Sydney’s Covid-19 lockdown extended beyond this month.

While it did not take long for API’s shares to hit Wesfarmers offer price, the fact they haven’t edged higher is a strong hint that market thinks the retail and hardware conglomerate is the best bet.

On Monday, Wesfarmers chief executive Rob Scott revealed the company, which owns Bunnings, Kmart, Target and Officeworks, has enough financial muscle to expand into healthcare, citing the divestments of its mining operations, supermarket chain Coles and insurance division.

“We have more than enough capacity to have a new division to invest in and to focus on without distracting our other operations,” Mr Scott said, describing Wesfarmers bid for API as a “modest small investment”.

“But we think it could be a useful platform to grow over time and create value for shareholders.”

It also has secured the support of API’s biggest shareholder Washington H. Soul Pattinson and a call option in its 19.3 per cent stake in absence of a superior offer. And Soul Pattinson chairman Robert Millner said it was not out of the question that another bidder could materialise.

“We have to wait and see what happens. These things take many months to play out,” Mr Milner said.

He said he had no inside information on what Wesfarmers were planning to do with API but “they have a very good track record of running retail operations” which was shown by its former ownership of Coles as well as Bunnings, Officeworks and Kmart.

“You would have to support them,” he said.

He said Wesfarmers had been talking to Soul Pattinson “for a couple of months” NS Wesfarmers’ experience in retailing could help it improve the performance of API.

Mr Scott, meanwhile, fired a shot at other potential suitors for API, saying they would have to be a supporter of Australia’s community pharmacy laws, which restrict pharmacy ownership to pharmacists.

“Whoever has an interest in the API business would need to be a very strong supporter of the current community pharmacy regulation and we‘ve, we’ve looked at that in detail and we think is very much aligned with how we see the future of the business.

“We can‘t control what other offers might come forward. But as noted, the agreement we have with the major shareholder, and the option agreement, obviously, puts us in a strong position.”