Myer plans to sweeten David Jones merger offer
Myer is considering ways to sweeten its A$3 billion ($3.2b) ''merger of equals" proposal for David Jones by taking on debt so it can offer cash as well as shares, The Australian Financial Review reports.
The department store chain has the capacity to borrow about A$500 million ($534m) after reducing its net debt to A$230m and cutting gearing to about 20 per cent in the past year.
Offering cash and shares would help Myer overcome one of the biggest hurdles to a deal: the widening gap between the companies' share prices.
Myer originally offered 1.06 of its shares for every David Jones share when it approached the David Jones board last October with a nil-premium merger of equals. The deal would have given shareholders of both companies an equal share of the combined group.
Myer shares have fallen 14 per cent to A$2.29 ($2.45) since last week, when it released disappointing first-half profits and warned earnings would fall further in the second half.
David Jones shares have fallen about 5 per cent to A$3.17 but remain well above the A$2.71 when first approached by Myer. Myer shares are now trading at a big discount to David Jones - a multiple of 12.2 times 2014 earnings compared with 18.8 times for David Jones.
Myer would have to lift its offer to at least 1.4 shares for every David Jones share to match its target's current value.
But if a merger proceeded on these terms Myer would have to forfeit some of the benefits and Myer shareholders would emerge with a smaller stake in the combined group. This could be unacceptable to Myer shareholders and the Myer board.
However, Myer has not lost hope and has been discussing the merits of the merger proposal with investors in Sydney and Melbourne over the past few days.
Myer and its advisers are working on new ways to structure a merger, including augmenting scrip with cash or hiving David Jones's A$600m property assets into a real estate investment trust so the two companies' retail assets are valued more equally.
David Jones has taken further steps towards pursuing merger talks, appointing Macquarie Capital as its investment banking adviser to work alongside long-term advisers Gresham Partners to assess Myer's proposal.
Macquarie was joint lead manager with Goldman Sachs on Myer's initial public offering in 2009 but has not advised Myer since the float.
Last week David Jones appointed management consulting firm Port Jackson Partners to assess the potential savings of a merger and weigh them up against the value created if David Jones continued to implement its strategic plan as an independent company.
Crunching synergy numbers
Myer has estimated the synergy benefits may be worth A$85m a year within three years - creating A$900m of incremental value that could be shared equally by shareholders of both companies.
But David Jones, which has crunched the numbers on a merger several times in the past, believes the synergies could be less than A$85m a year.
Last week David Jones chief executive Paul Zahra said a merger evaluation in 2011 found the synergy benefits would be "broadly half" the A$85m estimated by Myer but conceded the 2011 model was out of date.
Myer opened the door to a revised offer last month, prompting David Jones to reconsider the proposal.
Myer's cost base is about A$1b a year and David Jones is about A$600m.
The estimated savings - from merging head office functions, closing overlapping stores, harmonising trading terms, merging supply chains and consolidating procurement - would represent just 5 per cent of total costs.
Myer has told fund managers that only 22 per cent of Myer's and David Jones's product range overlaps.
A merger would enhance competition, enabling Myer to focus on mid-market customers and David Jones to chase wealthier consumers interested in premium international and national brands.
Analysts, however, are increasingly sceptical Australia's premier department store chains will merge, particularly after the release of first-half results that suggest David Jones is outperforming its larger rival.
"We struggle to see Myer paying any more than the current share price, which creates a challenge for David Jones shareholders as it may not be a sufficient control premium," said Citigroup analyst Craig Woolford in a report last week.
UBS analyst Ben Gilbert said a merger has merit, considering the challenges facing the department store sector and the size of the merger savings.
"But it would be difficult for Myer to make the deal attractive for shareholders given the premium it would need to pay," he said.
Myer chief executive Bernie Brookes declined last week to comment on what premium Myer would be willing to pay.
"We are not negotiating price through the media," Brookes said.
"If and when we get the opportunity to sit down with David Jones then that's the sort of discussion we'll have,"