Woolworths exorcises ghosts with in2food purchase

Retailer Woolworths is haunted by the ghost of deals past, with its R21.4bn purchase of Australian department-store chain David Jones in 2014 still an era-defining misstep. 

Its share price today of R52 remains nearly 30% below the R73 a share it was sitting at when then CEO Ian Moir announced the David Jones purchase 12 years ago.

Much has happened since: for one thing, Moir was replaced by Roy Bagattini, who then sold David Jones for 93% less than Woolworths had paid. And in the past two weeks, Bagattini surprised everyone by announcing his own exit.

Deal-making, in other words, hasn’t historically been a strong point of the Woolworths investor proposition. So you can imagine that hearts must have been very much in mouths at its head office in Longmarket Street in Cape Town yesterday, when Bagattini announced his own swansong deal: the purchase of food manufacturer in2food. 

In an interview with Currency, Bagattini would not reveal how much Woolworths will be paying, but while in2food isn’t exactly small fry, the price is unlikely to break the bank. 

In2food generates R5bn in revenue per year, and runs the largest fresh-food manufacturing facility in the southern hemisphere. And, importantly for a business scalded by previous deals, Woolworths knows in2food intimately, since it has been supplying most of the retailer’s fresh convenience food for some time already.

Is this the best use of capital for Woolworths?

“We are always looking at how we can strengthen our moat, and what we do either defensively or offensively to do that,” Bagattini responds. “And this does meet both of those types of requirements.” 

As far as the defensive rationale goes, Woolworths is buying the security that no rival could poach its primary supplier. “It would be very negative if in2food was acquired by a competitor such as Checkers,” says Shane Watkins, chief investment officer at All Weather Capital. 

On the offensive side, Woolworths says it will get access to new food science technology, new product development schemes that will improve the business, and intellectual property when it comes to fresh convenience foods. 

Bagattini says this is ultimately about making Woolworths’ supply chain more seamless, to improve the customer experience. A more efficient process will allow Woolworths to “reinvest back into things like price and make things more accessible”, he says.

The M&S connection

While Bagattini provides no details of the price paid, nor how profitable in2food actually is, he claims that in several areas the business is even more successful than Woolworths.

“The margins that in2food sells its products at are higher than the margins of our food business. The earnings that they make on a percentage basis [are] higher than our food earnings on a percentage basis, and their price-to-earnings ratio is lower than that of our business.”

Well, you would hope so, given that Woolworths’ price-to-earnings ratio exceeds 18 – making it relatively expensive compared to its peers.

He says that Woolworths will now “capture all the margin” of the in2food products it sells in store – a welcome cash boost for Woolworths. And in2food’s management will continue to lead the business as a standalone operation within the stable.

Oddly, Woolworths says it is eager to also grow the non-Woolworths based revenue of in2foods. This might seem antithetical to the idea of strengthening its moat, but Bagattini dismisses the worry: “The non-Woolies revenue here is primarily non-competing, so it’s not really an issue.” 

As it is, in2food gets about 80% of revenue from Woolworths, but it has a well-established offshore market too, including some household names in the UK.

“Marks & Spencer are one of their biggest offshore customers, and there are a couple of big retailers in the US and one or two in Europe. So [there are] really exciting prospects for growth there,” says Bagattini.

While Bagattini seems confident in the deal, it is also true that Woolworths continues to be dogged by challenges relating to shoddy acquisitions, beyond just David Jones.

Another Australian company it bought, Country Road, still looks to be in the casualty ward, reporting a pre-tax loss of R1.89bn for its most recent financial year. Efforts are under way to “reset” Country Road, but it’s clear there is still a way to go. 

But Watkins says this in2food deal has a higher chance of success. “The probability of an in-market acquisition being successful is just multiples higher than an offshore expansion,” he tells Currency. 

This one is far safer than David Jones and represents a last hurrah for Bagattini. 

“It is a very derisked transaction,” Bagattini acknowledges, noting the safety of the Woolworths’ food division, as well as its 30-year relationship with in2food. 

Watkins says the only real risk is that corporate ownership could dilute in2food’s entrepreneurial culture. “But overall, I’d say this is a good strategic acquisition that makes sense,” he says.

Bagattini says he’d like to get the deal sealed as soon as possible, but this all depends on when it gets approval from the Competition Commission. “That usually takes a couple of months,” he says.

He might not get to see the in2food deal through to the end before he leaves, but this transaction is unlikely to leave any sour taste in anyone’s mouth later. 

Evidently the market believes so too. After announcing this deal, Woolworths’ stock rose 0.1% – a far cry from the 7.6% plunge that ensued back in April 2014 when it announced the David Jones purchase. The market wasn’t wrong then.

ALSO READ:

• Packing his bags: Behind Bagattini’s surprise departure
• Is Woolworths back on the front foot?
• Battle of the grocery gourmets

_{Top image: Rawpixel/Currency collage.}