Is Foschini Group’s Jet deal the bargain of the century?

A lot has been made about TFG Limited’s rather public about-turn in its acquisition of (most of) Jet out of the business rescue process of Edcon.

This writer also questioned how TFG CEO Anthony Thunström could say publicly on June 18 that it had “no interest in any of those businesses [Edcon, Edgars or Jet] that don’t fit strategically with us” and then announce a deal not even a month later.

When pressed, Thunström did admit that the “Jet side of the business is probably the most attractive part of the Edcon group”.

“It does represent the value end. The reality though is both Edgars and Jet are tied together in a head office in Johannesburg with common IT, common infrastructure, common logistics, etc … To spend a lot of time trying to untangle a business in Johannesburg when we’re a Cape Town business … doesn’t seem to be a sensible risk to take or a good investment of our time and effort.”

What changed TFG’s mind?

Some suggested Thünstrom’s comments were a negotiating tactic, and perhaps they were. The truth, however, is that this deal was simply too good to refuse.

Tempting, but challenging

There were very few realistic buyers for these assets, despite the assertion by the business rescue practitioners that there were 15 “interested parties”. Interested parties do not a realistic buyer make. You can bet some private equity operators were among the 15.

But once any buyer saw the books and realised how entangled Edgars and Jet and (loyalty scheme) Thank U are, they would’ve soon realised they had neither the operational nous, working capital or – most importantly – stomach to try salvage all or part of the business.

It is telling that Retailability, which knows this business better than any other external party given its purchase of Legit in 2016, also said no to buying Jet.

It has cherry-picked only the most profitable Edgars stores (we’ll soon see which) from what’s left.

Here’s what TFG will be buying:

• The Jet brand;
• 371 commercially viable Jet stores;
• A distribution centre in Durban;
• Certain stores in Botswana, Lesotho, Namibia and Eswatini;
• Rights in and to the Jet Club;
• At least R800 million in stock; and
• “Certain head office staff and functions”.

The 371 store number is important, as this comprises only those South African stores that are profitable. The business rescues plan lists around 378 profitable stores, but there may have been some adjustment since.

TFG is also only buying certain stores in neighbouring countries. What’s more telling is what it’s not buying.

TFG will not be buying the at least 17 marginal Jet stores, including those in Centurion Mall, Cresta, Sandton City, Mall of Rosebank, and Tygervalley.

These are mostly far removed from the core Jet customer (at far higher rentals than they’ll be paying at Alex Mall, for example) and were really only opened in Edcon’s misguided chase to constantly grow its footprint at any cost.

The purchase also doesn’t include the at least 70 non-viable stores, or the 12 stores listed in the business rescue plan as those with “onerous leases” which were shut months ago.

It’s not touching the Thank U rewards programme, or the part of Edcon’s second-look credit book which pertains to Jet. Why would it? TFG has its own rewards programme and R9.75 billion gross debtors book.

Here’s what is likely to happen

The number one priority is to keep the 371 Jet stores trading and to keep them well-stocked. Leases are being renegotiated and form part of the conditions of the transaction.

A transitional services agreement is also being negotiated with the business rescue practitioners and this will make sure nothing “breaks” operationally. Here, TFG will pay Edcon for certain services rendered (think keeping the point of sale system running and so on).

The plan, surely, is to deploy its own point of sale system as rapidly as possible to ensure it can manage sales and inventory on its own backend. TFG Africa has a footprint of 2 577 stores – so, while not insignificant, an additional 400-odd stores is not that much of a stretch.

It will surely also want to start lending to these customers as soon as possible. Many customers (most?) will already be on TFG’s books.

It has 2.788 million accounts, and the pool of active credit customers in the country is not much larger than that.

This means it already has a relationship with some of these customers (and an understanding of their purchase behaviour). Those benefits will come in time, however.

What is the appeal of Jet?

It addresses the ‘value’ market segment, one where TFG is not particularly active. Exact is the closest to a value brand (at scale) that TFG operates, and one could argue that Jet extends this proposition into lower-income segments.

It has other value brands, but these are more niche (like The Fix, which is targeted at a younger shopper). So Jet fills the gap.

TFG says establishing “a value retail pillar” which the acquisition will achieve “would be costly and difficult to replicate organically”. These are the stores that sell ‘basics’ and cater primarily to women and children.

Obvious competitors are Pick n Pay Clothing (241 stores), Ackermans (837 stores) and to some extent Pep (2,357 stores). In the six months to end-March, sales grew by 7.3% (3.6% like-for-like) at Pepkor’s Pep and Ackermans unit.

This is a market segment that is incredibly resilient.

It is tough to know just how big a business is left at Jet (those 15 interested parties sure do!). In 2018, it generated approximately R10 billion in retail sales across 734 stores. But this included Edgars Active and Jet Mart (since sold/shut).

The core, profitable footprint is likely generating somewhere between R5 billion and R6 billion in sales a year. In 2018, the Jet division had a 33.3% gross profit margin.

Compare this to TFG Africa, which reported retail sales of R22.5 billion for the year ended March 31 (groupwide retail sales were R35 billion). The gross margin for this unit was 47.5%, with an Ebitda (earnings before interest, taxes, depreciation, and amortisation) margin of 27.9%.

Prospects

Getting Jet to a position where its gross margin is between 35% and 40% is definitely achievable. TFG’s debtors book operates at a healthy margin so expect a boost there as well.

In response to Covid-19, TFG plans to save approximately R6 billion in cash with a reduction in operating expenses of about R1 billion across the group (Africa, London, Australia).

With this kind of expertise and ability to act rapidly, plus the efficiencies to be gained by using its infrastructure, could it take even more costs out of the Jet business?

Is R200 million a year in costs achievable? Almost certainly.

And while the planned R3.95 billion TFG rights issue is not strictly necessary to fund this deal, it certainly gives the group more headroom (particularly regarding working capital) and removes much of the looming problem that is a R5.8 billion debt repayment due in March next year (some will no doubt be refinanced).

A purchase price of R480 million – including R800 million in stock! – is a steal.

There’s no other way to describe it. The upside for shareholders is what a Jet business firing on all cylinders would mean for the group two, three or four years from now.

This article first appeared on Moneyweb and was republished with permission.

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