The price of neutralising Solomon Lew

So, Solomon Lew and South Africa’s Woolworths have struck a deal to give him a massive profit on his Country Road shareholding in order to give him an inducement to not block Woolworths’ $2.2 billion bid for David Jones. Well, actually they haven’t -- because they know they can’t.

Woolworths’ today announced a $17 a share bid for the 12.12 per cent of Country Road that it doesn’t already own. That will deliver Lew, if he were to accept the offer, a profit of around $190m on the shares he has held since 1997. He has an 11.8 per cent stake in Country Road.

While there has been some reportedly minimal contact between Lew’s advisers and Woolworths’ advisers, the parties involved are going to great lengths to stress that there have been no discussions with Lew himself and there is no agreement or understanding in relation to his 9.9 per cent stake in David Jones.

The absence of any agreement is transparently an attempt by the parties to avoid getting caught up in arguments about whether Lew is receiving a 'collateral benefit' from the bid for Country Road that is not available to other shareholders in David Jones.

While the David Jones offer is being executed via a scheme of arrangement, it is unclear whether the prohibition on collateral benefits extends to schemes rather than conventional takeover offers. There was always a risk that someone -- the Australian Securities and Investments Commission, perhaps -- might take the question to the Takeovers Panel, seeking a declaration of unacceptable conduct.

The prohibition on collateral benefits flows from one of the core 'Eggleston principles' that under-pin the takeover provisions of the companies' laws.

It states that, as far as practicable, all shareholders should have a reasonable and equal opportunity to participate in any benefits accruing to shareholders through a proposal under which a person would acquire a substantial interest in the company. Obviously David Jones shareholders other than Lew won’t have an opportunity to benefit from the bid for Country Road.

Thus there could be no agreement or understanding that linked the bid for Country Road with the way Lew’s shares are voted at the David Jones scheme meeting, where he was threatening to block an offer that requires a 75 per cent majority of the shares voted.

Whether or not there were some winks and nudges during the advisers’ meeting, Woolworths has structured the bid for Country Road to give Lew a clear choice, and to demonstrate that there wasn’t a need for any understanding or agreement, whether formal or informal.

The offer for Country Road, which will cost Woolworths about $213m,  will deliver about $209m to Lew if he accepts. It values the business at about $1.8bn and is conditional on David Jones shareholders approving the scheme.

Lew therefore, if he were to block the scheme, would be turning his back on the Country Road bonanza. He can’t get the big price for his Country Road stake while also retaining his leverage over Woolworths in David Jones.

Ever since it became clear that Lew was assembling a stake in David Jones at prices just below the Woolworths bid price of $4 a share, there has been speculation that the shareholding -- with perhaps another 5 per cent he is thought to have a foot on via derivative contracts -- would be used as leverage to force Woolworths to take him out of Country Road. And so it has transpired.

For Lew, if he were to accept both the Woolworths offer, the $200m he has invested in David Jones will have been a very profitable exercise. After transaction and advisory costs he will break even at worst on the David Jones stake, which was accumulated at an average price of around $3.93 a share, while extracting about $209m of cash, and around $190m of profit from Country Road.

While the price of neutralising Lew (if indeed the Country Road offer does neutralise him) is steep, Woolworths can justify it.

Country Road has been a stellar performer under Woolworths’ ownership. Its brands -- Country Road itself, Witchery, Mimco and Trenery -- have been successfully launched in South Africa as part of Woolworths’ strategy of stocking only its own brands.

A version of that strategy of store-owned brands is a key to Woolworths’ conviction that it can leverage its supply chain to generate a significant structural improvement in David Jones’ earnings and justify the rather full price it is offering.

Full ownership of Country Road would make it easier to execute the strategy and give Woolworths the full benefit of the impact of the strategy on both David Jones and Country Road.

It would also no doubt be a relief for Woolworths to finally get rid of a thorn in its side. Lew has been an aggressive minority shareholder in Country Road ever since he bought his shares, at less than $2 a share, to prevent the South Africans achieving 100 per cent ownership of the business in 1997.

While paying $17 for shares that were trading below $5 at the start of this year is a big price to pay for that privilege, Woolworths might well believe it is worth it to see the back of him and to be finally able to de-list and completely absorb Country Road and the collection of brands within it.