Woolworths Australia

Tough negotiating with its staff and suppliers has allowed Woolworths in New Zealand to cut prices to boost market share, although not yet its profit, the giant Australian retailer said in reporting its first half sales yesterday.

The company's New Zealand supermarkets business grew 155.3 per cent to A$1.99 billion ($2.23 billion), although that figure was distorted by the timing of its purchase of Progressive Enterprises in November 2005.

It bought Progressive - owner of Countdown, Woolworths New Zealand and Foodtown chains - for $2.6 billion.

Comparable New Zealand sales for the first quarter were up 1.9 per cent and for the second quarter were up 3.8 per cent, but these were hit by an industrial dispute in the first quarter that affected the second quarter.

It lost market share to rival Foodstuffs during the strike, but chief executive Michael Luscombe said by December that had been recovered in volume terms, if not in value.

He said Woolworths' renegotiation of prices with suppliers to the New Zealand stores had allowed it to improve margins which the company had "reinvested" by cutting prices.

Luscombe said when Woolworths bought Progressive there had been a "very large gap" between its prices and Foodstuffs', which runs the New World, Pak n' Save and Four Square chains.

The Woolworths stores had had to cut prices significantly just to get near Foodstuffs' prices.

Overall inflation in Woolworths New Zealand stores had been just 1 per cent compared with generalised food price inflation of 2 to 3 per cent.

Luscombe said Foodstuffs had responded quickly "like a good competitor" but because of its price advantage it did not have to cut so aggressively. Woolworths was not seeking further changes in price relativities.

"We are not looking for a price war."

He said the initiative in December to give Woolworths' customers a petrol discount at Shell and Gull stations had generally positive results, even though Foodstuffs had quickly matched its move in a deal with BP.

The price battle has spilled over into a fight for control of New Zealand's largest general merchandiser, The Warehouse. Both Woolworths and Foodstuffs have purchased a 10 per cent stake and applied to the Commerce Commission for full control.

The winner is seen to gain a crucial advantage in spreading their influence into general merchandise sales.

Woolworths reported that group sales rose 11.5 per cent in the six months to December 31.

Shares in Woolworths added 0.7 per cent to A$23.81, having climbed 2.5 per cent yesterday on hopes of strong sales.

Luscombe said the group outlook was positive for the second half.

"Provided current retail trading pattern and the present business, competitive and economic climate continue, we expect sales from the continuing operations for the full year to grow in the region of 8 per cent to 12 per cent," he said.

The guidance is a restatement of the sales outlook the company gave last year.

The company's supermarket division posted sales growth of 16.7 per cent to A$18.84 billion in the half year.

- NZPA

Losing with dignity is a challenge. Supermarket giants Woolworths and Foodstuffs will be keenly aware of that. The two, tussling for control of The Warehouse, know that walking away from this one would give their rival a big leg-up in the fight for New Zealand's grocery and general merchandise markets.

It is difficult to see how either can make a graceful exit from the battlefield.

The battle lines as drawn have Woolworths and Foodstuffs each owning 10 per cent of The Warehouse. Founder Stephen Tindall has 52 per cent and will get to decide the company's fate.

Though Mr Tindall has given a general indication of wanting to resolve the situation in the first half of this year it might not happen in that timeframe, such are the potential complications. Whoever loses may well, for example, seek refuge in court action. Then there is the Commerce Commission, to which both Woolworths and Foodstuffs have applied for permission to take over The Warehouse.

The marketplace is certain both parties will be given the "okay" since there is not much crossover between supermarket activities and those of The Warehouse.

Well, don't be so confident about that. If the commission chooses to get very "micro" in how it looks at the applications, things might not be at all straightforward.

To take a random example, let us suppose the commission found a problem with the Woolworths-owned Countdown brand operating just across the car park from The Warehouse in Nelson.

Would it decide there would be a loss of retail competition in the Nelson area if Woolworths bought The Warehouse? Would Woolworths be forced to divest that particular Countdown supermarket?

These kinds of minute details are the very sorts of things the commission did examine when assessing the takeover by Progressive Enterprises of the Woolworths supermarkets in 2002.

Such an approach could therefore be very troublesome for both Woolworths and Foodstuffs. So do not assume that either party will be putting a bid on the table till they are sure there will not be problems obtaining clearance.

That means we are unlikely to see a bid for The Warehouse till March. As for what happens then, I'm sure even those at the centre of this don't have a clue how it will pan out.

The key might be which party has more to lose by not buying The Warehouse.

I would say that is Woolworths. It is a long way behind Foodstuffs in market share. If Foodstuffs grabbed The Warehouse its position as No 1 in supermarkets would appear to be unassailable.

Woolworths did not spend nearly $3 billion in buying its New Zealand supermarkets a little over a year ago to be a distant No 2 in the market.

It has the motive. It has the desperation. But don't expect all this to end amicably.

The top brass of Woolworths don't seem to seek out the media very often.  Chief executive Michael Luscombe and financial director Tom Pockett chose to give one-on-one interviews to a small group of New Zealand journalists last week, showing just how much the Australian supermarket giant wants to buy Kiwi discount retailer The Warehouse.

Before then Woolworths had pretty much maintained media silence since buying a 10 per cent stake in September.

Mr Luscombe and Mr Pockett bridled at any suggestion that they were now undertaking a "charm offensive". But they managed to say a lot of nice things, about The Warehouse, its founder and 52 per cent shareholder Stephen Tindall, New Zealand, New Zealanders and even Foodstuffs. "They (Foodstuffs) are a very very good competitor," Mr Luscombe said.  Perhaps wary that nationalistic concerns could loom - with an Australian company bidding against a Kiwi company for control of another Kiwi company - Mr Luscombe was keen to play down any differences between New Zealand and Australia.  "Because of the nature of the Anzac spirit this area of the world has shown how two countries can work together in a very harmonious way," he said.

Woolworths is now set to square up against Foodstuffs, which also owns 10 per cent of The Warehouse. Neither has committed itself publicly to making a bid. But neither would have applied for Commerce Commission approval if they were not serious about buying the company.

Woolworths has accused Foodstuffs of not being interested in general merchandising and seeking to "cannibalise" The Warehouse stores for the benefit of Foodstuffs' food retailing. Foodstuffs denied this, saying there was no way it would be looking to pay the sort of money required if it was not very interested in general merchandising.

The battle for The Warehouse is likely to intensify further.

Woolworths spent $2.6 billion getting into the New Zealand market a little over a year ago by buying Progressive Enterprises. It is a big investment. Through Progressive, Woolworths has 43 per cent of the supermarket share with its Foodtown, Countdown and Woolworths brands. Foodstuffs, through brands such as New World and Pak 'N Save, has 57 per cent.

Woolworths hasn't found things plain sailing since entering the New Zealand market. First there were grumblings of discontent from its suppliers. Then prolonged industrial action led to sparsely stocked shelves in the company's supermarkets.  "The industrial situation was one we did not anticipate. It has not happened anywhere else. We will put it in the past," Mr Luscombe said.  "Our aim is always to be a good employer."

He pointed to initiatives such as introduction of fuel and milk price discounts as ways in which Woolworths was trying to compete and give value to the customer.

"We've got a long-term commitment," he said. "We are out to earn the respect and loyalty of the New Zealand consumer.

"In Australia we were a clear number two (to Coles) for a long time. Over time we moved from number two to number one.  Just because we own a business does not give us a right to the spoils. We understand that just because we turned up doesn't mean the status quo will change overnight."

Stephen Tindall could yet be involved in a new takeover bid for The Warehouse alongside supermarket operator Foodstuffs and private equity investor Pacific Equity Partners.

Market sources say the three may be seeking to work together on a deal to rival the expected bid from Australian supermarket giant Woolworths.

One source said: "We could see a joint venture formed with Stephen and potentially the (Tindall) Foundation having 33-50%, PEP 25-33% and Foodstuffs with 25-33%. Potentially we could see them all with thirds.

"The working proposition is that (Tindall) is involved in it."

Tindall, who returns from holiday this week, controls 51% of The Warehouse, mainly through his personal holding of 27% and the 21% owned by the Tindall Foundation, a charity he set up in 1995. The Warehouse founder's position is therefore critical to the competing ambitions of Foodstuffs and Woolworths.

Sources say Tindall will ultimately go with the highest offer, even if it comes from Woolies.

A source said: "But if (a three-way deal with PEP/Foodstuffs) is the best offer on the table and the best price and all the rest of it, then I guess it's something he can look at."

The Warehouse's share price has leapt since September when Tindall proposed taking the company private. He was offering $5.75 a share, well above the then share price of around $5.

Later that month Woolworths bought 10% for $196.4 million, paying an average $6.43 a share for its stake, matching Foodstuffs' 10% holding and fuelling speculation of a takeover battle.

Both Woolworths and Foodstuffs have applied for Commerce Commission clearance to buy The Warehouse.

Last week the shares were trading around $7.24, a level unseen since 2002, valuing the company at $2.2 billion.

It's a steep valuation for a retailer that has struggled to grow.

"Increasingly at the prices being talked about, realistically Stephen is a seller," said another source.

Both sides can afford to pay a takeover premium, although analysts say Woolworths has the most to gain from merging The Warehouse with its existing New Zealand operations.

But recent merger and acquisition activity has been dominated by private equity firms such as PEP, with bigger appetites for risk and willingness to take on more debt than listed companies, to secure control of takeover targets.

In December PEP and CCMP Capital Asia bought Independent Liquor for a reported $1.2b, a price rival bidder Lion Nathan found too rich for its tastes.

PEP will proceed with a Warehouse purchase only if its consortium can secure 100% ownership.

"The problem's going to be getting Woolworths to sell," said a market source. "They won't be interested in making a lazy $25-$50m and walking away."

Conversely, Foodstuffs may be more inclined to do so.

"Because of Foodstuffs' co-op structure and its Warehouse shareholding forming a large part of its corporate wealth, it will walk away at some point," he said.

The battle for control of discount retailer The Warehouse is expected to resume in earnest soon but no outcome is likely till the Commerce Commission has had its say.

Supermarket group Foodstuffs, which owns 10 per cent of The Warehouse, made an application to the commission just prior to Christmas to buy the company, though it said it was not committed to any course of action and was keeping its options open.

It is expected that Foodstuffs' rival Woolworths, which also has 10 per cent of The Warehouse, will make a similar application sooner rather than later.

The commission has given itself till February 28 to make a decision on the Foodstuffs application. Any application made by Woolworths could presumably be looked at in a similar timeframe.

Foodstuffs has about 57 per cent of New Zealand's supermarket trade and Woolworths the rest. Ownership of The Warehouse with its large, superbly located sites would give either of the supermarket competitors a huge boost in the battle against each other for market share.

The Warehouse founder Stephen Tindall holds the key to his company's future as he controls about 52 per cent of the stock. He has had discussions with both Foodstuffs and Woolworths and has conceded that he might end up selling his shareholding.

It is unlikely that Foodstuffs would look to bid for The Warehouse by itself. Foodstuff's unusual structure - it is three separate cooperatives - would make such a bid difficult to set up. The assumption in the marketplace is that it would set up a joint venture vehicle with Australian private equity operator Pacific Equity Partners.

PEP, which already has substantial business interests in New Zealand, was originally set to team up with Mr Tindall in a privatisation of The Warehouse. This was, however, torpedoed by the involvement of first Foodstuffs then Woolworths.

But with PEP already having conducted due diligence on The Warehouse and having arranged a funding package for a takeover, it could easily structure a deal with Foodstuffs to bid for the business. It is possible that such a bid, if it materialises, might also still include Mr Tindall as a shareholder.

If Mr Tindall retained a stake this might make a bid more palatable to shareholders - many of whom have followed the business for a long time and don't want to see it privatised.

Woolworths has said nothing publicly about its intentions toward The Warehouse, but is known to be interested in a full takeover. The Australian company has the size and muscle to fund a bid without needing any outside assistance. It is unlikely that Mr Tindall would retain a stake in The Warehouse under the terms of any Woolworths bid.

A key issue will be how much any of the players are prepared to pay for the company. The Warehouse shares doubled in price last year as a result of the takeover speculation.

However, the company's update to the market last Friday on its Christmas trading period painted a picture of a business still battling patchy trading. The Warehouse said its after-tax profit for the half-year to January 28 would be similar to the $59.1 million figure at the same time last year.

The shares fell 8 cents to $7 yesterday. Whether either Woolworths or Foodstuffs would want to pay much more than that to buy the company based on its current prospects is a key question.

However, neither Woolworths nor Foodstuffs is seen as wanting to yield the prize to their rival.

Mr Tindall indicated late last year he would like to see a resolution to the ownership of The Warehouse within six months. But there remains no certainty that a deal will be struck within that timeframe.