Wesfarmers Cuts Coles Seeking Growth

It’s the 1980s. Hotel giant, Marriot is aggressively expanding their empire.

Everything looks rosy.

At the time, Marriot had two core businesses. The first was building hotels. The second was managing them.

So like any developer, Marriot was always on the hunt for new locations. Once they bought the land and built the hotel, usually with borrowed money, they’d find a buyer and offer to manage the hotel for a fee.

They were making bundles of cash on the sales, and generated a steady stream of income on the management side.

What more could you want?

But as always when times are good, Marriot got a little too greedy. US real estate was humming along in the 80s. Getting a loan at attractive rates also wasn’t that much of a problem.

Management borrowed billions to fund multiple new hotels at the same time.

This wouldn’t have been too much a problem. But as the US was heading into the 1990s, the real estate market took a turn for the worse.

Marriot suddenly had little luck finding hotel buyers. And that meant their newly built hotels, funded through debt, went on sitting idle.

According to the New York Times, Marriot was sitting with 141 hotels they couldn’t sell. The situation would be dire if Marriot couldn’t find any buyers in time to repay their debts.

Luckily, Stephen Bollenbach had a plan.

1+1=3

Bollenbach was Marriot’s CEO.

Before heading the company, he helped Donald Trump turn his real estate empire around. And he was about to do the same for Marriot.

Bollenbach’s plan was simple.

Why not spin-off Marriot’s cash friendly management business?

This meant Marriot would become two companies.

One would hold almost all of Marriot’s construction debt. They would continue to try and find hotel buyers in a tough real estate market.

The hotel management entity would be almost debt free. They would continue to grow their management business while helping to fund the first entity’s survival.

This wouldn’t mean Marriot could jump ship from their hotel building business. In fact, the Marriot family continued to own 25% of both companies.

But the benefit of a focused management and board of directors for each business would hopefully get Marriot out of their jam.

Those running the hotel building side of Marriot were thinking of nothing but moving hotels and reducing debt. The hotel management side of Marriot could instead focus on growth.

Luckily for Marriot, it was only five years before the market for hotels rebounded. Those who invested in both companies made a good deal of money.

And if Wesfarmers Ltd [ASX:WES] spins off Coles, there could be money in it for you as well. 

Should you buy Wesfarmers or Coles in 2019?

On Friday, Wesfarmers announced their intention to spin-off Coles in financial year 2019.

The demerger is still subject to shareholder’s approval. But if approved, it will mean Wesfarmers and Coles will be separate entities.

They’ll have separate boards and management. Wesfarmers will still trade under the ticker WES, but Coles could soon be a new admission to the ASX.

The decision to spin-off Coles comes after a portfolio review. You may already know Wesfarmers doesn’t just own Coles supermarkets. They also own Bunnings, Kmart, Target, Officeworks and various chemical and energy groups.

You could argue Coles is a mature, cash generating business. Whereas other businesses under Wesfarmers still have room to grow.

We believe Coles has developed strong investment fundamentals and is of a scale where it should be operated and owned separately. It is now a mature and cash generative business, which is expected to have a strong balance sheet and dividend paying capacity,’ Wesfarmers CEO, Rob Scott said.

According to Wesfarmers, spinning off Coles will create a new top 30 company on the ASX. They also plan to retain a 20% stake in the new Coles business.

The Coles entity will include:

  • 806 supermarkets Australia-wide, and Coles online
  • 849 liquor stores
  • 712 fuel and convenience stores under Coles Express
  • 88 properties managed under Spirit Hotel
  • Coles financial services, which offers insurance and credit cards.

As with many spin-offs, Wesfarmers shareholders will receive a proportional number of Coles shares. Many of those shares will go to fund managers, who own more than 80% of Wesfarmers stock.

The opportunity for you is if either Coles or Wesfarmers is sold down considerably. Maybe fund managers won’t want the low growth Coles group and decide to get rid of it.

If enough do the same, it could push Coles into bargain territory.

Alternatively, you might see Wesfarmers as far more attractive without Coles. Instead of making massive investments into their supermarket business, Wesfarmers could focus on growing Bunnings and Officeworks.

According to research from Credit Suisse, Coles is worth roughly $19.4 billion.

While the demerger is still months into the future, it seems shareholders have already shown their support. They added more than $2 billion to Wesfarmers’ market cap on Friday.

Potentially, there could be easy money up for grabs in 2019.

Kind regards,

Harje Ronngard,
Editor, Money Morning


Money Morning is Australia’s most outspoken financial news service. Your Money Morning editorial team are not afraid to tell it like it is. From calling out politicians to taking on the housing industry, our aim is to cut through the hype and BS to help you make sense of the stories that make a difference to your wealth. Whether you agree with us or not, you’ll find our common-sense, thought provoking arguments well worth a read.

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