Could The Coming Wesfarmers Coles Demerger Turn Into A Train Wreck?

The Australian conglomerate Wesfarmers is demerging its largest company within its portfolio, and from the day it was purchased it has been an example of the axiom; the price you pay for an asset determines your investment return. Which is what Warren Buffett refers to when he says’ “Price is what you pay and value is what you get.”

Cartoon: David Rowe (AFR)

Summary:

Wesfarmers’ chief executive Rob Scott announced a demerger of Coles from Wesfarmers’ by spinning off Coles as a listed ASX independent company.

“Therefore a demerger is a logical way of separating the businesses and giving our shareholders the opportunity to have a direct interest in Coles.” CEO Rob Scott

Wesfarmers’ will retain 20% ownership of the newly listed entity and the remaining 80% ownership will be transferred to current Wesfarmers shareholders’ via newly issued shares.

The Australian Financial Review reported that Mr. Scott said every business in Wesfarmers’ was theoretically for sale, but a demerger was the best way of separating Coles from the Wesfarmers’ business without incurring capital gains tax.

So, you will have the opportunity to buy an ownership share in Coles in the near future (6-8 months according to Mr. Scot), if you aren’t already a Wesfarmers’ shareholder, but should you?

It was reported in the Financial Review that Credit Suisse put the value of Coles at $19 billion (All amounts in Australian dollars & Source).

Amusingly, that was the same price they paid for Coles in late 2007.

The most optimistic valuation I calculated for Coles was $13 billion, but once the optimistic assumptions are removed from the equation the valuation drops like a stone.