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What will Wesfarmers do with 1.845 billion bucks?

Shareholders can breathe a sigh of relief after the announcement this week that the Australian Competition and Consumer Commission (ACCC) has waved through the acquisition by Insurance Australia Group Limited (ASX: IAG) of the underwriting businesses of Lumley and WFI which are owned by Wesfarmers Ltd (ASX: WES).

As announced back on 16 December 2013, IAG and Wesfarmers reached agreement for the sale of Wesfarmers’ insurance underwriting operations for $1.845 billion with the big hurdle to overcome being the approval of the ACCC. With that hurdle now passed, shareholders can turn their attention to what management will do with the cash haul.

For the six-months to December the earnings before interest, tax and amortisation (EBITA) for Wesfarmers from insurance underwriting were $64 million. There is also speculation that the insurance Broking division could be put on the sale blocks too. In the first half, Broking earned EBITA of $41 million. Although just speculation, Wesfarmers’ Broking could be of interest to listed peers Steadfast Group Ltd (ASX: SDF) and Austbrokers Holdings Limited (ASX: AUB). Given the consistency and lower risk earnings of the Broking business, this division could quite possibly be worth a similar amount as the larger underwriting business.

Foolish takeaway

With the IAG transaction expected to complete by 30 June, it’s likely that management will update shareholders at the full year results presentation – if not before – with how they plan to utilise the cash from the sale. Last November Wesfarmers paid a 50 cent per share capital return, however given that the sale of the underwriting business effectively reduces the company’s revenue and earnings base, it is quite likely management will look to re-invest this $1.845 billion back into other areas of the company.

The most likely candidate is the Coles division where the company recently unveiled plans to spend around $1.1 billion opening 70 new supermarkets over the next few years. Shareholders will want to keep a close eye on the returns produced from any retained capital – if it is below the company’s cost of capital, it would have been wiser to have distributed the cash to shareholders.

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Motley Fool contributor Tim McArthur does not own shares in any of the companies mentioned in this article.

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