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The Woolworths sale of Dick Smith now looks brilliant

Credit: Scott Lewis

Woolworths Ltd’s (ASX: WOW) decision to sell Dick Smith Holdings Ltd (ASX: DSH) to private equity firm Anchorage Capital for $20 million now looks like a brilliant decision.

For a start, the supermarket retailer actually received much more than that (more on that below) and secondly, Dick Smith’s share price has fallen in a hole.

Dick Smith’s share price plunged more than 50% today – giving the company a market cap of around $75 million – after the consumer electronics retailer announced a writedown on inventory of around $60 million before tax. The company also says it’s “unable to re-affirm the profit guidance previously provided”, thanks to the writedown and “the uncertain trading outlook”.

In late October, Dick Smith said it expected 2016 financial year (FY16) net profit to be between $5 and $8 million below previous guidance of $45 to $48 million, or in other words, around $40 million.

That’s a marked difference to its main rival, JB Hi-Fi Limited (ASX: JBH), which recently reported sales up 5.3% and like-for-like sales of 3.7% (which represents organic growth from existing stores and excludes new stores) for the last quarter, and maintained its guidance for FY16 sales of around $3.85 billion.

The problems at Dick Smith appear to be accounting games with inventory when it was taken private by Anchorage Capital, with large slabs of products (inventory) sold at below-cost prices, and not re-stocked. Unfortunately, shareholders are now paying for that and we are seeing the real results Dick Smith is capable of producing.

$20 million price tag misleading

The $20 million price Anchorage paid Woolworths is also misleading. That was the initial cash payment only, and all up, Anchorage Capital paid Woolworths $115 million, including the $20 million, another $21 million in working capital adjustments and $74 million to buy out Woolworths’s rights to a portion of float proceeds.

$115 million now looks like a great deal for Woolworths to offload a struggling non-core business, particularly given the recent Dick Smith announcements.

As for Anchorage Capital, they sold 78% of Dick Smith into the float for proceeds of $358.1 million, and their remaining 20% holding in September 2014 for $2.22 a share, netting them a further $105 million, making $463.1 million in total. A further $24 million from the float proceeds was used as part payment to Woolworths, so Anchorage reaped $487 million from selling Dick Smith to the public.

Not that Woolworths is likely to mind since it doesn’t have egg on its face anymore over the ‘sale of Dick Smith for $20 million’. The supermarket retailer also didn’t have to contend with a struggling Dick Smith as it was launching its home improvement business Masters and Home Timber & Hardware (not that that has gone according to plan).

Foolish Takeaway

The fact is that Dick Smith is a poor business, and is not a serious competitor to the likes of JB Hi-Fi nor many of the online retailers that sell similar or the same products. The company’s strategy of selling a large proportion of private label brands appears to have backfired, particularly when equivalent products are available online at cheaper prices. Even at these prices, much could still go wrong at Dick Smith.

For a brief moment, Woolworths’ management can smile and say ‘We told you so’, and we’ll also refer you back to an article we wrote at the time, suggesting the IPO would be a dud.

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Motley Fool writer/analyst Mike King owns shares in Woolworths. You can follow Mike on Twitter @TMFKinga

Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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