Why JB Hi-Fi Limited shares are jumping on The Good Guys deal

Credit: Peter Heath

Specialty electronics retailer JB Hi-Fi Limited (ASX: JBH) has responded to speculation in the press today that it is exploring a potential acquisition of The Good Guys.

The retailer made an announcement to the market this morning as part of its continuous disclosure obligations under the ASX listing rules that came after The Australian Financial Review’s Street Talk column said it was of the understanding that JB Hi-Fi had made an indicative offer for the business.

The ASX-listed JB Hi-Fi responded by saying that it is in preliminary discussions, and that it is yet to enter into any agreement with respect to the acquisition.

Indeed, an agreement between the two rivals is far from guaranteed. To begin with, Street Talk highlighted that JB Hi-Fi had already made an offer for the business within the last two years, which had been knocked back for being too low.

JB Hi-Fi also noted that it understands The Good Guys is exploring a range of options that could yield it the best financial outcome, which could even include an initial public offering (IPO) on the ASX.

Of course, the success of an IPO today would depend on the economic environment at the time, together with the market’s confidence after the recent catastrophic failure of rival Dick Smith.

Would an acquisition make sense?

If an acquisition by JB Hi-Fi were to succeed, it would make sense for the business strategically. After all, the pair are both customer-centric and they are two of the country’s biggest electronics retailers.

What’s more, JB Hi-Fi is eager to continue expanding its ‘HOME’ format stores, which sell white-goods. It is aiming for 75 stores by the end of financial year 2017, but that figure could be much higher thanks to the 100 stores owned by The Good Guys. Based on the synergies it could likely extract by combining the two businesses, JB Hi-Fi could drastically increase its market share whilst also gaining an edge over rival Harvey Norman Holdings Limited (ASX: HVN).

However, it’s a well-known fact that many acquisitions fail. Of course, many also succeed, but that largely depends on management’s ability to share its focus between integrating the new business and growing the underlying company, while it is also vital that the acquirer does not overpay.

Thankfully, history is on shareholders’ side this time around. As noted above, JB Hi-Fi is believed to have launched a bid for the business in the past but refused the deal based on the notion that The Good Guys were asking for too much money, suggesting JB Hi-Fi will only pay what it believes makes sense for investors.

The Financials

According to estimates from Street Talk, an acquisition of The Good Guys could add more than $2 billion to JB Hi-Fi’s sales and $110 million in earnings before interest, tax, depreciation and amortisation, or EBITDA.

JB Hi-Fi’s shares are currently trading for $23.18, giving them a market capitalisation of $2.32 billion. Meanwhile, the company has achieved EBITDA just shy of $250 million in the 12 months to 31 December 2015, putting them on an EBITDA multiple of around 9.3x.

Assuming that The Good Guys was worth roughly the same EBITDA multiple, that could mean JB Hi-Fi would need to pay close to $1 billion for the business. JB Hi-Fi would likely have to take out more debt for the business or else issue more equity to investors via a capital raising.

Foolish Bottom Line

JB Hi-Fi’s share price has risen following the announcement, suggesting that investors are on board with management’s interest in acquiring The Good Guys at this stage. It could certainly make sense for the business strategically as it pushes to expand its HOME store count, so long as it doesn’t overpay for the business.

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Motley Fool contributor Ryan Newman has no position in any stocks mentioned. 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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