Stockwatch: what price might bidders pay for Currys shares?

The market is currently getting excited about two early stage possible offers for electric retailer Currys (LSE:CURY), but broker Shore Capital reckons JD Sports Fashion (LSE:JD.), Marks & Spencer Group (LSE:MKS), AO World (LSE:AO.). and Dunelm Group (LSE:DNLM) should all be re-rated following Currys’ rejection of an approach worth £700 million, equivalent to 62p a share.

Currys’ share price has jumped 37% to around 65p and remains firmly supported rather than settling back after the initial surprise. Vanished are recent concerns about UK consumer discretionary spending, tough competition such as AO World and Marks Electrical Group Ordinary Shares (LSE:MRK), and Currys’ weak balance sheet – its pension fund restoration payments compromising dividends.

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A striking example how UK plc is materially undervalued

Perhaps this is finally the wake-up call, how UK equities really are attractive in terms of “worth to a private owner”, the true benchmark for value investing.

If Currys’ operating margins can be proven to be about 3% - as was achieved only five years or so ago – then it would leverage profit on circa £9 billion of turnover, enough to justify an equity value of at least 100p, if not nearer 200p.

It is a sudden about-turn in perception, if apparently justified by a long-term chart that shows Currys equity still very much at a low in a context where there does not appear to have been material dilution.

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True, 62p was hit around the 2008 financial crisis, but this was followed by a rally to 420p by July 2011. Despite a drop to near 130p going into 2012, there was a run to 485p by late 2015. There followed a near-relentless downtrend that appears only to have bottomed as recently as last November at around 45p.

Mean-reversion implies probability of equity upside

The value equation balances gingerly on a forward price/earnings (PE) multiple still below eight times, versus negative net tangible assets and a sub-3% dividend yield offering little prop.

I drew attention to Currys last May as a “buy” at 57p which did not time the low, but I thought represented a classic example, value-wise, of how even shares in a market leader can fall out of favour. While Currys may seem just another electrical retailer nowadays, it includes what used to be Dixons and PC World – very strongly established across the UK, also Nordics.

My concern remains that the business is strongly reliant on trade creditors; then in an 18 January update the company upgraded profit for the year to the end of April 2024, inclusive of £18 million from a Greek disposal happening now.

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But now it has percolated out in the press how Chinese retailing giant JD.com Inc ADR (NASDAQ:JD) first made overtures to Currys about a commercial link-up late last year, which helps explain Currys’ motivation to talk up its shares from a low.

Adjusted annual pre-tax profit was guided from a £104 million consensus figure into a £105-115 million range, although precise reasons were not given beyond “stable gross margin and continued cost savings” in the UK and Ireland, which showed a 3% slip in like-for-like revenue.

Sales were strong in mobile over the 10 weeks to 6 January, but offset by weakness in TV and computing. In services – such as “care & repair” – however, there was “strong growth driving growth in margins”. Amid the current takeover excitement, one analyst estimate is that this care & repair business alone justifies £700 million of value – at 64p a share today, the entire group is valued at below £730 million.

The Nordics side saw a 2% revenue slip albeit improving trends compared with the first-half-year. Sales grew in Norway, offset by other countries.

Currys - financial summary
Year-end 29 April

Source: historic company REFS and company accounts.

A retail operator looks best placed to remove further costs

Two parties have declared early stage interest in Currys.

US hedge fund Elliott Capital – a classic international scavenger of value which took a 13% opportunistic stake in Poundland in 2016, before that company was taken over by South Africa’s Steinhoff conglomerate for near £600 million. Yet Elliott’s ownership of Waterstones bookshops proves it to be an owner-operator of businesses, and no mere financial trader.

Yet Elliott is not the first to reflect perception of value. Frasers Group (LSE:FRAS) owns 6.6% of Currys’ voting rights, plus “other instruments” that takes the stake to 11.2%. This begs the question whether the mercurial Mike Ashley might want to take a radical step – or is he essentially taking a portfolio interest similar to Ruffer LLP with 4.6%, which is sometimes seen as the UK’s closest example of Warren Buffett in action.

It looks clear to me the strongest contender is JD.com – China’s burgeoning answer to Amazon.com Inc (NASDAQ:AMZN). Capitalised at around $35.5 billion (£30.6 billion) it remains small relative to Amazon’s near $1.8 trillion but is around the seventh-largest tech company in the world and has overlap with Currys by way of selling electronics, mobile phones and computers.

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JD’s 2023 results are yet to be published, but it may have around $250 million of cash and short-term investments versus only $40 million debt. That implies a big increase in borrowing to stump up the £1 billion-plus it would probably need – equivalent to 88p per Currys share – to get a recommended offer.

In contrast with Eliott, however, JD could more easily eliminate head office costs and integrate operations to derive synergies. It only needs a small improvement in operating margin – where 3-4% was being achieved back in 2017-18 – to leverage profit on Currys’ circa £9 billion turnover.

While demand for electrical products seems tricky to predict in the UK right now – the driver for replacement typically being when a device fails, rather than upgrading – I would expect a Chinese company to look well beyond current uncertainties in retail.

If financing was any kind of hurdle for JD, it would seem unlikely its advisers – Goldman Sachs, no less – would have declared yesterday, “very preliminary stages of evaluating a possible transaction that may include a cash offer for the entire issued share capital of Currys.”

Still plenty to sort out on the balance sheet

Take care how the market mood is rather euphoric, given talk about how Currys selling its Greek operation for £156 million net cash should clear net financial debt, as if that resolves matters.

At end-October 2023 there were £2.5 billion trade payables versus £0.7 billion trade receivables; and with just £94 million cash, the ratio of current assets to current liabilities was 0.86. It begs the old question whether suppliers are being used as a source of free credit and profit being enhanced with a tough approach to working capital management.

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While the pension deficit looked an innocuous £190 million, down from £251 million, pension contributions are scheduled to rise to £50 million in the April 2025 year and £78 million the following three years before a final payment of £43 million in 2028-29. Moreover, end-October goodwill/intangibles constituted 136% of £1.9 billion net assets.

The Chinese just might step up to the plate

Will either Elliott or JD step up and make the kind of offer able to get recommended? I think JD might. Both sides have until close of play on 18 March to decide, during which time plenty of negotiation seems likely.

I rate Currys a strong “hold” for those already in. Potentially the Chinese may pay over 100p a share, but it is a gamble to assume so. This is not a takeover arbitrage. With fresh money and a disciplined approach to risk, possibly wait to seize a price slide should a takeover not materialise – on this occasion.

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.