230909 Woolworths in woodmead.photo by Simphiwe Mbokazi

Sydney - South Africa’s Woolworths agreed to buy Australian retailer David Jones for A$2.15 billion ($2 billion), to expand in a market targeted by global rivals including Inditex SA and Hennes & Mauritz AB.

David Jones shares rose by a record 23 percent today to close at A$3.91 in Sydney, below the A$4 cash offer.

Myer Group, its main listed department store competitor, also withdrew an all-stock, zero-premium merger proposal first made October 28 when the target company’s shares closed at A$2.71.

Buying the 38-outlet Australian chain increases Woolworths’ presence in a country Credit Suisse Group AG says is the world’s second-wealthiest.

The deal also gives the retailer buying power to compete against global fast-fashion groups including Zara, H&M and Arcadia Group Plc’s Topshop, which are expanding into both countries.

“Those chains are in a global arms race to open new stores now,” Caroline Finch, a senior analyst at Ibisworld in Melbourne, said by phone.

Local retailers in Australia and South Africa have to work harder, she said, because “the H&Ms and Zaras of this world have been nipping at their heels, taking the attention of a very fashion-focused consumer.”

Woolworths Holdings, South Africa’s second-largest retailer by market value, isn’t related to the Australian supermarket chain Woolworths Ltd.

Southern Hemisphere

“We’re buying this business to build a bigger southern hemisphere brand,” Ian Moir, Woolworths chief executive officer, told reporters in Sydney today.

“We’ve got real scale in the southern hemisphere, we’ve got the same seasonality, so we’ve got a real competitive advantage over northern hemisphere entrants.”

Southern hemisphere winters fall in the north’s summer, creating a challenge for incoming clothing retailers from Europe, North America and North Asia, Moir said.

The deal, which has already been agreed to by David Jones’s board, is Australia’s largest retail takeover since 2007, when Wesfarmers bought Coles Group, according to data compiled by Bloomberg.

It values the target at about 11.1 times the last 12 months’ its A$192.7 million in earnings before interest, tax, depreciation and amortisation, according to data compiled by Bloomberg.

That’s a 13 percent premium to the median valuation in developed-market retail acquisitions over $1 billion in the past five years, the data show.

‘Looks Expensive’

“It does look expensive currently, but they’ve obviously done their sums,” Evan Lucas, a market strategist at IG in Melbourne, said by phone, referring to Woolworths Holdings.

Woolworths slumped as much as 6 percent to 69.10 rand in Johannesburg before trading at 69.99 rand as of 9:03 a.m. local time.

Myer made its initial approach on October 28 last year, when David Jones shares closed at A$2.71.

The retailer said today it was dropping the merger proposal in light of the Woolworths offer.

“We have always maintained a disciplined approach to valuation,” the company said in a regulatory statement.

Woolworths’ offer is “a decent price which I probably will accept,” Simon Marais, chairman of Allan Gray Australia, said by e-mail.

The fund manager is David Jones’s fifth-biggest shareholder with a 5 percent stake, according to data compiled by Bloomberg.

Moir had a “robust negotiation” with David Jones chairman Gordon Cairns over the price, the Woolworths chief executive told the media call.

The acquisition would be funded through a mix of cash, debt and a sale of new shares, with the value and other details of the equity raising to be disclosed in a shareholder letter in mid-May, Moir said.

Upmarket Retailer

Buying 176-year-old David Jones will give Woolworths control of an upmarket retailer in a country that has the world’s highest wealth per adult after Switzerland, according to Credit Suisse.

“The Australian economy is a little sluggish but this is a strong economy and it will come back,” Moir said.

The strong Australian dollar “creates a natural rand hedge for our business in South Africa,” he said.

David Jones, which has seen sales from stores open at least 12 months decline in all but two of the past 13 quarters, now stands to benefit should spending from higher-end consumers in Australia rise, Michael Simotas, a Sydney-based analyst at Deutsche Bank AG, wrote in a February 11 note to clients.

The Reserve Bank of Australia has cut the benchmark interest rate to a record-low 2.5 percent as it seeks to avoid a growth gap emerging in the economy from waning mining investment.

Consumer Spending

That’s helped boost Australian house prices, retail sales, and confidence.

The nation’s household savings ratio, a key measure for forecasting consumer spending, fell below 10 percent in the fourth quarter of 2013 for the first time since 2010.

The offer “recognises the potential of the David Jones business, the positioning of the department store here and the value of the property” owned by the Australian company, Grant Saligari, an analyst at Credit Suisse in Melbourne, said by phone.

Woolworths already owns 88 percent of fashion chain Country Road Ltd. in Australia, so “they’ve got experience in this market,” Credit Suisse’s Saligari said.

The South African company currently gets about 16 percent of its revenues from Australia, where sales by Country Road have more than doubled over the last four fiscal years to A$706 million in the year ended last June.

If the two companies had been combined during their 2013 fiscal years, Australasia sales of 22.6 billion rand ($2.16 billion) would have amounted to about 43 percent of total revenue, according to a calculation by Bloomberg.

That size will help compete with offshore entrants, Moir said: “You’ve either got to accept that competition’s there and compete with it, or roll over and die.” - Bloomberg News