Wesfarmers is hoping bigger isn't always better.
On Friday the West Australian conglomerate announced it would spin off its Coles supermarkets, hoping to turn the company into a business with stronger growth prospects.
In divesting its flagship business, Wesfarmers is once again remaking itself. A decade ago it added Coles, Officeworks, Target and K-Mart to its hardware chain Bunnings to become a major retailer. With the divestment of Coles and the likely acquisition of industrial businesses, it will be a smaller, leaner company with a new focus.
Coles is expected to be valued at about A$19 billion ($20.3b) by the sharemarket and will be a top 30 company when it lists as a separate entity on the Australian Stock Exchange. What's left of Wesfarmers - a business worth roughly A$30b with Bunnings as its centrepiece.
The company also owns several chemical, energy and fertiliser businesses as well as Greencap, the largest integrated risk management and compliance company in Australia. The Workwear Group, which manufactures fashion staples including King Gee, Hard Yakka and Stubbies, is also among its stable of investments.
The diversity of Wesfarmers' industrial portfolio suggests the list of possible acquisitions and sectors in its sights is probably a long one.
The Coles demerger won't raise any cash for Wesfarmers. The conglomerate will simply transfer shares in Coles to Wesfarmers shareholders.
Nonetheless, it will free up funds, because Coles accounts for 60 per cent of the capital employed across the Wesfarmers portfolio, but accounts for only 36 per cent of the earnings.
Following the divestment, Bunnings' contribution to the group's earnings will rise from about a third to more than half.
Wesfarmers chief executive Rob Scott denies he is divesting a business with little growth ahead of it.
But the spin off begs the question, why sell it? Supermarkets aren't a high growth sector. Most sales growth comes either by taking market share from Woolworths or by cutting margins, and both of these strategies are expensive.
Wesfarmers did a good job of turning around the poorly-run supermarket chain after acquiring it in 2008. But it came at a cost. All up, it has invested A$8b in Coles.
And now sales growth has dropped to the slowest rate since Wesfarmers bought the business.
Wesfarmers reinvigorated the Coles business at a time when Woolworths was underperforming and struggling with its disastrous foray into hardware. But Woolworths - owner of the Countdown chain in New Zealand - has put those problems behind it and is back as a serious competitor, having stolen the momentum from Coles.
The poor performance shows in the Wesfarmers share price. In the past five years its stock has underperformed the overall ASX-200 by more than 10 per cent.
Wesfarmers will retain a 20 per cent stake of Coles and interestingly it will also hold on to a substantial stake in the flybuys loyalty business that sits within Coles. With its huge wealth of information on consumers and their consumption habits, this is the sort of business that will thrive as companies rely more and more on data to make decisions and sales.
A standalone Coles is likely to settle into a steady-as-she-goes business, generating solid but unspectacular profits and earnings growth. Without the deep pockets and growth ambitions of Wesfarmers, a return to the price war with Woolworths is unlikely. In fact, Woolworths shares rose following the demerger announcement.
The big question is about whether this will create more value for shareholders.
They haven't done very well out of Wesfarmers over the past five years, with the shares trading between about A$40 and A$45. Wesfarmers shares trade at around 16.6 times what it is forecast to earn in the coming year, which is below the 18 times multiple on which industrial stocks typically trade at.
Coles will be a steady cash generator so its share price is unlikely to grow much. Investors will be looking to the new Wesfarmers for capital appreciation.
That will depend on two things.
Firstly, can Wesfarmers sort out Bunnings' troubled expansion to the UK? The division is expected to lose about A$450 million this year and will cost about A$2.5b to exit if it can't be turned around.
Secondly, there is the acquisition strategy. Getting this right is at least as difficult as turning around Bunnings UK. Many chairmen and chief executives have lost their good reputations - and a lot of shareholders' money - with failed acquisitions.
Scott and the Wesfarmers board will be eager to get on with the new strategy and will have any number of businesses to run the ruler over. They will have to resist the temptation to jump in too early. Their eager intent is evident in the hiring of Ed Bostock, previously an executive at private equity giant KKR.
And then there's execution risk. A lot of deals that appear to make a lot of sense in presentations to analysts after the deal never deliver the promised returns and efficiencies.