Divide and rule

Metro demerger might lift valuation by a third

A 10 per cent jump in German Metro AG's shares on March 30 is impressive, yet still just a pre-taste of the full valuation uplift the demerger of the clumsy retailing giant can provide. The group's food unit and its retail electronics business had few synergies, but created a big valuation discount. If Metro can close half the valuation gap to peers, and Russia doesn't deteriorate further, shareholders should be significantly better off.

Metro's Chief Executive Olaf Koch, in charge since 2012, has already turned the conglomerate into a leaner and more focused company, selling its Kaufhof department stores in Germany, supermarkets in Eastern Europe and Turkey, and wholesale markets in several countries. By the end of 2015, net debt stood at just one times EBITDA, down from 1.6 times two years earlier. Moreover, profitability at the consumer electronics unit Media-Saturn has improved.

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Now to take apart the conglomerate discount. Metro, including its debt, trades at merely 4.3 times expected 2017 EBITDA, compared to an average of 6.5 times for the wider European food retail sector. Focused consumer electronics retailers like Dixons and Darty - the latter having recently attracted dueling takeover approaches by rival Fnac and South Africa's Steinhoff - on average are valued at around seven times next year's EBITDA.

Some discount may be justified by concerns over Metro's Russian cash and carry business, which has been suffering from the weak rouble. Yet halving the valuation gap to standalone rivals would mean the food could be worth around Euro 9.6 billion including debt, while the consumer electronics division Media-Saturn could fetch around Euro 4.3 billion. Take off net debt of Euro 2.5 billion, and adjust for minority investors in Media-Saturn, and the group could have an equity value of Euro 11 billion - around a third above the company's market capitalisation on March 29. Divide and rule is a winning strategy.