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Morningstar | Uny Deal Fairly Valued; Itochu Benefiting From a Strategic Perspective

The announcement of FamilyMart Uny Holdings, or FamilyMart, selling its 60% stake in Uny, its general-merchandise-store, or GMS, arm, to the discounter Don Quijote, or Donki, while injecting as much as JPY 212 billion to acquire a 20% stake in Donki came as a surprise. Despite the fact that we had anticipated FamilyMart’s divesture of Uny after it sold a 40% stake of Uny to Don Quijote in November 2017, the deal took place earlier than we had expected and the tender offer came as a surprise. It appears that FamilyMart/Itochu was concerned that Donki might turn to Seiyu if Walmart decided to divest its business in Japan and decided to accelerate its decision-making. We do not plan to materially change our fair value estimates of FamilyMart at JPY 8,000 and of Donki at JPY 5,600 as the deals look fairly valued.

The tender offer price at JPY 6,600 implies an 18% premium to our fair value estimate of JPY 5,600 and 19% premium to its closing price on Oct. 9 before Nikkei leaked the news. While the premium is below the norm of 20%-30%, we do not expect FamilyMart to raise its tender offer price. We had suspected that Donki’s founder Yasuda may tender his shares and FamilyMart’s management confirmed the possibility that it may borrow from Yasuda’s personal asset management firm owning a 14.7% stake if the tender offer fails. The borrowing will allow FamilyMart to purchase the shortfall from the market over an extended period of time, lowering the risk of overpaying for the shares.  Yasuda appears to own a 28%-plus stake in Donki.

On the other hand, the price of JPY 28.2 billion for the 60% equity in Uny appears to be fairly valued. The implied price/earnings multiple at 18.5 times on fiscal 2019 is within the range of multiples of other supermarket/GMS operators trading between high teens and low 20s. Given Donki’s reputation for not overpaying on deals, we believe that both parties agreed to the deals at their fair prices.

The acquisition of Uny will allow Donki to accelerate new store openings, particularly in Central Japan where Uny has a strong presence but Donki hasn’t fully penetrated. It also allows Donki to maintain domestic growth momentum and buy time to build its overseas presence. The tie-up will extend Donki access to Itochu’s overseas resources to accelerate expansion in Asia. Nevertheless, we consider Itochu the winner of the event from a strategic perspective.

Itochu will unload the undesired low-margin GMS business while building a new relationship with Donki. Donki immediately becomes a prospect of the new digital payment and marketing big data services that Itochu and FamilyMart appear to be considering launching. The big data analytics service is likely to developed through a royalty program. Given that FamilyMart/Itochu is catching up to peers 7-Eleven and Lawson/Mitsubishi in building its loyalty ecosystem system, acquiring an influential retail chain is more likely to ensure a successful launch of the new businesses largely relying on the scale.

Donki will convert 20 Uny stores into Donki/Mega Donki format per year over the next five years starting 2019 as it and FamilyMart had agreed before the deal announcement. While management claims that it will keep the rest of 90-plus Uny stores, we suspect a large number will be shut down once the rental lease expires. We have made no change in our forecasts in Uny as we have factored in Donki’s restructuring efforts with an average 3.5% operating margin compared with Donki’s 4% and Donki’s subsidiary Nagasakiya’s nearly 3% margins.

Donki plans to finance the Uny deal through borrowing, likely subordinated debt, the same as it did for financing the deal of the 40% stake. It has also registered to sell up to JPY 200 billion bonds although it was unclear whether the bonds will be used for the deal financing. Itochu’s tender offer is likely to be scheduled for early November and last for four to six weeks.