Bloomberg

Wesfarmers has won board support for its record A$18.2 billion ($21.6 billion) cash and stock bid for Coles Group, Australia's second-biggest retailer, after promising to top-up the offer if its share price doesn't rebound.

The takeover was in danger of failing after Wesfarmers' stock plunged as much as 19 per cent from a record A$45.73 the day the deal was announced, wiping A$2.5 billion from the value of the offer. Wesfarmers yesterday pledged to give Coles investors more stock if its shares are trading at less than A$45 in four years' time.

Wesfarmers shares, which accounts for three-quarters of the value of the bid, have slumped on concern the Perth-based company is paying too much for Coles, whose profit growth has stalled. Rather than increase the offer now, Wesfarmers' chief executive officer Richard Goyder is betting he can revive Coles' fortunes and boost his share price. "This modification of our offer reflects our confidence in the value of the transaction to shareholders of both companies," Goyder said yesterday.

Coles shares rose A68c, or 4.8 per cent, to A$14.92 by early afternoon in Sydney. Wesfarmers shares rose A$1.17, or 3 per cent, to A$39.71. Coles shareholders will get A$4 cash, a 25c dividend and the rest in shares. Half the share component will be ordinary Wesfarmers stock, and half will be so-called price-protected stock. The price-protected shares, which will trade on the Australian Stock Exchange, will pay an annual dividend of at least A$2 each. If Wesfarmers shares are trading below A$45 in four years, owners will get free stock to make up the difference.

The sweetened bid is in the best interests of shareholders, Melbourne-based Coles said, citing a report by Grant Samuel & Associates. Coles did not release the Grant Samuel report, which was commissioned to assess if the bid was "fair and reasonable". The offer from Wesfarmers, whose businesses include mining and insurance, was valued at A$17.25 a share when it was announced July 2, based on the company's record stock price at the time.

The deal was worth A$15.22 a share at Tuesday's prices, which is below a A$15.25 cash offer Coles rejected in October as too low and "substantially" undervaluing the company. Coles owns 3000 stores including supermarkets, Officeworks stationery supply outlets, filling stations and the Target and Kmart discount department stores. Coles shares haven't traded at or above A$17.25 since the bid was made. Wesfarmers was the only bidder for Coles after buyout firms TPG and Kohlberg Kravis Roberts & Co. dropped out of an auction.

Goyder made the bid alone after his buyout partners, Permira Holdings and Pacific Equity Partners, withdrew just before the deadline for bids because of rising borrowing costs. Coles rejected a A$15.25-a-share cash offer from KKR in October as too low, instead backing CEO John Fletcher's promise to boost earnings 35 per cent. In February, the company put itself up for sale after giving up on Fletcher's forecast.

Deutsche Bank and Melbourne-based Lazard Carnegie Wylie are advising Coles. Wesfarmers is being advised by Gresham Partners and Macquarie Bank.

COLES chairman Rick Allert yesterday fired the starting gun for the group's big sell-off, confirming that a second consortium led by Kohlberg Kravis Roberts wants to buy the retailer and is prepared to outbid Wesfarmers' opening offer.

The official start of the bidding war confirmed the entrance into the race of KKR - a move widely predicted.  The six-member KKR-led consortium told Coles it was "confident" of matching or bettering Wesfarmers' $16.47 per share offer, providing it is satisfied with Coles's books. These are to be shown to suitors from as early as today.

The sharemarket, in particular hedge funds, appeared to be confident final offers will come in well over $17, with Coles shares closing yesterday at $17.33, up 36c from Thursday's closing price, and above Wesfarmers' offer.

Tyndall Investment Management fund manager Craig Young said he believed a bidding war was a "possibility", but not a certainty.

"Still, there's a big chance KKR will be the only bidder for the whole lot," he said, supporting market talk that Wesfarmers is only after the Officeworks and Target stores.

The news comes one week after Wesfarmers secured an 11.3 per cent stake in Coles, which owns a suite of supermarkets and petrol stations, as well as Officeworks, Kmart, Target, liquor stores and hotels.  The Perth group has since obtained control of 12.8 per cent of the retailer's shares, beginning with the purchase of 34 million shares from former chairman Solomon Lew.

He stands to make more money if the bid increases, thanks to an escalator clause in his contract with Wesfarmers, according to documents released to the stock exchange. For example, if the company is sold to a rival for $17.47 a share, Mr Lew will take home a further $17 million on top of the $659 million he has already made.

The retailer put itself on the auction block in February after admitting it was unable to generate ambitious profits promised in the wake of earlier offers by KKR.

Sources close to KKR yesterday said they were still nutting out a confidentiality deal with Coles which restricts it from making approaches to other potential bidders or buying shares.

The confidentiality agreement is a condition of entering the virtual data room.  The due diligence process is expected to take between four and six weeks, and will likely be followed by offers.  The Coles board will ultimately recommend one of the offers to shareholders, who will vote on the outcome.

Wesfarmers yesterday emphasised its offer was preferable because it was the only bidder able to offer Coles shareholders scrip in its company, which meant they could continue to profit from growth in the supermarkets, liquor, petrol and general merchandise stores.

It also appealed to investors' patriotism, saying its ownership would "ensure that Coles remains in Australian hands" and crowed that it could do a deal faster than any competitor.

"[Wesfarmers' offer] is not subject to regulatory impediments, ensures that Coles remains in Australian hands and can be implemented with minimum delay to avoid further damaging ownership uncertainty impacting on the Coles's businesses," chairman Richard Goyder said in a statement.