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Ellerine Holdings Ltd and Relyant Retail Ltd (56/LM/Aug04) [2005] ZACT 46 (5 July 2005)
.RTF of original document
COMPETITION TRIBUNAL
REPUBLIC OF SOUTH AFRICA
Case No: 56/LM/Aug04
In the large merger between:
Ellerine Holdings Ltd
and
Relyant Retail Ltd
______________________________________________________________
Reasons
______________________________________________________________
INTRODUCTION
1.
The Tribunal has been asked to approve the merger between Ellerines Holdings Ltd and Relyant Retail Ltd.
2.
The hearing took place on 7, 8 and 9 March 2005. The following witnesses were called:
1.
Mr Jeff Dritz, Executive Director of Ellerines
2.
Mr Bruce Sinclair, Chief Financial Officer of Relyant
3.
Mr Peter Squires, Chief Executive Officer of Ellerines
4.
Mr Aubrey Karp, Divisional Manager OK Furniture and House and Home
5.
Mr Peter Griffiths, Managing Director Steinhoff Africa: Furniture Division
6.
Mr James Moore, Managing Director of Poco International
7.
Mr Alan Schlesinger, Chief Executive Officer of Relyant
3.
We have decided to approve the transaction. The reasons for our decision are set out below.
THE TRANSACTION
4.
This is a horizontal merger. Both merging parties are active in the retail market selling furniture and home appliances. They each
trade through a number of retail brands directed at various income-based segments of the market. In addition, a number of vertical
issues are raised by the transaction. These relate to the relationship of Steinhoff, a major supplier of furniture, to the merging
parties.
5.
The primary acquiring firm is Ellerine Holdings Ltd (‘Ellerines’). It is a public company listed on the JSE Securities
Exchange. Ellerine’s shares are widely held and the company is not controlled by any single shareholder. Ellerines trades through
five primary branded retail chains:
•
Ellerines
•
FurnCity
•
Town Talk
•
Wetherlys
•
Osiers
6.
Ellerines, the oldest and strongest brand in the Ellerines Group, and Town Talk target the lower LSM categories. FurnCity targets
the middle LSM categories. Wetherleys and Osiers are targeted at the top end of the market. There are 310 Ellerines stores, 156 Town
Talk stores, 137 FurnCity stores, 11 Wetherley stores and 6 Osiers stores.
7.
Ellerines is well positioned in the bottom and high end of the markets with strong, well-known brands. Its weakness, however, lies
in the middle segment – as we shall elaborate below, it avers that although FurnCity is targeted at the middle segment of the
market it has never succeeded in differentiating itself from the more down-market Ellerines chains.
8.
The primary target firm is Relyant Retail Ltd (‘Relyant’), a public company listed on the JSE Securities Exchange. Relyant’s
largest single shareholder is Poco International, a German-based furniture retailer. However, a consortium of banks controls a very
large bloc of Relyant’s shares. Relyant’s shareholding structure is as follows:
Poco International
40,54%
First National Bank
26,28%
Absa Bank
15,67%
Standard Bank
5,08%
Investec Bank
5,00%
9.
Relyant operates through three primary divisions. These are referred to as the furniture chain division, comprising a number of retail
chains directed at the lower and middle segments of the market, a value retail division directed at somewhat higher market segments
and a services division. The distinction between the furniture chain division and the value chain division essentially corresponds
to the distinction between, on the one hand, customers who purchase furniture on credit extended to them by the retailers and, on
the other hand, cash customers. Relyant trades through the following brands:
•
Geen & Richards
•
Beares
•
Lubners
•
Savells/Fairdeal
•
Furniture City
•
Glicks
•
Dial a Bed
•
Mattress Factory
10.
Ellerines intends to acquire Relyant. This is a share-based transaction with Relyant shareholders receiving 10 shares in Ellerines
for every 225 shares in Relyant. Upon successful implementation of the proposed transaction Ellerines will control Relyant. The
share exchange will result in Poco International, currently the largest shareholder in Relyant, becoming the largest shareholder
in the merged entity.
11.
The largest shareholders in the merged entity will be:
•
Poco International
14.3%
•
First National Bank
10.11%
•
Public Investment Commissioners
9.98%
•
Investec
7.31%
•
Standard Bank
4.22%
•
RMB
4.12%
12.
The post-merger Board of Directors will comprise seven non-executive and four executive members. Two of the non-executive directors
will be appointed by Poco International. Mr P.J.B. Pohlmann, the current chairman of Relyant and of Poco International, will serve
as the non-executive chairman of the merged entity and the current chairman of Ellerines, Mr D.S. McGlashan, will serve as deputy
chairman of the merged entity. Mr P. Squires, the current CEO of Ellerines, will retain this position in the merged entity.
THE BACKGROUND TO THIS TRANSACTION
13.
The competition authorities have reviewed several transactions in the furniture retail sector. In July 2000 the Tribunal prohibited
a proposed merger of the JD Group and Ellerines. In essence, the Tribunal held that the merger would substantially lessen competition in that segment of the furniture retail market
that served low-income consumers. However, since the prohibition of the JD/Ellerines transaction, the competition authorities have
approved five important mergers in this sector, these being the Massmart/Furnex transaction, the First Rand/Profurn transaction, the JD/Profurn transaction, the Ellerines/Wetherlys transaction and the Lewis/Lifestyle Living transaction.
14.
Most of these mergers were approved on the basis that the merging parties were not active in the same market segment. The exception
is the JD/Profurn merger where the Tribunal was extremely concerned about the horizontal overlap between the merging parties. However, imprudent
credit granting by Profurn, aided and abetted by their largest shareholder, First Rand Bank, compounded by an economic downturn,
had brought Profurn to the brink of demise. The Tribunal was persuaded that, absent a merger, a significant part of Profurn’s
capacity would have exited the market. It accordingly approved the merger subject to conditions designed to address certain vertical
problems.
15.
The JD/Profurn transaction has proved to be something of a watershed in this sector. JD’s timing, whether a result of good fortune
or prescience, was brilliant. Aided by a significant economic upturn, JD’s considerable managerial resources have managed,
more rapidly and effectively than most observers believed possible, to turn around the struggling Profurn brands. In the process,
JD’s risk taking has been rewarded by its successful establishment of a portfolio of brands across the entire spectrum of LSM
profiles with particular strength in the middle-income segment of the market, generally designated as that segment of the market
serving consumers in the LSM 4-7 category. This, as we shall elaborate below, is particularly significant because, it appears, it
is precisely consumption in this segment of the market that has fuelled the strong economic upturn of recent years.
16.
This confluence of factors – the acquisition and rapid turnaround of Profurn, the particular strength acquired through this
transaction in the middle segment of the market, the economic upturn led precisely by consumers in this segment - has enabled the
JD Group to assume an increasingly powerful position in the furniture retail market. In short then, JD’s success, it is argued,
lies in its ability to serve, ‘from cradle to grave’, the increasingly large swathe of consumers who make up LSM 4-7.
In other words, in its ability to service, its customers through their purchasing life-cycle. In this consumer life-cycle, a powerful
position that is focused on the lowest consumer segments – LSM 3-4 – has diminished in importance because, it appears,
a number of factors, notably, easier access to cheaper credit, has enabled a significant grouping of low to middle-income consumers
to enter the consumer life cycle at a somewhat higher level than was hitherto possible and then to proceed somewhat more rapidly
up the consumer ladder. Hence from a consumer life-cycle perspective – or, expressed otherwise, from the critically important
perspective of ‘re-serving’ customers - it is the ability to satisfy consumers in the LSM 4-7 category that is crucial.
17.
The JD group is not alone in possessing this attribute. Certainly the Lewis group appears uniquely capable of capturing this large
grouping of consumers within the umbrella of a single brand, and the aggressive OK furniture chain is a growing presence in this
market.
18.
However it is argued that the venerable Ellerines group is left vulnerable in the face of these market dynamics. Although it continues
to outrank its competitors on most operational and financial measures, Ellerines’ future growth is threatened by its weakness
in the LSM 4-7 market. It pioneered the sale of furniture on credit to low income black consumers and this is where it is, for the
most part, mired as its customers and their progeny steadily migrate to stores in competitor chains that serve higher incomes and
aspirations. It has, through the acquisition of Wetherley’s, successfully located itself in the upper echelons of the furniture
market but its attempts, through the Furncity chain, to establish itself in the crucial middle segment of the market have met with
only limited success. Ellerines’ predicament is graphically described by Mr. Jeff Dritz, an Ellerines executive director, who
testified at the hearings:
“Ellerines sits like a body with legs and arms without the body in the middle..”
19.
The target company, Relyant is, for its part, a group with different problems and prospects. The group was formed as a result of the
merger of the Amrel and Beares groups, a merger that apparently bequeathed the new group a mixed legacy comprising a family of some
solid and well-established brands and a number of less salubrious relatives. The group attempted to solve its inherited problem by
closing down or repositioning some brands complemented by a programme of acquisitions designed to plug up gaps in the new group.
The upshot is that Relyant has, throughout its lifetime, been characterised by an excessive number of brands in its stable and by
what appears to be an almost permanent state of restructuring.
20.
In fact at the time of the JD/Profurn merger, in 2002, Relyant had embarked on a strategic review of its major brands. The upshot
of this review was inevitably a new strategy, the implementation of which required substantial capital. Shortly after the review
process was embarked on, Poco, a German-based furniture retail company looking for investments outside Germany, invested in Relyant. The implementation of the results of the strategic review came to a halt while Poco, which had acquired a 40% share of Relyant and
the chairmanship of the Board, attempted to negotiate more funding for the cash strapped Relyant with the banks, who collectively
held 49% of the shares. However, in late 2003 these negotiations, between Poco and the Banks, broke down. It appears that the banks
were able to hold up the restructuring of Poco both through their position as sources of loan capital as well as through their equity
shareholding and board membership. It appears that Poco offered to purchase the banks equity with the intention of de-listing the
company but this offer was rejected.
21.
In early 2003 the Relyant board had also appointed a new CEO, Mr Schlesinger, who was given the task of stabilising and turning around
the Relyant business. He was immediately tasked with reviewing the turnaround strategy that had been completed some time earlier.
In February 2004 management advised the Board that the identified strategy remained viable. They also suggested that a rights issue
for approximately R150 million should proceed to fund the process. Although the Board was not ad idem on the restructuring strategy in view of Relyant’s financial constraints, in March 2004 the Board approved the process and
tasked Schlesinger and Sinclair with seeking underwriting for the rights issue. However, they could not persuade the Banks to support
a rights issue.
22.
During the latter part of 2003 Mr. Theunie Lategan, a First Rand Bank employee and a member of the Relyant board of directors, introduced
Mr. Peter Squires, CEO of Ellerines, to Mr. James Moore, with a view to exploring an arrangement that would allow Ellerines to piggyback
on Relyant’s Triad credit control hubs. It was one of Ellerines stated objectives to improve its IT system. This came to nought
largely because Ellerines was anxious to ensure the confidentiality of its credit information and customer data. However, although
this process failed, the meetings did pave the way for Relyant and Ellerines to canvass a possible merger between the two competitors.
It is this transaction that is before us today.
THE RATIONALE FOR THE TRANSACTION
23.
This then is the rationale from Ellerines perspective for this transaction: it is principally interested in acquiring key Relyant
brands in the LSM 4-7 category. It believes that in the absence of this transaction Ellerines will be unable to penetrate this critical
market segment and that it will continue losing ground to its better placed competitors, notably, although not exclusively, the JD
Group. It has attempted to penetrate this segment of the market by developing its own brands. Its chosen vehicle for this task was
the FurnCity brand. However although FurnCity is by now a large and commercially successful chain, it has not effectively distinguished
itself from the Ellerines brand, it has not, in other words, succeeding in penetrating its target market. Ellerines argues that the
power of its flagship brand and its inextricable relationship to the lowest income consumer ‘taints’ all efforts to penetrate
higher income segments of the market – it suggests implicitly that to aspire to move into a higher consumer class has become
synonymous with moving away from those brands associated with Ellerines.
24.
Relyant, although, on every measure, the weaker of the two parties, does not suffer the same structural shortcomings as Ellerines.
It is reasonably represented across the LSM range and it has several strong brands in the all-important middle segment of the market.
Under the leadership of its current CEO and with the active participation of Poco, its largest shareholder, it has made enormous
strides from its parlous position of recent times although it has also been assisted by a favourable economic environment. But, while,
unlike Profurn, it is careful to disavow any prospect of failure, it insists that its turnaround has not been secured, that it remains
vulnerable to changes in the external economic environment and to several internal shortcomings. It believes that the turnaround
and rationalisation of its brands will be secured by access to Ellerines’ financial and managerial resources and its IT infrastructure.
25.
Moore describes the situation in which Ellerines and Relyant respectively find themselves as follows:
“At the moment Ellerines can’t do that because they don’t go high enough and we can’t do it now because we’re
not strong enough. … We haven’t got enough money…”
COMPETITION ANALYSIS
Relevant market
26.
As already suggested, in earlier transactions in this sector, notably the Ellerines-JD and the JD-Profurn transactions, the relevant
markets were determined by a three-fold segmentation of furniture consumers into a low-income category (LSM 3-5), a middle-income
segment (LSM4-7) and an upper-income segment (LSM8). For reasons which are exhaustively elaborated in these decisions, it was determined
that the geographic markets were national – that is, that these three relevant markets comprised national chains of furniture
shops and did not include locally-based ‘independents’. Without attempting to present the large body of evidence supporting
the conclusion on the relevant geographic market, it suffices to say that we were satisfied that the pricing and other competitive
strategies of the national chains were not responsive to the competitive behaviour of the independents.
27.
The parties to this merger have argued for a single product market, that being the retail market for furniture and appliances.
28.
As regards the geographic market, the parties insist that these are local and that the independents be incorporated into those local
markets in which they are active. The merging parties aver that the chains have regard to the prices of the independent furniture
stores, which act to constrain the market behaviour of the chains. They argue that the merchandise supplied by the independents is
the same as that supplied by the national chains, that they are located in the same part of town and that many offer credit on terms
much the same as the chains.
29.
In its assessment of the current transaction, the Commission argues that the dynamics of the furniture retail market lend support
to a new definition of the relevant product market. The Commission found that although certain practical indicia pointed towards
a lower, middle and upper segment in the furniture market, it is difficult to clearly and accurately distinguish between the different
LSM groups targeted by the various market participants. It found that certain branded stores targeted both the traditional lower
segment and middle segment customers. Accordingly, it defined a somewhat narrower relevant product market than the parties, as furniture
shops directed at credit sales excluding independent furniture shops and mass discounters.
30.
On the geographic market the Commission recommends maintaining the Tribunal’s earlier view that this is national. Although this
is opposed by the parties who continue to insist on local markets, the Commission points out that the very arguments advanced by
the parties in favour of this transaction – in particular the argument that scale economies represent a critical competitive
advantage in the retail furniture trade – emphasise the independents’ inability to compete effectively with the national
chains.
31.
This view of the relevant geographic market may not hold for the up-market chains, those like Wetherlys and Osiers and possibly Glicks,
who serve consumers in the LSM range 8-10. While it appears that the upmarket chains are also centrally managed, these generally
comprise a significantly smaller number of larger stores than in the case of their counterpart chains serving the lower LSMs. Accordingly
this segment of the market is not characterised to the same extent by the simultaneous existence of massive country-wide chains and
locally based independents that is a feature of the lower segment. This is consistent with the evidence that suggests that in the
upper LSMs the independents have a significant larger market share than do the independents competing with the giant chains in the
lower LSMs.
32.
We do not accept the Commission’s broad market definition. Clearly the distinction between the LSM categories remain an important
element in the furniture chains’ branding strategies. The fact that Ellerines acknowledges that it needs to compete in the
middle market, in order not to lose its entry-level customers when they migrate to higher LSM categories, evidences the continuing
segmentation of the furniture market and of the orientation of the retail brands. In fact Mr. Squires’ explanation for Ellerines’ failure to penetrate the ‘middle market’ – and Ellerines
consequent inability to achieve the status of what Squires terms a “universal chain” – rests on the continued salience of LSM-based segmentation. Mr. Dritz also refers to the different LSM categories that exist when he notes that: “low-end consumers aspire to brands targeting higher LSM groups”.
33.
However we do accept that the lower and middle-income segments of the furniture market have drawn closer together. The greater congruence
of these previously segmented markets has been promoted by no less significant a structural change than the emergence, for the first
time in the country’s history, of a black ‘middle class’. As already noted, the evidence suggests that this has
been facilitated by the significantly lower rates of inflation that have characterised recent years, the lowering of interest rates
and thus the effective decline in the cost of credit, and the emergence of new sources of credit notably the extension of credit
card facilities to the broad middle mass of furniture consumers. This is, undoubtedly, underpinned by the de-racialisation of mid-
and higher- level employment opportunities in both the private and, particularly, the public sectors and is likely complemented by
a greater sense of confidence amongst black consumers in the sustainability of these gains and, hence, in a greater willingness to
assume debt. But whatever the underlying cause of this break down in the historic segmentation of furniture consumers, certainly, a major imperative
of the furniture retail chains is to ensure that their stores provide for the possibility of a relatively seamless transition of
their customers from LSM 3 to LSM 7 or, ‘from cradle to grave’.
34.
We, therefore, find that this transaction covers two national product markets these being, firstly, the market for sale of furniture
to consumers in the LSM 3-7 and, secondly, the market for the sale of furniture to consumers in the LSM 8-10 categories.
