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The Foolish Lunchbox
The ripples are spreading across the pond following Monday's mega-media marriage. This saw Internet access provider AOL (Nasdaq: AOL) propose to film, television and magazine giant Time Warner (LSE: TWX). This morning investors were particularly keen to see what impact Dixons (LSE: DXNS), 80% shareholder in AOL's leading UK equivalent Freeserve (LSE: FRE), thought the deal would have on its operations and strategy. This opportunity was granted as Dixons delivered interim results.
Since the electrical retailer spun off its fledgling Freeserve arm last July, long term followers of the stock have been trying to decide whether they should be concentrating on the cuckoo which has fled the nest or the old-style retail operations of old mother Dixons. Which is more important to the group? At noon today Freeserve is worth £4.8b, making its parent's 80% stake worth £3.84b. The total value of Dixons is £6.1b. Therefore, stripping this stake out, the remaining parts of Dixons' business are worth £2.26b.
The first half figures to the middle of November showed that the group had net funds of £403m at the end of the period. This was garnered from selling off 20% of Freeserve when it floated in July. Some £121m of this will be returned to shareholders via a special 25p-per share dividend, before a four-for-one stock split takes place. Take this cash away and the remaining retail operations -- the chain of Dixons and Currys shops, PC World stores and the Link mobile phone emporia -- are worth £1.86b.
Work out how these have performed lately and it should be possible to discover whether Dixons looks cheap or expensive relative to its retail peers. These latest sales figures reveal some of the picture. In the first half of their fiscal year the group made a £299.4m pre-tax profit on total turnover of £1.72b, up 17.8% from last time. However, this profit figure includes the one-off £219m received from the flotation of Freeserve and the £4.9m exceptional losses Dixons had to endure before performing this deft move. Take these away and underlying profits before tax rose 14% to £92.5m.
Looking at the retail operations alone, like-for-like sales improved 8% during this period to £1.68b. However, in the subsequent eight weeks to January 8th, the rate of like-for-like sales increase dropped to 5%. The market reacted adversely to this disappointing news, sending the shares down almost 15% to 1247p. This shows that retail gross margins slipped over Christmas. This trend looks likely to continue. Even though Dixons sells more and more electrical goods and gadgets as the tech-revolution sweeps consumers up in its tailwind, it makes less and less from these sales as margins are eroded.
Freeserve users can now surf the web and find bargains at QXL.com (LSE: QXL) and other bargain basement sites. More importantly they can buy direct from producers of these goods. Dixons must utilise Freeserve to make it the destination of choice for selling computer-related goods online. Otherwise people will begin to realise how over-priced the goods in Dixons' off-line shops are and margins will collapse at a higher rate. To this end it is reassuring that all computers sold in PC World come automatically linked up to Freeserve. Also today the group announced a £30m spend to beef up its e-commerce operation over the next two years.
Assume, with these declining margins, Dixons makes a similar full year profit before tax as it did last year of £186m. That puts the group's retail arm, worth £1.86b, on a forward price to earnings (P/E) ratio of just 10. That's pretty cheap for the sector, given that general retailers are on a historic P/E for the sector of 20. However, only really dominant players will succeed in the future as price deflation continues.
Dixons has a 20% market share in the UK. This will have to rise significantly to ensure it wins in the long run. PC World sales shot up 26% in the first half and sales at the Link levitated 43% on a like-for-like basis! So there is some hope here. What will be most interesting to watch going forward will be how Dixons capitalises on the Freeserve Frankenstein it has created without destroying its old-style existing business.
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Morning Movers
Dixons (LSE: DXNS) shares plunged 220p or 15.1% to 1240p as the market digested their interim results. Elsewhere on the high street Marks & Spencer (LSE: MKS) reported a 5.3% decline in like for like sales in the last fifteen weeks. This was not quite as bad as the market feared and the shares responded by rising 13.25p or 4.6% to 304p.
Whitbread (LSE: WTB) also updated investors on its latest trading saying it was in line with market expectations. Sales were reported to be increasing by a few per cent across its portfolio of leisure interests. The shares rose 11p or 1.8% to 630p as a result.
Sage (LSE: SGE) continues to gobble up US software companies providing similar packages. Today it was the turn of Best Software (Nasdaq: BEST). Sage made an offer of £270m and saw their own shares add 21.5p or 3.1% to 712p. The company also hinted that more acquisitions in the US were likely in the future.
Metal Bulletin (LSE: MTLB), publisher of the magazine of the same name, has broken its reputation of delivering reliable earnings growth. It predicted that this year's profits would be similar to last year's and its shares dived 205p or 12.4% to 1445p.
Over in the US, Yahoo! (Nasdaq: YHOO) found itself the centre of attention after it released some rather impressive fourth quarter results last night. Yahoo! can boast 120m unique visitors a year and 465m page views a day. But most interest was reserved for how Yahoo may react to the AOL Time Warner merger.
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