QUALIPORT
Qualiport Sells DFS Furniture

By Maynard Paton (TMFMayn)
May 11, 2004

Following the announcement on Tuesday last week, the Qualiport disposed of its entire 236-share holding in DFS Furniture (LSE: DFS) the next morning. This article rounds off the portfolio's involvement with the sofa retailer.

Buy

This table summarises the Qualiport's investment return on DFS:

	(£)
Buy 236 shares at 458p (15/02/2002)	(1,080.88)
Sell 236 shares at 444.75p (05/05/2004)	1,049.61
Accumulated dividends of 47.55p	143.49
Return excluding costs	112.22
Dealing costs and stamp duty	(35.40)
Net return	76.82

During the two-year three-month holding period, the FTSE 100 recorded a 6% decline (with dividends reinvested but excluding costs). The DFS investment can therefore be deemed a minor success, and one that emphasised the importance of good dividends in a troubled market.

So why sell?

The decision to sell was made after DFS boss Graham Kirkham revised his 415p per share proposed offer for the company.

The terms of his new possible bid are:

* A takeout price of 435p per share;
* Plus the right to retain the forthcoming 7p interim dividend;
* Plus the proceeds from the ongoing 'Primback' VAT wrangle, which could be worth something between 0p and 40p per share.

But hold on -- wasn't the original 415p offer called 'derisory' back in March? It surely was. So why now accept a minimum of 442p, less than 7% higher?

The major reasons are:

1. The non-execs favouring the deal: "The Independent Committee believes that the terms of the proposed offer should be recommended to shareholders in the event that a firm offer is forthcoming and in the absence of a higher offer from another party."

Given that assurance, Kirkham is unlikely to raise his offer again.

2. No other interested parties: "The Committee notes that it has not received any approaches from other parties indicating a possible interest in making an offer for the Company."

Successful sofa selling is all about management talent. To justify a better price, any other bidder would have to bring in people just as talented as the present incumbents. That would be a difficult task, especially as Kirkham founded DFS 30-odd years ago and is probably the industry's most respected participant.

3. Waiting for Primback: "DFS shareholders will receive additional consideration equivalent to any amounts which the Company receives as a result of the ongoing litigation in relation to the Primback case (net of relevant tax and expenses). The aggregate gross amount under dispute in relation to Primback is in excess of £60 million (prior to the deduction of relevant tax and expenses)."

The maximum Primback distribution looks to be around 40p per share, equating to 9% upside on the Qualiport's 444.75p sale price. However, the case has dragged on for years and how the eventual appeal ruling will go, or how much VAT will be repaid to the company, is anybody's guess.

Primback frankly isn't worth the wait. It'll be months before the formal bid procedure (if it starts in the first place) winds up and shareholders get on the register for any litigation windfall. The portfolio has already effectively bagged Primback money worth 2.75p per share (a bird in the hand...) and the capital freed up could now make a better return elsewhere.

4. The proposal falls through: "The proposal is subject, inter alia, to due diligence and financing, thus there can be no certainty that any firm offer will be made."

A formal offer has yet to be made, so there's a slight chance the funding or due diligence paperwork throws up a terminal problem.

The real unknown is what would happen to Kirkham if the bid doesn't come good? Would he carry on as before? Maybe he'd lose his motivation? Or quit even? DFS isn't worth holding without Kirkham.

Anyway, no bid would mean shareholder attention diverted back to...

5. Poor trading: "This increase in competition combined with the prospects of higher interest rates means that conditions in our market will become even more demanding."

April's half-year results admitted the growing competition had caused underlying sales to contract by 3% and profits to slide 6%.

Debt (and mortgage equity withdrawal in particular) has underpinned consumer spending in recent years. If interest rates continue to rise, it's fair to assume discretionary spending will deteriorate. Big-ticket items such as sofas (the average DFS sofa goes for £1,500) will be the first to get hit.

6. Not a franchise: The news of poor trading brings another fact into focus: DFS does not have a great moat.

This is not a revelation of course. However, during the past two years, better long-term businesses have cropped up on the portfolio's radar. Sure, there's the boardroom experience at DFS, but that is nothing compared to the crocodile-filled waters surrounding many other companies on the Qualiport's watch list.

Summary

So that's it with DFS. Not the greatest of investment results, but recent events have provided the portfolio with an acceptable exit. The company had plenty of pluses, not least the simple accounts and mind-boggling returns on equity, but there was always that niggling doubt about its sustainable competitive advantage. Time now to move on.

Where next? DFS Half-Year Results | Kirkham's 415p bid: Derisory For Shareholders | Qualiport Buys DFS Furniture