Dick Smith ASX debut flat, as experts predict a bumpy road ahead

Electronics retailer Dick Smith has debuted on the Australian Securities Exchange to a flat start, as analysts predict it will eventually settle around 50 cents under its starting price of $2.20.

Shares in Dick Smith Holdings gained 5.5% in trade yesterday, before falling back $2.20 by close.

IG Markets market strategist Evan Lucas told SmartCompany Dick Smith’s shares closed higher than he’d anticipated.

“I was actually expecting it to be slightly negative. Having a look at what’s going on in terms of how private equity has worked in discretionary stocks, it seems the market is concerned about these,” he says.

“There have always been concerns it will be another Myer.”

When Myer debuted on the stock exchange in 2009, under the direction of a private equity group, its issue price was $4.10, but by 2011 it had dropped to near $2.00. It is now trading at $2.79 and has struggled to get above $3.00 since early 2011.

Lucas says investors are worried Dick Smith will follow a similar path.

“Yesterday was a soft day on the market, but the question will always be if its numbers can be maintained like they expect them to be in the long term. I think it will drop to around $1.70,” he says.

Dick Smith was purchased by private equity firm Anchorage Capital in September last year from Woolworths for the small sum of $20 million.

The agreement had a catch, that Woolworths would collect a portion of the sale price when Anchorage eventually sold the business. Earlier this year, Anchorage paid Woolworths an additional $74 million to dissolve that agreement.

Even with the extra cash, Woolworths lost out in the transaction, as Anchorage received a healthy return on investment given its initial public offering saw the private equity firm bank $344.5 million yesterday.

Prior to lodging its prospectus in November, it had been projected Dick Smith’s IPO could have been worth up to $600 million.

But while its shares stayed flat yesterday, Lucas says the real test for Dick Smith will come around when it announces its first half earnings next year.

“It will be steady to begin with, but it will be interesting to see what happens with its first half profit numbers. That will be the first really key level for people to observe,” he says.

“At first they may go higher (than $2.20) on momentum… But the shares will respond to what’s actually happening. That will be when we see if it’s the new Myer, or if it will be looked after by Anchorage.”

Invast chief market analyst Peter Esho told SmartCompany Anchorage will need to adequately balance the need to reinvest in Dick Smith with keeping cash flow free, in order for it to be successful in the long term.

“We think it will need cash to reinvest in the business and it will have to come out of their cash flow,” he says.

“You have to look at the amount of free cash flow of the business after investment and how much investment will be needed in the next few years. There will be some pretty obvious challenges for Dick Smith.”

Esho says the reinvestment could negatively impact cash flow, but needs to be done to keep the business relevant and competitive.

“The successful retailers in the market are those who have managed to sort out this balance between earnings and cash flow,” he says, pointing to the strategies of JB Hi-Fi and Kathmandu.

Esho says stores which are cash flow positive and have a niche product are preferred by the market.

“They always trade at a premium, not because the market is excited about the product they sell, but because they appreciate a niche product and the balance between earnings and cash flow,” he says.

Esho says investors will be wary about Dick Smith because Anchorage is yet to invest heavily in the concept of the retailer. He says Anchorage has to back Dick Smith’s potential with investment.

“I’m not saying Anchorage didn’t invest anything, they obviously did and they took the risk, but a lot of investment is required in the next five years to stay relevant and competitive.”